Such concerns should not be an impediment to developing and growing your business, but you should know what happens to that expense as it goes on your tax return and how it affects your bottom line.
The first rule for any expense to be deductible from income tax is that it must be what the Internal Revenue Service (IRS) deems an “ordinary and necessary expense” to your business. This rule is primarily designed to keep those items more closely related to personal expenses from being deductible. For example, you can’t deduct the family’s holiday brunch on your tax return.
If your expenses pass the first hurdle of being ordinary and necessary, then the IRS Code allows for meal and entertainment expenses to be deducted at 50 percent. The expenses are defined as “food or beverages and any item generally considered to be entertainment, amusement or recreation.”
This is generally referred to as a “limitation” on your deductibility of these types of expenses. However, before you can deduct anything, the IRS also requires you to meet recordkeeping requirements.
You must be able to provide “documentary evidence” such as receipts and expense reports that contain the amount and description of the expenditures; the time, date and place the entertainment or meal was provided; the business purpose of the activity; and the business relationship to the person entertained.? In addition, tax regulations require the original receipt for expenses more than $75.
100 percent deductible
No rule would be complete without exceptions and this rule has many. To list all in this article would not be possible, so contact your tax professional with specific questions or to obtain a more comprehensive list.
The most pertinent expenses where meals and entertainment are entitled to a 100 percent deduction include the following:
1. Meals provided for the convenience of the employer. One of the most common areas where meal costs are mistakenly subjected to the 50 percent disallowance is when meals are provided on the business premises for the convenience of the employer.
The term “convenience of the employer” is defined as when a meal is provided for mandatory business meetings, required overtime to complete a project or when employees are encouraged to stay on the business premises and not take time away for meals.
2. Expenses treated as compensation. Another scenario to achieve 100 percent deductibility is when the amounts paid by the employer are included as compensation to the employee. In this case, the employer is able to take a compensation deduction for amounts paid, which is not limited to 50 percent, and the employee would have these amounts included as income on the W-2 and also on the personal income tax return.
Expenses paid or incurred by a non-employee when performing servicesfor a company under a reimbursement agreement are not subject to the 50percent deduction limitation.
3. Recreational expenses foremployees (such as golf fees at a company party). Similar to theprevious exception, expenses for recreation or social activities usedprimarily for the benefit of employees are not subject to the 50percent deduction limitation.
The purpose of the limitation is not to penalize employers forproviding social and recreational activities for their employees, butto prevent lavish client meals from being subsidized through taxdeductions.
4. De-minimus (insignificant) amounts of food or beverage. The IRSdefines a de-minimus fringe benefit as property (meals in this case)where the value is so small that keeping track of it is nothing morethan a burden. In this situation, the 50 percent disallowance shouldnot be applied.
When looking at this rule, you must consider both the frequency andvalue of the benefit.? For example, providing an employee an annualbenefit worth $1,000 would probably be too high in value; similarly,providing an employee’s bus fare every day may not be too great invalue, but would be too frequent.
An example of a qualifying benefit could be a refrigerator stocked withsoda or water that employees occasionally drink during company meetingsand events.? The administrative burden to keep track of when and howmuch employees consume falls within the description of being “overlyburdensome” and the benefit derived from these beverages is relativelysmall.? Therefore, the IRS has allowed an exception to the general ruleand these types of expenses are fully deductible.
Examine prior returns
You can save tax dollars by taking a closer look at your company’smeals and entertainment expenses.? Much of this work can beaccomplished through adjustments to your internal accounting systemthrough more detailed and accurate data entry.
In addition, it may be possible to re-examine prior tax returns andidentify any of the many statutory exceptions that were missed.
All of this can lead to larger deductions, less tax liability and moremoney in your pocket.? As in all cases, the use of a tax professionalin this complex area is highly encouraged.