Entertainment Expenses

You may be able to deduct business-related entertainment expenses you have for entertaining a client, customer, or employee.

You can deduct entertainment expenses only if they are both ordinary and necessary (defined earlier) and meet one of the following two tests.

1. Directly-related test.
2. Associated test.

Both of these tests are explained in Publication 463.

The amount you can deduct for entertainment expenses may be limited. Generally, you can deduct only 50% of your unreimbursed entertainment expenses. This limit is discussed later under 50% Limit.

Club dues and membership fees. You cannot deduct dues (including initiation fees) for membership in any club organized for:

1. Business,
2. Pleasure,
3. Recreation, or
4. Other social purpose.

This rule applies to any membership organization if one of its principal purposes is either:

1. To conduct entertainment activities for members or their guests, or
2. To provide members or their guests with access to entertainment facilities.

The purposes and activities of a club, not its name, will determine whether or not you can deduct the dues. You cannot deduct dues paid to:

1. Country clubs,
2. Golf and athletic clubs,
3. Airline clubs,
4. Hotel clubs, and
5. Clubs operated to provide meals under circumstances generally considered to be conducive to business discussions.

Entertainment. Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation. Examples include entertaining guests at nightclubs; at social, athletic, and sporting clubs; at theaters; at sporting events; on yachts; or on hunting, fishing, vacation, and similar trips. You cannot deduct expenses for entertainment that are lavish or extravagant. If you buy a ticket to an entertainment event for a client, you generally cannot deduct more than the face value of the ticket, even if you paid a higher price.

Gift or entertainment. Any item that might be considered either a gift or entertainment generally will be considered entertainment. However, if you give a customer packaged food or beverages that you intend the customer to use at a later date, treat it as a gift.

If you give a customer tickets to a theater performance or sporting event and you do not go with the customer to the performance or event, you have a choice. You can treat the cost of the tickets as either a gift expense or an entertainment expense, whichever is to your advantage.

You can change your treatment of the tickets at a later date by filing an amended return. Generally, an amended return must be filed within 3 years from the date the original return was filed or within 2 years from the time the tax was paid, whichever is later.

If you go with the customer to the event, you must treat the cost of the tickets as an entertainment expense. You cannot choose, in this case, to treat the cost of the tickets as a gift expense.

Separating costs. If you have one expense that includes the costs of entertainment, and other services (such as lodging or transportation), you must allocate that expense between the cost of entertainment and the cost of other services. You must have a reasonable basis for making this allocation. For example, you must allocate your expenses if a hotel includes entertainment in its lounge on the same bill with your room charge.

A meal as a form of entertainment. Entertainment includes the cost of a meal you provide to a customer or client, whether the meal is a part of other entertainment or by itself. A meal expense includes the cost of food, beverages, taxes, and tips for the meal. To deduct an entertainment-related meal, you or your employee must be present when the food or beverages are provided.

You cannot claim the cost of your meal both as an entertainment expense and as a travel expense.

Taking turns paying for meals or entertainment. If a group of business acquaintances take turns picking up each others' meal or entertainment checks without regard to whether any business purposes are served, no member of the group can deduct any part of the expense.

Trade association meetings. You can deduct expenses for entertainment that are directly related to, and necessary for, attending business meetings or conventions of certain exempt organizations if the expenses of your attendance are related to your active trade or business. These organizations include business leagues, chambers of commerce, real estate boards, trade associations, and professional associations.

Additional information. For more information on entertainment expenses, including discussions of the directly-related and associated tests, see chapter 2 of Publication 463.

50% Limit

In general, you can deduct only 50% of your business-related meal and entertainment expenses. (If you are subject to the Department of Transportation's "hours of service" limits, you can deduct a higher percentage. See Individuals subject to "hours of service" limits, later.)

The 50% limit applies to employees or their employers, and to self-employed persons (including independent contractors) or their clients, depending on whether the expenses are reimbursed.

Figure 28-A summarizes the general rules explained in this section.

The 50% limit applies to business meals or entertainment expenses you have while:

1. Traveling away from home (whether eating alone or with others) on business,
2. Entertaining customers at your place of business, a restaurant, or other location, or
3. Attending a business convention or reception, business meeting, or business luncheon at a club.

Included expenses. Expenses subject to the 50% limit include:

• Taxes and tips relating to a business meal or entertainment activity,
• Cover charges for admission to a nightclub,
• Rent paid for a room in which you hold a dinner or cocktail party, and
• Amounts paid for parking at a sports arena.

However, the cost of transportation to and from a business meal or a business-related entertainment activity is not subject to the 50% limit.

Application of 50% limit. The 50% limit on meal and entertainment expenses applies if the expense is otherwise deductible and is not covered by one of the exceptions discussed later in this section.

Does the 50% Limit Apply to Your Expenses?

The 50% limit also applies to certain meal and entertainment expenses that are not business-related. It applies to meal and entertainment expenses incurred for the production of income, including rental or royalty income. It also applies to the cost of meals included in deductible educational expenses.

When to apply the 50% limit. You apply the 50% limit after determining the amount that would otherwise qualify for a deduction. You first determine the amount of meal and entertainment expenses that would be deductible under the other rules discussed in this chapter.

Example 1. You spend $100 for a business-related meal. If $40 of that amount is not allowable because it is lavish and extravagant, the remaining $60 is subject to the 50% limit. Your deduction cannot be more than $30 (.50 � $60).

Example 2. You purchase two tickets to a concert and give them to a client. You purchased the tickets through a ticket agent. You paid $150 for the two tickets, which had a face value of $60 each ($120 total). Your deduction cannot be more than $60 (.50 � $120).

Exceptions to the 50% Limit

Generally, business-related meal and entertainment expenses are subject to the 50% limit. Figure 28-A can help you determine if the 50% limit applies to you.

Your meal or entertainment expense is not subject to the 50% limit if the expense meets either of the following exceptions.

Employee's reimbursed expenses. If you are an employee, you are not subject to the 50% limit on the amount of expenses for which your employer reimburses you under an accountable plan. Accountable plans are discussed later under Reimbursements.

Individuals subject to "hours of service" limits. You can deduct a higher percentage of your meal expenses if the meals take place during or incident to any period subject to the Department of Transportation's "hours of service" limits. The percentage is 60% for 2001, and it gradually increases to 80% by the year 2008.

Individuals subject to the Department of Transportation's "hours of service" limits include the following persons.

1. Certain air transportation workers (such as pilots, crew, dispatchers, mechanics, and control tower operators) who are under Federal Aviation Administration regulations.
2. Interstate truck operators and bus drivers who are under Department of Transportation regulations.
3. Certain railroad employees (such as engineers, conductors, train crews, dispatchers, and control operations personnel) who are under Federal Railroad Administration regulations.
4. Certain merchant mariners who are under Coast Guard regulations.

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