The little piles of credit card receipts on the desks of many small-business owners can mean only one thing: They’re trying to figure out how much of their 2006 lunches, dinners and entertainment expenses can be deducted on their tax returns.
Meals and entertainment are a popular tax deduction with businesses. Under the tax law, a company can deduct 50 percent of the cost of meals and entertainment expenses that were incurred in the course of doing business.
But these are deductions that should be taken only with discretion. Accountants say the IRS is particularly wary of meal and entertainment expenses because of the possibility of abuse, and they believe the government is likely to question any numbers on a tax return that seem out of line.
Mark Toolan, a certified public accountant in Exton, Pa., said business owners need to ask themselves about each expense: “Is it reasonable, is it ordinary?” And, he warned, “it cannot be lavish.”
Toolan said a critical part of taking deductions for meals and entertainment is being sure you have the proper substantiation for each expense. That way, if the IRS does inquire about your expenses, you’ll be able to back up your claim.
The problem for many business owners is that record-keeping, while an important part of doing business, is something that can become slapdash while they’re trying to juggle everything else. “People try to overlook it, or do it after the fact,” Toolan said, recommending to owners, “do it as you go along” through the course of a year.
There are five essential parts to substantiating a meal or entertainment expense:
Credit card receipts or restaurant checks are an easy way to substantiate an entertainment expense, since they contain the date, amount and place. You’d still need to provide the rest of the information.
Many business owners also input their expense information into the software they use to keep their books – some expense-tracking software will also export the data into tax preparation applications. That’ll make the process easier during tax season – but you’ll still need to hold on to your receipts in case the IRS has questions.
What constitutes a deductible meal or entertainment expense is more complex. For a business to be able to deduct the cost of dinner or an event, it has to fall within the realm of, as Toolan noted, an ordinary and reasonable expense.
The easiest and most clear-cut example is taking a client out to lunch and discussing the services you’ll provide. The tab is certainly deductible. But if, for example, you own a dry cleaning business and take an average customer – who’s also a friend – out to a very expensive dinner, there’s a good chance it wouldn’t stand up to IRS scrutiny.
“It comes down to common sense. … There has to be a business purpose,” Toolan said.
Business owners also routinely take customers and clients out to the theater, to sporting events or to play a round of golf. It can be argued that there’s no business purpose to a baseball game, but if you can show you were talking about that deal you were trying to close between innings, it could be deducted. In compiling your records, you might want to go into some detail about what you and your client discussed.
If you have any questions about the deductibility of these expenses, you should consult a tax professional.
There are some instances where the line between entertainment expenses and business gifts can look a little blurred. For instance, if you give a customer tickets to an event but don’t go yourself, is that entertainment? Most likely the answer is no – it’s not entertainment unless you or one of your employees attends the event.
“If it’s entertainment, it typically involves the company, and a representative going out with someone,” Toolan said. “With a gift, typically, the company is not involved, and it’s pretty much an expenditure made on behalf of a customer with no pleasure on behalf of an employee” or the owner.
What if you bring a bottle of wine or food to a party given by a customer? Toolan suggests that’s probably a gift.
Gift deductions, by the way, have very strict rules – a business can deduct only $25 worth of gifts per recipient per year. You can, however, give multiple gifts to employees in one firm and deduct up to $25 for each.
Joyce Rosenberg writes about small business for The Associated Press.
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