As a self employed service professional, one of your main interactions with current or potential clients is one on one meetings over coffee, lunch, or a drink or two. Over the course of a year, this builds up to potentially a very large expense. You want to have this recognized as a real, legitimate cost to your business, but wait! Your tax preparer gets all strict and sniffy about where they were, who you were with, what you talked about, and whether you have receipts for these meals or not. What gives?
With these types of interactions ever on the rise, many businesses of all sizes would abuse this expense item – recognizing expenses where there weren’t any; calling fancy dinners with their spouses where business was briefly discussed, a business meal, and writing the whole thing off. To combat this, the IRS imposed tougher strictures on what counts as meals and entertainment, who is eligible to do these things with, and how much is actually deductible.
What counts as Meals and Entertainment?
Meals are easy – Any meal with an eligible person at which business is conducted – i.e. , where business is the main driver of the meeting, is able to be recorded and written off as a business expense.
Entertainment can be more tricky. Entertainment counts as any fun activity that the business pays for to the benefit of an eligible person. This can include taking a client or valued vendor to a ball game, sponsoring tickets to a show or concert, taking long term clients to a ski resort for a weekend, etc.
Who are these eligible persons you keep referring to?
The IRS deems a person eligible if they are connected to your business to some way, and are not yourself (the owner). This list includes, but is not limited to:
- Coaches/Professional Advisors
- Service Providers
What if I take my client or business partner out, and we spend the whole time talking about sports or our kids? That relationship building is still important!
Absolutely, those relationship building conversations are important, but that alone is not enough to qualify the meal as a business expense. The main purpose of the meeting must be business related for the IRS to allow the expense. This meeting should primarily be about the new house you are helping them to buy, a retirement or investment plan that you are putting together; whatever your service is, that should be the driver of the meeting. Kids, sports, and the weather should all be auxiliary topics on top of that.
What is actually deductible as a business expense?
The IRS allows you to deduct 50% of qualified meals and entertainment purchases from your business. Why 50%? The IRS will not buy you lunch. Ever. However, they do allow you to write off the half of the expense that was related to the person you met with.
The onus to make sure that all meals and entertainment purchases on your business credit or debit card is on you – Not your tax professional. The first instinct when reaching for a credit card should be towards your personal card as you settle the question of business vs. personal in your head. If a meals and entertainment expense cannot be proven to the IRS as legitimate, they may disallow the expense during an audit.
I am a Real Estate Agent, and throwing open house and marketing events is expensive – is 50% really all I can write off?
If you host and throw an event for potential clients and business related persons, you can capture 100% of the cost if it is treated as a marketing expense. For the food portion, the easiest way is to make sure the event is not held at a restaurant. If you purchase food for an event in a client’s home or an event space, it is far easier to prove to an auditor that it is a marketing expense, rather than a business meal. It is difficult to argue with the IRS as to why a restaurant or banquet bill should be 100% written off instead of 50%. If you pay a caterer to provide food, make sure the invoice specifies the event details for your records.
I travel a lot for work, and I need to eat. Are those meals 100% deductible as travel expenses?
No. Travel meals should be treated in the same way as meals at home. Again, the IRS will never buy your meal for you. If you conduct business related meals with eligible persons, you can deduct 50% as normal. If you are just paying for yourself, that meal should be a personal expense. The IRS can argue that you have the option of bringing your own food from home, and therefore will not allow personal meals to be deducted.
I like to meet clients and partners on the golf course – What of that activity is deductible?
Related to the idea that the IRS will not pay for your lunch, neither will the IRS pay for your golf club rentals or green fees. If you are sponsoring these costs for a client and yourself, it can be deducted the same as meals, but that receipt showing the detail becomes extremely important at that point. If you meet a client on the course or at the club, and the client pays their own fees, your fees are then a personal expense. If you pay for lunch for the two of you while you are at the course, that meal is 50% deductible like normal.
How to properly deduct business meals and entertainment?
Once you get into the nitty gritty of why the IRS allows or disallows meals and entertainment costs, the logic behind deciding whether something is a business expense or a personal one becomes easier. At the end of the year during tax preparation, your tax professional will add up all your meals and entertainment costs and create an adjusting entry to bring the amount down to 50%. To this extent, make sure that the costs are initially recorded at 100% of cost to avoid confusion.
Making sure that you accurately track and record expenses correctly as either personal or business is an important element of taking your tax destiny into your own hands. You can have a potentially large impact on the possible outcome and additional penalties of an audit if you pay attention to daily decisions like this one.