The IRS tells us that a business can deduct expenses that are “ordinary and necessary” and directly relate to active conduct associated with the taxpayer’s trade or business. In layman’s terms, that means there must be a valid business purpose for a purchase to qualify as a deductible expense. While meals and entertainment may meet the IRS’s definition of a business expense, the caveat is that this expense is also related to personal consumption. It’s a fundamental income tax principle that items used for personal consumption are not deductible – i.e., everyone has to eat no matter what their trade is – but what if a personal expenditure also passes the IRS’s “ordinary and necessary” test for your business activity? How can you know what is and isn’t a tax deduction? In the case of meals and entertainment (M&E), the IRS has decided to meet businesses halfway – literally. More specifically, the IRS has allowed for a 50% deduction for meals and entertainment that meet the business deduction test. But before you pick up that tab for lunch with that 50% deduction in mind, there are a few rules to consider:
How should you substantiate your deduction?
You must be able to demonstrate that the M&E expense is “ordinary and necessary” and be able to prove that the expense was related to your trade’s active conduct or business activity. To do this, you must retain the receipt for your M&E expense along with a record stating who the meal was with and the business purpose of that meal. In the event of an audit, the IRS may ask for these records to validate your M&E deductions, so good record keeping is essential for any business owner.
What types of expenses are included in the 50% M&E deduction?
The most common type of M&E expenses are client business meeting and meetings with co-workers. This can include events such as lunch with co-workers or clients, golf outings to develop client relationships, and meals with vendors. Some other expenses that meet the 50% M&E deduction can include out-of-office meals while traveling and reimbursement for meal expenses for an employee on a business trip which is not included in the employee’s compensation.
What type of expenses are excluded from the 50% M&E deduction?
Any time that you eat out alone and you are not traveling you are ineligible for the 50% deduction. Just because you decided to eat out instead of bring your lunch to work doesn’t mean you can claim your meal - that’s a non-deductible personal expense. However, if you are out of town on a business trip eating alone or with others, you qualify for the 50% M&E deduction.
Are there any types of M&E expenses that are fully (100%) deductible?
There are some opportunities for taxpayers to claim a 100% deduction. While it is not possible to provide a complete list of every exception, some of the more common examples of fully deductible M&E expenses include meals for the occasional in-office meeting, meal expenses incurred while attending promotional seminars or trade shows, and M&E expenses incurred for social or recreational purposes, such as holiday parties or company picnics. The IRS also allows a business to fully deduct the cost of food provided to employees on the business premises, which can include coffee, snacks, bottled water, and similar items.
Conclusion
It’s important for any business owner or manager to develop a method to manage the day-to-day M&E expenditures. From establishing a meal allowance or a per diem plan, to keeping records and establishing a system for tracking expenses, we can help you conduct an M&E review of your business to provide best practices for your company’s M&E expenditures.