The IRS has plenty of rules regarding deducting expenses from business income; one area that has plenty of rules is entertainment. While buying meals or taking clients to events is a great way to form a relationship with new and existing clients, entertainment is also the one area the IRS knows is rife with exaggeration and personal expenditures masquerading as business related.
That’s why Lucrum Consulting is placing a spotlight this month on the new entertainment tax reform laws, which went into effect at the end of 2017. Business owners will want to use the following rules as a guide to better understand what expenses remain deductible and which ones are now disallowed by the IRS.
Let’s start at the beginning
Before we break down the new Tax Act rules, let’s first understand what makes entertainment deductible. To qualify as a tax deduction, the main purpose of the entertainment must be to conduct business with a reasonable expectation of obtaining a specific business benefit from the event.
That means inviting a customer out to dinner and discussing their favorite vacation spots or sports teams is not a deductible entertainment expense. On the other hand, talks that focus on business plans, contracts or strategy would quality for an entertainment deduction. Keep in mind, there is no mention of how long the business discussion needs to be or that more time needs talk needs to be spent on business rather than entertainment, so exercise best judgement.
Business activities defined
So how does the IRS define a business meeting?
Be careful when considering a business fishing, hunting, or weekend golf trip. The IRS generally does not think that business is the main purpose when combined with some other clearly non-business activity. An exception is made for team-building or retreat type events such as a manager trip to the beach for strategic planning (with some incidental fishing) or a golf day as a reward for hitting certain goals within an organization.
One note regarding rewards: they may be considered compensation. While these incentives may be deductible to the business, they could be taxable to the employee. Also, any expense that is lavish or extravagant under the circumstances is not going to be allowed. Please consult a tax advisor for more details on these topics.
The new tax laws explained
While many of the tax laws remain relatively unchanged, such as office holiday parties, meals incurred while traveling on business and meals enjoyed with clients, there are several deduction changes that are worth mentioning. Read on.
Previously, tax payers could deduct 50% of expenses for event tickets or receive a 100% deduction on charitable event ticket purchases. Going forward, no deduction for either expense will be given, meaning business owners who pride themselves on treating clients to a Carolina Panthers game or philanthropic dinner will have to re-think their options.
In addition to client entertainment, meals provided to an employee at the business location or offered as a convenience to the greater business objective (think Lunch & Learn while training employees) will no longer be 100% deductible; instead that percentage will be cut in half beginning in 2018.
Another area reformed under the new law was fringe benefits. Businesses can no longer deduct the cost of employee parking and transit passes (although bike commuting reimbursements remain the same), and any achievement awards must be tangible personal property. In other words, no more swag items that include gift cards or vacations.
Document, document, document
One of the most important things to remember when considering an expense as a business deduction is documentation. Keep adequate records to prove the business purpose, the amount, date, place of the entertainment and the business relationship of the persons entertained.
There is no requirement to show that a business benefit really resulted from the entertainment expense, but this clearly will help the argument. Even the IRS would have a hard time arguing that a couple rounds of golf or lunches prior to making a big sale or landing that big client wasn’t a good investment.
Always make copies
All of the facts of the deduction must be considered in order to make the determination of whether the expense is deductible as entertainment. Keep copies of invitations sent out for a product demos, a company anniversary party or other communication that states there will be entertainment.
Trying to re-create substantiation of an expense a year or more after it occurred can be difficult, although this is one area where hindsight may be helpful. Likewise, repeated expenditures with a small group of folks (friends being called “prospects”) can have the opposite effect. Keep this balancing act in mind when considering what information should be required on an employee’s expense reports.
For more information on this topic, please visit the website IRS.gov and do a search on business entertainment expenses. Another resource is Publication 463 (Travel, Entertainment, Gift, and Car Expenses), which includes details about entertainment expense deductibility. And as always, ask Lucrum for guidance on your specific situation, or contact your tax professional for additional assistance.