When we are in entertainment mode, we take pride in buying a round of drinks for our friends. However, you should not forget the receipt and remember who is partaking in the round. If you are buying drinks for a client or prospective client, the IRS has and always will request documentation for your meals and entertainment (M&E) expenses. Professionals who serve the automotive industry build relationships with customers primarily by entertaining. Such expenses must be both ordinary and necessary in carrying on a trade or business before they can even be considered as a deductible expense. An ordinary expense is one that is common and accepted in a trade or business. A necessary expense is one that is helpful and appropriate for the business. There are three steps to consider in order to deduct the round you purchased.
An Ordinary and Necessary Expense
First, if an expense qualifies as ordinary and necessary, it must then meet one of the following tests:
Directly related test
The main purpose of the expense was the active conduct of business
The taxpayer engaged in business during the entertainment period
The taxpayer had more than a general expectation of generating income or obtaining another business benefit at some future time
The expense must be associated with the active conduct of a trade or business
The entertainment must be provided directly before or after a substantial business discussion
M&E Expense Deductibility
Second, the percent of the deductibility of the M&E expenses falls into one the following three categories:
100% Deductible - A few examples:
Meals consumed while working overtime
Lunch or dinner meetings for the convenience of the employer
Company holiday party
Excess over FMV of tickets to charitable fundraising events
50% Deductible - A few examples:
First $25 for client/customer gifts
Taking employees to lunch/dinner
Meals related to conferences and seminars for employees
Meals at networking events
FMV of tickets to charitable fundraising events
100% Non-deductible - A few examples:
Cost in excess of $25 for client/customer gifts
Personal expenses, which include taking your family to a sporting event
Internal Revenue Code (IRC) §274
Lastly, we need to have adequate record of the expense under IRC §274, which includes the following:
The receipt and amount
The time and place
The business purpose
The business relationship to the taxpayer of any person entertained
Please do not miss out on an expense due to an administrative matter. These steps are important to prevent IRS scrutiny of a valid business expense.
If you have further questions regarding the deductibility of M&E expenses, please contact Steve Barber.
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