What Business Entertainment Expenses are Deductible?
Entertaining customers is part of the sales function of many businesses. And paired with meal expenses, entertainment expenses are often considered a package. After all, we have to eat while we are being entertained. Meals and entertainment are a legitimate business expense. But because these expenses can be misused and mixed up with personal expenses, the IRS keeps a close eye on them in audits.
The 2017 Tax Reform Law made some drastic cuts to entertainment expenses and many entertainment expenses are no longer deductible. Beginning with the 2018 tax year, here's what has changed:
- Business lunches are still deductible at 50%. So, a businessperson or salesperson can take a client to lunch to discuss business and an employee eating lunch while traveling are still deductible.
- But taking a client or customer to an "experience" is no longer deductible. For example, a box at the ballpark, tickets to a concert, or a golf outing with clients is not going to be deductible. To be clear, expenses for entertaining clients are no longer deductible as business entertainment expenses.
What Is Required to Deduct Entertainment Expenses?
Businesses can deduct expenses for the entertainment of customers, business associates, and employees, if the business owner can show that the expense was:
- an "ordinary and necessary" business expense, and
- if the expense meets the direct test, directly and specifically business-related.
Look at these requirements a little closer:
First, expenses for entertainment must be ordinary and necessary business expenses. That is, the IRS says the expense must be common and accepted in the trade or business and helpful and appropriate for the business. An expense does not have to be required to be considered necessary.
To be deductible, Showing either that the event was held in a business setting (an office, for example), or that there is a clear business purpose to the entertainment, business was discussed, and that the objective was income or business benefit.
The new tax law also allows a company to deduct expenses for entertainment for the benefit of employees, except for highly compensated employees.For example, your company picnic or holiday party for employees can meet the test. A catered meal for employees at your office or elsewhere at your business location for the purpose of presenting employee awards would also probably be deductible as a business expense and it would be 100% deductible. But the main purpose of a hunting or fishing trip can't be directly tied to your business.
Those expenses have never been, and continue not to be, deductible.
Entertainment Expenses vs. Advertising and Promotion Expenses
If your business entertains the general public for the purpose of advertising or promotion, this cost is fully deductible as a business expense.
For example, if a children's clothing store pays for the expense of hiring a clown at a community event, that might be considered promotion rather than entertainment.
How to Deduct Business Entertainment Expenses
To deduct business entertainment expenses, you must be able to prove the business purpose (under the applicable test as described above) and
- the amount of each expense,
- the date and place of the entertainment, and
- the business relationship of the persons entertained.
Without this proof, the IRS can disallow this expense (take it off your tax return).
Some entertainment expenses are fully deductible. A company event at which employees are invited is deductible at 100%. Travel to and from an entertainment event is 100% deductible.
Non-deductible Entertainment Expenses
Some entertainment expenses are not deductible at all.For example, if you attend an entertainment event while you are traveling for business, this entertainment will probably not be deductible.
Also, if you attend an entertainment event while you are considering business locations or investigating a business, you cannot deduct the event as entertainment if you don't start the business.
And "lavish and extravagant" entertainment is never deductible. And in case you are wondering about entertaining clients on your yacht, the IRS probably won't allow a deduction for the purchase of the yacht, but it might allow the entertainment costs.
Self-employment and Entertainment Expenses
If you are self-employed (not an employee of a corporation), your deductible entertainment expenses are not subject to the 50% limit if all of the following conditions are met:
- These expenses are related to your work as an independent contractor
- You are reimbursed or given an allowance for these expenses in connection with the services you perform, and
- You provide adequate records of these expenses for your customer or client.
Keeping Records of Business Entertainment Expenses
As with other business expenses, you must keep careful records to show how the entertainment passes either the direct test or the associated test. The best record is contemporaneous (at the time), stating the specific business purpose.
For example, noting on the bill from a caterer and your note on the bill that the purpose was the company's annual holiday party would be helpful.
For More Information
Read more about recordkeeping requirements for business expense deductions.
For more detailed information on entertainment expenses, see IRS Publication 463. Check to make sure you are looking at the 2018 version, which includes the new tax law provisions.
Disclaimer. The information and examples in this article should not be considered to be tax advice. The new tax law is complex and every business situation is unique. Before you deduct any business expenses, check with your tax professional.