The deductibility of entertainment expenses is often seen as a perk of business ownership.
Going out to dinner with a colleague? Spending thousands on a country club membership? No problem – you can just deduct it on your company's annual income tax return.
But from the IRS' perspective, every entertainment deduction means less money in their coffers. So not surprisingly, the IRS has tightened up its rules about entertainment expenses over the years. Business owners are still permitted to deduct certain entertainment expenses on their tax returns, but the IRS is watching closely to make sure the expenses you claim are legitimate and fall within deductibility guidelines.
The days when business owners can claim full deductions on pricey entertainment junkets that have little business value are over. Although we advise all business taxpayers to consult with their tax preparer on the deductibility of entertainment expenses, here are some of the general restrictions and allowances that apply to business tax returns.
IRS Entertainment Expense Rules
IRS rules stipulate that entertainment expenses are only deductible if they are "ordinary" (common in your trade or business) and "necessary" (helpful and appropriate for your business), and meet one of two tests: (1) Directly-related test or (2) Associated test.
For the directly-related test you must demonstrate that the main purpose of the entertainment was to actively conduct business and that you had more than a general expectation of receiving income (or other benefits) as a result of the entertainment. The associated test requires you to demonstrate that the entertainment was associated with the active conduct of your business and that it occurred either directly before or after a substantive business discussion. Both tests are predicated on the notion that you have a legitimate business reason for participating in the entertainment that is being expensed.
What expenses are deductible?
The IRS defines entertainment as activities that provide entertainment, amusement, or recreation. Deductible expenses can include the cost of hosting business guests at entertainment venues, sporting events, theaters, combined pleasure and business trips, meals, etc. However, it's important to note that some entertainment expenses (e.g. meals) may be subject to a 50% deductibility limit and other restrictions may apply.
What expenses aren't deductible?
Club dues and membership fees (e.g. country club fees) are not deductible as entertainment expenses. Likewise, expenses for spouses and other entertainment-related costs may not meet IRS deductibility requirements.