When are Meals & Entertainment Expenses 100% Deductible?
Taking out customers, vendors or potential employees for a meal and some entertainment is a great way to build your business. In addition, meals and entertainment for business purposes are legitimate business tax deductions but there are limits on what you can deduct.
Taking these deductions for meals and entertainment is a three-step process:
First, you must verify these expenses are legitimate business expenses.
- The expenses must be “ordinary and necessary” business expenses
- The expenses must meet one of two tests:
- The directly related test applies if you can show that the main purpose of the activity was business. For example, if you are meeting with clients in your office, meal expenses during the meeting would probably meet the “directly related” test.
- The associated test applies if the expense is associated with (along with, in conjunction with) a “substantial” business discussion. For example, if you had a meeting with clients at a restaurant and then you take the clients to the theater, this might satisfy the “associated” test.
Second, you must have the documents to back up the deduction. You don’t need to include these documents in your business tax return, but you will need them in case of an audit.
Finally, you must determine if you can take the full amount as a deduction or if the amounts are subject to the “50% rule”
Here are the details:
How to Deduct Meal Expenses
You may deduct 50% of costs for business meals, whether you are just going to lunch with a customer or traveling out of town. The two ways to determine meal costs are:
- Actual costs for meals
- Use the standard IRS meal allowance
With either method, you must still keep your receipts and track actual costs. You can find the standard meal allowance (called the “Meal and Incidental Expense” rate (M&IE) for most major U.S. cities in IRS Publication 1542 (Per Diem Rates) (PDF)
How to Deduct Entertainment Expenses
If you entertain clients or customers, you may deduct up to 50% of these costs. Be sure to keep good records on who was present, the dates and times, and the reasons for the entertainment and business discussions that took place. I would suggest you write these items on the back of the receipt
SUMMARY OF EXCEPTIONS TO SEC. 274(a)
Sec. 274(e)(2), Expenses treated as compensation. Expenses treated as compensation paid to an employee or otherwise included in the gross income of the recipient of the meal or entertainment. Example: An employer may fully deduct its reimbursement of meals consumed by an employee during a job-related move. The reimbursement is included in the employee’s income and isn’t deductible as a moving expense. Code Sec. 217(b)(1) and Sec. 82.
This section also includes meals when the meal is the nature of a tax-free fringe benefit under Code Sec. 132(e). Other exceptions include:
- An employer-operated eating facility is a de minimis fringe if it is located on or near the employer’s business premises, and its revenue normally equals or exceeds its direct operating costs.
- An employer may fully deduct the cost of supplying on-premises meals if the meals are tax-free to employees under Code Sec. 119.
- Supper or supper money provided occasionally so that the employee can work overtime.
- Food or beverage expenses of crews of certain drilling rigs and crews of certain commercial vessels but not fishing vessels.
- Traditional recreational expenses for employees.
Sec. 274(e)(1), Food and beverages for employees. Expenses for food and beverages (and facilities used in connection therewith) furnished on the business premises of the taxpayer primarily for his employees. Example: Coffee and other free beverages.
Section 274(e)(3), Reimbursed expenses. If the accountable plan requirements are met, the employee can fully exclude the reimbursement for his or her own meal or entertainment. It is the employer who can only deduct 50% of the meal’s cost under Sec. 274(n) and Reg. § 1.62-2(h)(1). NOTE: The deductible percentage of meals for certain transport workers (e.g., air transport employees, truck and bus drivers, railroad employees) while away from home during or incident to the period of duty subject to the hours of service limitations of the Dept. of Transportation is 80% versus 50%.
Sec. 274(e)(4), Recreational, etc., expenses for employees. Entertainment-type rewards, such as occasionally give out theater or sporting event tickets, are all tax free de minimis fringe benefits, Reg. § 1.132-6(e)(1). Example: Items such as holiday meals or an annual company picnic and extends to expenses for recreational, social, or similar activities (including health clubs) are exempted if they are primarily for the benefit of employees, other than employees who are highly compensated individuals within the meaning of Code Sec. 414(q).
Sec. 274(e)(5), Employee, stockholder, etc., business meetings. Expenses incurred by a taxpayer which are directly related to business meetings of his employees, stockholders, agents, or directors.
Sec. 274(e)(6), Meetings of business leagues, etc. Expenses directly related and necessary to attendance at a business meeting or convention of any organization described in section 501(c)(6) (relating to business leagues, chambers of commerce, real estate boards, and boards of trade) and exempt from taxation under section 501(a) .
Section 274(e)(7), Items available to public. Expenses for goods, services, and facilities made available by the taxpayer to the general public.
Sec. 274(e)(8), Entertainment sold to customers. Expenses for goods or services (including the use of facilities) which are sold by the taxpayer in a bona fide transaction for an adequate and full consideration in money or money’s worth. Example: Cost of meals sold by a restaurant or daycare provider.
Sec. 274(e)(9), Expenses includible in income of persons who are not employees. Expenses paid or incurred by the taxpayer for goods, services, and facilities to the extent that the expenses are includible in the gross income of a recipient of the entertainment, amusement, or recreation who is not an employee of the taxpayer as compensation for services rendered or as a prize or award under Sec. 74 .
The Take Away: Business owners and taxpayer should understand the exceptions to the 50% meals and entertainment rules of 274(a) by reading 274(e) and 274(n). The business’ general ledger should capture the various exceptions to the 50% disallowance rules of Sec. 274(a).