Taking clients or customers out for dinner or giving them gifts are standard ways for a small business owner to cement good relationships. Dealing with such expenses on your income tax return isn’t always a straightforward process.
The IRS has very different rules for how much money you can deduct for meals and entertainment, and how much you can deduct for gifts.
For meals and entertainment, the general rule is that you can deduct 50 percent of what you spend on restaurant dinners or taking clients to shows or sporting events — as long as the expense can be considered an ordinary and necessary part of doing business.
For gifts, you can deduct $25 per recipient per year. That means if you give one client two gifts for $25 each, or a total of $50, you can only deduct $25.
As is often the case with the tax code, there are a few loopholes and pitfalls to look out for.
With entertainment, for example, if you’re traveling or attending a trade show and take a client out for dinner, in that case you are permitted to deduct 100 percent of the check, said Bill Egan, a certified public accountant in Pittsburgh.
And if the entertainment is a company party for employees that you also invite clients to, then you can deduct the full cost of that event, Egan said.
Some of the pitfalls include the fact that you can’t deduct just any activity as entertainment. So dinner at a restaurant is deductible and a round of golf probably is, too. But Egan noted that events such as plays might not be.
You might find in such a situation that the examiner allows you to deduct half the amount of dinner before the show, but not the tickets. Of course, you can always appeal the examiner’s finding.
Another gray area is whether tickets to an event such as a baseball game or play that you give a client should be listed on your return as a gift or entertainment.
Egan said it might take a reading of some tax court rulings to figure that out. "I’ve read things going both ways," he said.
As in many other cases, your best course of action is probably to consult a tax professional.
Perhaps the most critical part of deducting meals, entertainment and gifts is documentation. Egan noted that you technically don’t need receipts for meals or entertainment that costs less than $75, but to be on the safe side, keep your receipts for everything.
Egan strongly advises business owners to immediately write on the back of the dinner check or ticket receipt the name of the client and to give specifics of what was discussed — for example, a particular project.
While the rules are specific, there are some ways to increase your deduction. Kroner noted, for example, that instead of sending one big gift to a client’s firm, send smaller ones. You can deduct only $25 for a $200 food basket, but if you send four $50 baskets, you can give yourself a $100 deduction.
Small Business is a weekly column on the topic by the Associated Press.
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