Taking a customer to lunch, dinner or the theater is part of doing business. And often, a lot of fun. But company owners may find that claiming such entertainment expenses as income tax deductions is complicated, and maybe painful.
Many owners find out when they're compiling their income tax returns that they can't deduct the full amount of a meal or event. Maybe they can't deduct any of it.
IRS Publication 463, Travel, Entertainment, Gift and Car Expenses will give you a good grounding in deductions for entertainment expenses. And, as with any tax matters, it's always a good idea to consult a tax professional like an accountant or an attorney to be sure you're following the rules.
Here's an overview of what the IRS allows, and doesn't allow, for business entertainment deductions:
WATCH OUT FOR UNPLEASANT SURPRISES
If you took your client out for a $300 dinner and consoled yourself with the idea that at least you got a big deduction, the truth is, you can claim only $150 on your return. The tax code allows only 50 percent of an entertainment expense to be deducted.
And, if $300 would be considered a lavish expense considering the line of work you're in and where your company is located, the IRS might limit how much of the check you can deduct. The amount the government allows will still be subject to the 50 percent rule.
Let's say the meal takes place during a business trip. While your airfare and hotel bill may be fully deductible, only half of the restaurant check can be claimed.
WHAT'S THE REAL REASON YOU'RE ENTERTAINING CUSTOMERS?
It's so common for business associates, especially when they're friends, to get together for dinner or a drink and compare notes about how things are going. Or ask each other for advice. But according to the IRS, the bills for these occasions can't be deducted.
In order to claim an entertainment deduction, the government requires that the main purpose of a dinner or other form of entertainment be "the active conduct of business." And an owner must have "more than a general expectation of getting income or some other specific business benefit at some future time."
In other words, if you're getting together just to network with a client or add some goodwill to the relationship, it might not pass the IRS' test. If you talk about a specific project or contract, you've got yourself a deduction.
Here's an exception: If the entertainment takes place before or after a business discussion, then you can deduct it. So let's say you make a presentation to a client and then go out to dinner and you don't discuss business during the meal. It's still deductible.
It's common for owners to bring their spouses and a customer's spouse to a big night out. Unless the spouses are an essential part of the business discussion, their meals and/or tickets aren't deductible.
TICKETS AND GOLF GAMES
If you take a customer to the theater or a baseball game, the same rules generally apply. But there can be exceptions, and that's why you need to read Publication 463. For example, if the ticket is to an event that will benefit a charitable organization -- local golf tournaments are often held for charitable reasons -- then you can deduct the full amount.
Many business owners will treat clients to a round of golf at the club they belong to. The fees they pay for a guest are deductible. But yearly or monthly membership dues for the club are not.
RECORDS, RECORDS, RECORDS
Many accountants say the biggest problems their clients have with entertainment expenses is that they don't keep good enough records. Many have a pile of receipts and credit card statements at the end of the year. But that won't be good enough for the IRS if it questions your deductions.
The government and tax professionals recommend that business owners keep a log or diary where they can enter their entertainment expenses. That's where you need to keep track of the business purpose of the meal or other event. If the expense is more than $75, you also need restaurant checks, hotel bills and other receipts to document the amount you're claiming.