Business entertainment deductions can be complex
NEW YORK -- Taking a client out for lunch is one of the most basic business activities there is. And it's one that can run a business owner afoul of the IRS.
The agency is on the lookout for companies that take excessive deductions, or that try to bundle together personal and business expenses. Barbara Weltman, author of "J.K. Lasser's Small Business Taxes," said this has been one of the most litigated areas in tax law.
What follows is a basic look at the deduction for entertainment expenses. Anyone who wants to claim the deduction should read IRS Publication 463.
Defining entertainment: Most commonly, people think of entertainment as business meals, or taking clients to the theater, a sporting event or a nightclub. But the IRS has rules that can limit the deductions for most forms of entertainment. For example, you can probably deduct the costs of playing golf with a client but not your membership fees at the club.
50% rule: A business owner who spends $5,000 a year on business meals and theater or sports tickets isn't going to get a tax windfall. Weltman said a big mistake is that owners don't realize they can only claim half of their expenses. So $5,000 becomes $2,500 on a return and the savings are considerably less.
If your entertainment seems too lavish, the IRS might put a limit on how much you can claim. It might question your deductions as employees review your return. Or it might challenge expenses during an audit.
Meals: There's an old joke about two business people who want to deduct the cost of their dinner out. "How's business?" one asks. "Don't ask," is the reply. So, they move on to talk about anything and everything else, confident that they've satisfied the deduction rules.
The IRS doesn't think it's funny. Although many owners deduct the cost of any meal with a business associate, the rules require that the main purpose be "the active conduct of business." Moreover, an owner must have "more than a general expectation of getting income or some other specific business benefit at some future time."
But the IRS does allow a deduction if a meal takes place directly before or after a business discussion. It may turn out that despite your best efforts, you couldn't cut a deal. You can still deduct it.
Tax professionals warn that owners should keep careful records. Weltman suggests a detailed diary.
That's the ticket: Deducting the cost of tickets to events can be tricky. For example, if you get the tickets through a broker, you can only deduct half the face value. But if you buy tickets to a sporting event that benefits a charitable organization, you can deduct the full amount.
If you decide to give the tickets to your client rather than go yourself, the IRS gives you a choice to treat it as entertainment or as a gift. Do the math. Businesses are limited to deducting $25 per gift per person in a tax year. So if you gave a $100 ticket as a gift, you can deduct $25. If you treat it as entertainment, you could deduct $50.
If the tickets are to be considered an expense, you'll have to engage in a business discussion before or after. If you decide to go, you must treat it as entertainment.
Who's who? Often business associates are friends. And many owners are inclined to deduct the cost of entertaining these friends but it has to be legitimate, Weltman said. If your client brings a significant other along, chances are you can only deduct what you spend on your client. But if it's an event where everyone brings a mate, it might be acceptable. In any case, consult a professional.
