Meals & Entertainment

Because you are in the selling business, you may take business associates to lunch or otherwise entertain them. The cost can be a deductible business expense. However, certain conditions must be met before you can take a deduction for business meals and entertainment, and you generally can deduct only 50% of the cost. This section discusses those rules.

Meals. Include as meals the amounts spent on food and beverages and the taxes and tips on those amounts. Generally, no deduction is allowed unless you or your employee is present when the food or beverages are provided.

Entertainment. Include as entertainment any activity generally considered to provide entertainment, amusement, or recreation. This includes entertaining guests at nightclubs; social, athletic, and sporting clubs; theaters; sporting events; on yachts; and on hunting, fishing, and vacation trips or on similar outings. It can also include meeting your customers' personal, living, or family needs, such as furnishing a hotel suite or a car. However, see Not directly related, later.

Directly Related or Associated

To be deductible, meal and entertainment expenses must be ordinary and necessary expenses of carrying on your direct-selling business and you must be able to prove them as explained later under Proving Your Deductions. Unless certain exceptions apply, you must be able to show that they are "directly related" to or "associated" with the active conduct of your business.

For more information, see chapter 2 of Publication 463.

Directly related. For meal and entertainment expenses to meet the directly-related test, all the following must apply.

• You had more than a general expectation of getting income or some other specific business benefit from the expense.
• You engaged in business with the person during the meal or entertainment period.
• The main purpose of the combined business and meal or entertainment was the active conduct of business.

You do not have to show that business income or another business benefit actually resulted from each entertainment expense.

It is not necessary to devote more time to business than to the meal or entertainment. However, if the business discussion is only incidental to the meal or entertainment, it does not qualify as directly related.

Example. You are a direct seller of women's cosmetics. A state women's organization is holding its annual convention in a local hotel and you decide to display your products in a hospitality room in the hotel. You also provide entertainment and give out product samples. You can deduct the cost of the hospitality room and entertainment provided.

Not directly related. Generally, expenses are not directly related if you are not there or there are substantial distractions that prevent you from actively conducting business. The following are situations where there are substantial distractions.

1. A meeting or discussion at a nightclub, theater, or sporting event.
2. A meeting or discussion during what is essentially a social gathering, such as a cocktail party.
3. A meeting with a group that includes persons who are not business associates at places such as cocktail lounges, country clubs, golf clubs, athletic clubs, or vacation resorts.

You may prove the meal or entertainment is directly related by clearly establishing you had a substantial business discussion during the meal or entertainment.

When meals and entertainment take place on a hunting or fishing trip, or on a yacht or pleasure boat, the conduct of business is not considered the main reason for the combined business and entertainment unless you clearly show otherwise.

Associated. You can deduct meal and entertainment expenses that do not meet the directly-related test if both the following apply.

• The expenses are associated with your direct-selling business.
• The meal or entertainment is directly before or after a substantial business discussion.

An ordinary and necessary meal or entertainment expense is generally associated with your direct-selling business if you can show you had a clear business purpose for the expense. The purpose may be to get new business or to encourage the continuation of an existing business relationship.

Substantial business discussion. Whether a business discussion is substantial depends upon the facts and circumstances in each case. You must show that you actively engaged in a discussion, meeting, negotiation, or other business transaction to get income for your business or another specific business benefit.

The meeting does not have to be for a specified length of time. However, you must show that the business discussion was substantial in relation to the meal or entertainment. It is not necessary to devote more time to business than to the meal or entertainment and you do not have to discuss business during the meal or entertainment.

Business and nonbusiness guests. You must divide your entertainment expenses between business and nonbusiness expenses. You can deduct only the business part. If you cannot establish the part of the expense for each person participating, you can allocate the expense to each participant on a pro-rata basis. For example, if you entertain a group of 11 (including yourself)-three business prospects and seven social guests-deduct only four-elevenths of the expense.

Expenses for spouses. You generally cannot deduct the cost of entertainment for your spouse or for the spouse of a business customer. However, you can deduct these costs if you can show that you had a clear business purpose, rather than a personal or social purpose, for providing the entertainment.

Example. You entertain a business customer. The cost is an ordinary and necessary business expense and is allowed under the entertainment rules. The customer's spouse joins you because it is impractical to entertain the customer without the spouse. You can deduct the cost of entertaining the customer's spouse as an ordinary and necessary business expense. Furthermore, if your spouse joins the party because the customer's spouse is present, the cost of the entertainment for your spouse is also an ordinary and necessary business expense.

Lavish or extravagant expenses. You cannot deduct expenses for meals and entertainment to the extent they are lavish or extravagant. An expense is not considered lavish or extravagant if it is reasonable considering the facts and circumstances. Expenses will not be disallowed merely because they are more than a fixed dollar amount or take place at a deluxe restaurant, hotel, nightclub, or resort.

Your meals. Generally, you can deduct your business meal expenses while traveling away from home for business (other than lavish or extravagant amounts). However, if you entertain a business customer locally and the conditions discussed earlier are met, the cost of your own meal is deductible only to the extent the cost exceeds the amount you would normally have spent for personal purposes.

Limit

You can usually deduct only 50% of your unreimbursed business-related meal and entertainment expenses. The 50% limit applies, for example, to expenses you incur while traveling away from home on business (whether eating alone or with others), entertaining business customers at your place of business or a restaurant, or attending a business function, convention, or reception.

Taxes and tips related to a business meal or entertainment activity are included in the amount subject to the 50% limit. Expenses such as cover charges to a nightclub, rent for a room where you hold a dinner or cocktail party, or the amount paid for parking at a sports arena are subject to the 50% limit. However, the cost of transportation to and from an otherwise allowable business meal or entertainment activity is not subject to the 50% limit.

If you pay or have an expense for goods and services consisting of meals, entertainment, and other services (such as lodging or transportation), you must reasonably allocate the expense between the cost of meals and entertainment and the cost of other services. For example, you must make an allocation if a hotel includes one or more meals in its room charge.

Apply the 50% limit after figuring the amount that would otherwise qualify for a deduction. First determine the amount of meal and entertainment expenses that would be deductible under the rules discussed earlier. Then apply the 50% limit to figure the deductible amount.

Example. 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. You cannot deduct more than $30 (50% of $60).

Exceptions to the 50% limit are discussed in Publication 463.

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