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Enjoy Glad Tax Tidings for Business Entertainment Deductions

Jan 6th 2015
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Did you entertain family and friends this past holiday season? Generally, you can’t deduct any expenses for such social gatherings. But you may be in line for deductions relating to business entertainment—if you meet the strict rules spelled out in the tax law.

For starters, you may deduct only those expenses that are “directly related to” or “associated with” your business.  Furthermore, the deduction for such expenses is generally limited to 50 percent of the cost (but more on this later).

As you will see, it’s more difficult to qualify for deductions for directly-related-to entertainment than it is for associated-with entertainment. To pass the directly-related-to test for entertainment expenses, including meals, you must show all of the following:

  • The main purpose of the combined business and entertainment was the active conduct of business.
  • You actually engaged in business with the person during the entertainment period.
  • You had more than a general expectation of getting income or some other specific business benefit at some future time.

However, if the entertainment takes place in a clear business setting and it’s for your business, the expenses are considered to be directly related to business. This might occur, for example, if your firm uses a hospitality suite at a convention to display its goods and you explain the benefits to potential clients while serving food and drinks. But this rule doesn’t help when you’re out on the golf course talking business with clients.

Conversely, entertainment is associated with your business if it relates to the active conduct of your business and occurs directly before or after a substantial business discussion. For this purpose, an expense is generally associated with the active conduct of business if you can show you had a clear business purpose for incurring the expense.

As the term implies, a “substantial business discussion” involves matters specifically relating to your business. There’s no definitive guideline for the “substantial” part, but it has to be more than just a casual mention.

Assuming you hold a substantial business discussion with a client and entertain the client before or afterwards, you can deduct 50 percent of the entertainment, including meals, even if you don’t actually discuss any business during the entertainment. This is the most common source of business entertainment deductions.

Other special rules may come into play. For instance, you can’t deduct club dues even if you entertain clients at your club before or after a substantial business discussion (although other qualified expenses may be deductible). If you give clients tickets to an athletic event or musical performance, 50 percent of the cost of the tickets may be deductible as associated-with entertainment under the general rules if you also attend. However, if you don’t go along, you may deduct the cost as business gifts instead, subject to a limit of $25 per recipient. And, when you’re entertaining clients, you can’t deduct any costs that are lavish or extravagant under the circumstances.

Did you throw a holiday party for employees and a smattering of clients and social guests? Naturally, costs attributable to clients are deductible only if you qualify under the associated-with rule, while amounts attributable to social guests are completely nondeductible. However, you can write off the entire cost attributable to employees as long as the party isn’t restricted to higher-ups.

In other words, you may deduct 100 percent of the cost of a party or other get-together for the whole staff despite the usual 50 percent limit.