As April 15 approaches, businesses are faced with a major challenge: They not only need to communicate their tax returns to the IRS, but also their previous year’s profits. Small businesses, self-employed individuals, and freelancers need to take the cash inflow and outflow principle into account when calculating their profit. But what exactly does this mean? This guide will help you through this...
Entertainment expenses – make the most of the tax incentives
Parties, meals, celebrations, social events: these things are an integral part of the day to day life of many businesses. Being surrounded by food and drink so often makes for the perfect setting for constructive business discussion as well as a more relaxed occasion for employees to congregate. For entrepreneurs, business dinners are an important means of winning clients, finalizing contracts, and maintaining current client relations. When it comes to paying these company entertainment expenses, a company can benefit from various tax incentives – as long as you fulfill the necessary requirements.
What are business entertainment expenses?
The IRS has clearly set out what counts as a deductible entertainment expense. According to them, entertainment refers to any activity that has the aim of providing entertainment, amusement, or recreation, which of course includes meals provided to a customer or client. This includes things like service charges, coat room fees, nightclub entrance, etc. However, they also make sure to outline the two different sorts of company entertainment expenses that exist: directly related and associated. These two variants are named “tests”:
- The directly related test means that the main purpose of the entertainment was to actively conduct business, which was engaged in during the course of the event and that you had an expectation of gaining future income or another business specific benefit as a result of the entertainment.
- The associated test is where there are still clear business purposes for organizing the event, or that the event took place immediately before or after a substantial business-related discussion. The IRS recognizes ‘before or after’ as usually meaning on the same day but is also willing to make exceptions to this rule if enough proof is supplied. Substantial, in this case, means that it involved one or several discussions on a business transaction or some other activity that is specific to your company. It is worth noting that these IRS guidelines do not specify how long an event needs to take.
To what extent are entertainment expenses tax deductible?
The directly related and associated tests mentioned above are crucial when it comes to determining which tax, as well as how much tax, is applicable to the company entertainment expense in question. The meal or event in question needs to have involved some sort of business discussion or purpose, otherwise, it is in no way a deductible item on your tax report. Usually, with an entertainment expense, it’s the case that it is 50 percent deductible. However, there are some situations where a business entertainment expense can be 100 percent deductible. These include:
- If a meal is provided on the premises of the employer and if more than 50 percent of employees are catered for by said meal
- If it’s a promotional activity that is also made available to the general public as well
- If you purchase tickets to a charitable fundraising event
Who can be invited to a company entertainment event?
With a business dinner, it is imperative that there is as at least one person present who is not an employee of the company. Otherwise, this makes it an employee dinner/party—something that needs to be handled quite differently when it comes to filing taxes. Although such events usually involve a current or potential business partner, it is not explicitly stated by the IRS that this needs to be the case. It could also be an event involving the likes of:
- Public officials
- Tax authority auditors
Along with these external guests, it is also possible to invite employees who can support you during this business endeavor. When it comes to making tax deductions, these employees can only be considered as another guest. The cost of their meal, drinks, etc. can only be seen as a 50 percent deduction and not a business expense that is 100 percent deductible.
With such occasions, the client feeling at ease and comfortable should be a priority for you and you should not hesitate to invite additional guests. For example, if a client or business partner brings their spouse to a meal then the cost of their food, drinks, etc., this is also tax deductible. Furthermore, this will allow you to bring your spouse or significant other and have their entertainment expenses deducted as well. The same thing applies to children, i.e., if your guest brings their children then you can also bring yours and these costs will also be 50 percent deductible. However, it is crucial that your client’s extra guests are present, otherwise, you cannot include your spouse, children, etc., in your tax deductions. This is the case even if your spouse is your significant other is your business partner or even a client.
Although it might seem like an obvious thing to say, in order to claim the expenses, you yourself need to be present at the event. In the past, people have bought event tickets for clients with the hope of being able to write them off as a business entertainment expense. Purchases like this are actually only subject to the ‘gift expense’ deduction, which is $25.
Up to what value amount are entertainment expenses deductible?
Whether you are organizing a business dinner or a staff party, it’s important to keep an eye on the overall cost of such an event. The IRS not only checks out the reason for expenditures like this, it also checks the amount that has been spent. This is very important when it comes to tax deductions. You must make sure not to spend an excessive amount on these events otherwise the IRS will start to ask questions regarding the extravagant amount of money spent.
Whether the respective company entertainment expenses are suitable for tax deductions, this is something that has to be assessed on an individual basis using the criteria and tests mentioned above. In order to avoid nasty surprises, it is also probably worth calculating and budgeting for the cost of such entertainment events in advance. This should also allow you to make all the right preparations regarding taxation, paperwork, etc.
Entertainment expenses: proof is everything
Regardless of whether it’s a simple dinner, a Christmas party, or special occasion (anniversary, etc.), it’s possible to save a lot of money through tax deductions. This money can then be invested in other aspects of the company. It is of utmost importance that the expenses are comprehensively and correctly documented and that all the required paperwork is available. Otherwise, this will lead to complications with the authorities later.
Of course, it is important for you to have a suitable accounting system and to be aware of where and how details on entertainment expenses need to be booked. Equally important is that you fill out the right paperwork and hang onto the correct documents in order to prove the expenditures that have been made. Exactly how to go about dealing with entertainment expense receipts can be read about in these articles.