It's common knowledge that there's a cap on deductions for business meals and entertainment: Winers and diners get to deduct only 50 percent of their expenses. But it can be a little unclear about what is and is not included in the 50 percent category. For example, besides meal and entertainment charges, expenses subject to the ceiling include meal- or entertainment-related taxes and tips, cover charges for night club admissions, room rentals for dinners or cocktail parties and parking at sports arenas.
However, transportation to and from business meals, such as cab fares to restaurants or theaters, is not subject to the limit.
For instance, the charge for a business meal comes to $100, comprising $80 for food and beverages, $6 for sales taxes and $14 for tips. The limit on the deduction is $50, half of $100. However, cab fare to the restaurant of $10, including tip, is 100 percent deductible.
But what about using your home to entertain clients, customers, or other business associates? That's permissible, but whether you have at-home gatherings to keep clients or woo new ones, you should be up to date on stringent rules for business-entertainment deductions.
Like other kinds of meals and entertaining, home entertaining has to satisfy either of two requirements: It must be "directly related" or "associated with" the active conduct of business; and there has to be a substantial and bona fide business discussion directly before, during, or after the dining or entertaining. However, IRS regulations make an important exception when you're host to business guests from out of town: They allow you to deduct entertaining that takes place the day before or after the business discussion.
Even though the event takes place in your home, you don't have to limit your write-offs to modest home-cooked meals for yourself and your business guests. It's still possible to host catered affairs at your home before or after business discussions, invite a few friends, and deduct 50 percent of your qualifying expenditures.
However, even though you're not stuck with tuna casserole, home-entertaining expenses must be reasonable. IRS regulations mandate disallowance of deductions for entertaining deemed "lavish or extravagant" under the circumstances. Examiners realize that hosting a first-class bash isn't necessarily lavish or extravagant, but might be a tad skeptical when your explanation for uncorking a $400 bottle of wine is that it enabled you to sell $1,000 worth of equipment. But they will nod agreeably if the merrymaking helped you to land a mega-bucks account.
How to Avoid Problems
Here's an example: you're involved in a business venture with Ennui Enterprises. Four Ennui executives come to your office for an afternoon business meeting. Afterward, you invite them and their spouses to a gathering at your home. Also on the guest list are five other couples, who are your good friends and have no business connection. So, counting yourself and your spouse, a total of 20 people attend the affair.
Because the party directly follows a business discussion, it passes muster as deductible "associated with" entertainment. And just how much do you get to deduct for the party? You get no deduction for expenses attributable to those five couples who aren't business guests, and you are subject to a cap of 50 percent on the remaining expenditures. Assuming the party's total cost runs to $1,600, the allowable deduction is $400—50 percent of $800, the amount left after the total cost of $1,600 is reduced by the $800 allocated to those five couples who are social, as opposed to business acquaintances.
Make a list of all the guests and your business relationship to them, the purpose of the function, what you bought for the party and how much it cost. Other evidence: Invitations and thank-you notes from guests. Granted, the true cost might be impossible to prove; still, the more details you are able to furnish, the more likely that the IRS will allow a reasonable deduction.
Keeping good records in the first place is the best way to avoid audit problems. And, if you forget to write down your expenses, you might forget them by the time you file your return.
Working Around the 50 Percent Rule
Some kinds of home entertaining sidestep the 50 percent rule, according to Code Section 274. It doesn't impose the 50 percent cap when you use your home to host social gatherings for employees—Christmas parties or summer picnics are some of the standard get-togethers. At that kind of socializing, business doesn't have to be discussed before, during or after the event.
The Section 274 regulations specify that there's a full deduction only for an affair that's open to employees generally—the rank and file, not just the top execs or other higher-ups.
Finally, there's another hurdle if you're an employee and aren't reimbursed for your entertainment expenditures. You have to include those unreimbursed outlays with other miscellaneous itemized deductions, such as return-preparation fees, on Schedule A of Form 1040. Most miscellaneous expenses are allowable only to the extent that their total in any one year exceeds 2 percent of your adjusted gross income.
About the author:
Julian Block writes and practices law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator) and an attorney. More on this topic is available from " Julian Block's Year Round Tax Strategies", available for Kindle at Amazon.com and as a print copy at julianblocktaxexpert.com.
About Julian Block
Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes” (Wall Street Journal), and “an authority on tax planning” (Financial Planning magazine). More information about his books can be found at julianblocktaxexpert.com.