Updated: Nov 5
Another Misinterpreted Tax Deduction
Many business owners use every possible means they can in order to save on taxes, and understandably so. For instance, if a business owner is allowed to deduct money spent on themselves, their employees, clients, or future clients, why not do so? Putting the money to use that way is easier to swallow than sending it off to the government. However, many are misinformed about how certain deductions work, and how to use them. One major one that comes to mind is “meals and entertainment.”
In the past this was considered a qualified deduction, with some stipulations and guidelines of course. But starting in the tax year for 2018, the deduction is no longer allowed. This is one example of constantly changing tax laws, and how staying informed and up to date is of utmost importance when running a business. Using company money to fund tickets to a ball game with a client is no more (for now).
What does the IRS consider to be “entertainment”? According to IRS Pub 463, “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. Entertainment may also include meeting personal, living, or family needs of individuals, such as providing meals, a hotel suite, or a car to customers or their families.”
Exceptions to the rule
It seems that almost with every rule there come a number of exceptions along with it. Two that stand out to me in this category are:
Recreational expenses for employees such as a holiday party or a summer picnic would be excepted.
Entertainment sold to customers. For example, if you run a nightclub, your expenses for the entertainment you furnish to your customers, such as a floor show, aren’t subject to the nondeductible rules.
Knowing the rule is one thing, but knowing the exceptions, and how to use them is what can help one still capitalize on legitimate deductions. Maybe the tickets to the game are not deductible, but the food and beverages that are bought separate during the game can be.
While meals are still a qualified deduction, there have been some changes to the rule and a few exceptions that a normal taxpayer may not know. Before we get into that though, lets cover the basics.
In general, the deduction for meals is limited to 50% of the expense, which applies to the taxes and tips related to the meal as well.
The owner or an employee must be present for the meal.
The food and beverages must not be considered “lavish or extravagant.”
The meal can be provided to a current or potential customer, client, consultant, or other similar business contact.
With that said, according to the Pub 463 mentioned earlier, the meals purchased separately during a sports game, are not considered entertainment, and therefore may be deducted (at 50% of course). In addition, there are some exceptions where 100% of the meal deduction is allowed. For instance here are two exceptions where the 50% limit does NOT apply.
Recreational expenses for employees. You aren’t subject to the 50% limit for expenses for recreational, social, or similar activities (including facilities) such as a holiday party or a summer picnic.
Advertising expenses. You aren’t subject to the 50% limit if you provide meals to the general public as a means of advertising or promoting goodwill in the community. For example, neither the expense of sponsoring a television or radio show nor the expense of distributing free food and beverages to the general public is subject to the 50% limit.
Knowing what is and what is not allowed can be a constant challenge. Everyone wants to deduct what they can to help save on their tax bill, but it’s important to use deductions correctly so if an audit were to happen, you can still sleep well at night. Many of our clients ask us things that they have heard from friends and family that are just blatantly wrong. It makes us wonder how certain ideas get spread about tax laws and how so many run with the idea. Don’t take it at face value, do some research.
And if you need help preparing your individual or small business taxes, let’s talk. Paying a professional to provide accurate advice can save you money in the long run, along with having a lot less stress in your life. In addition, often times when people are trying to save money doing their taxes themselves, they miss many other qualified deductions and credits that if they had paid to have it done professionally, they would have been returned more money on their tax refund than with the money “saved” going the DIY route.
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