Many business owners entertain clients, colleagues, potential sources of new business. Networking and building relationships is often critical, and few things help build a relationship like a shared meal or a joint social event.
But those activities can also be expensive and can greatly impact your bottom line - unless you have an effective plan, and you know how the tax code works. The meals and entertainment expense deduction changed significantly with the passage of the Tax Cuts and Jobs Act (TCJA) in 2017. The deductibility rules are in effect between 2018 and 2025.
Under the old rule you were allowed to deduct the cost of meals or entertainment that have a bona fide business purpose. A bona fide purpose includes meals or entertainment with clients, prospects, referral sources, and business colleagues. The new tax law eliminates nearly all deductions for entertainment expenses and several additional requirements for meal expenses.
Under TCJA most business entertainment expenses incurred after December 31, 2017, are considered 100% nondeductible, with the exception of expenses incurred for the benefit of employees (e.g., office holiday parties), which remain 100% deductible. The list of nondeductible entertainment expenses under TCJA include:
- Night clubs
- Cocktail lounges
- Country clubs
- Golf and athletic clubs
- Sporting events
- Vacations and similar trips, including such activity relating solely to the taxpayer or the taxpayer’s family
A number of entertainment related expenses are not affected by the new tax law. For example, an employee working overtime can be provided with dinner money that’s 100% deductible. Or, cars used for trade or business, even if used for personal reasons such as driving to and from work.
Meals are still 50% deductible as long as they aren’t “lavish or extraordinary.” Why can you only deduct 50% of the cost? The IRS assumes you would eat, even if you didn’t have a business purpose for the meal, so they compromise and meet you halfway on the expense.
You will need to meet several requirements to claim a business deduction for a meal. First, the meal must occur during the taxable year for the business. The business owner or an employee must be present during the meal and the client must be a current or potential client previous clients are not allowed. If a meal is part of an entertainment activity (i.e., a sporting event), you must have proof the meal was purchased separately from the cost of the entertainment event. Business meals occasionally provided to employees for the convenience of employers used to by 100% deductible. Under TCJA, they are now 50% deductible.
You can deduct 50% of meals at your place of business, at a separate venue, or even at your home. To do so, they must have a necessary relationship to your business activities. Expenses must be closely related to your business to be deductible.
- Additional examples of business meals that are 50% deductible:
- Meals for business meetings of employees, stockholders, agents, and directors
- Any meal during business travel
- Meals at a convention, seminar, or any business meeting even if the meals cost is not separately stated from the cost of the event.
- Business related meals with clients, customers, and vendors as long as there a business purpose
- Office snacks or beverages provided for employees on the business premises
To claim any deduction, you need to prove two things: What the expense was for and that the expense was in fact paid for. In other words, you can’t fake a receipt or invoice. What qualifies: Receipts or invoices with a description of the item/service and its cost, canceled checks, and credit card statements and/or receipts.
If you are audited and do not have records of a certain expense but it seems obvious you must have incurred the expense (like, for instance, you ordered and received business cards but aren’t able to find the invoice), the IRS will typically estimate the amount of your expenses. But why estimate - and possibly miss out on deductions - when you can keep accurate records and deduct everything possible?
Certain expenses are subject to special documentation rules mostly because the IRS feels these expenses lend themselves especially to, well, cheating. If you don’t have accurate records these expenses are likely to be disallowed:
- Expenses for travel away from home (including meals and lodging)
- Meal expenses
- Business gifts
- Automobile and other transportation expenses
- Cell phones, computers, and other items that can be easily used for entertainment or recreation
For anything in the list above you will need receipts for expenses over $75. For lodging you need receipts even if the cost was less than $75.
You must substantiate the expense by showing the amount, the time and place, and the business purpose. For meals and allowable entertainment expenses, you must identify the business relationship of the persons involved. An easy way is to simply write names and purpose(s) on all your receipts.
Note: The IRS does not require you to keep a contemporaneous - in other words, completely up to date - record of your expenses. On the other hand, if you save receipts and make notes about time, place, participants, and purpose, your records will be as accurate as possible - and the likelihood is greater the IRS will accept them at face value. Recreated documentation looks and feels recreated and raises a red flag for an auditor. Plus, if you systematically record your expenses, you can ensure you do not let any items slip through the cracks, allowing you to maximize the use of deductible expenses.
So, act like a reporter but, instead of "who, what, when, where, why and how," make a record of:
- How much?
- What was the business purpose?
- What was the business relationship of the participants/recipients?
As always contact a tax advisor for tax deductibility information.