Two deductions often misunderstood by taxpayers are the Business Gift Deduction and the Business Meals and Entertainment Deduction. The IRS limits the amount that may be taken for both deductions and requires adequate documentation to prove the business purpose of the expenses.
A business gift deduction is limited to $25 per person per year for each person you give to during the tax year.
The following are not considered gifts for the purpose of the $25 limit:
• An item that costs $4 or less, and has your name clearly and permanently imprinted on the gift, and is one of a number of identical items you widely distribute (e.g. pens and desk sets)
• Signs, display racks, or other promotional material to be used on the business premises of the recipient.
• Incidental costs such as engraving on jewelry, packaging, insuring and mailing are generally not included in determining the cost of the gift.
The following records should be kept to prove the expense of the gift:
• Receipt or proof of payment showing the cost of the gift
• Date of the gift
• Business reason or business benefit gained or expected to be gained
• Name and other information about recipient to show the business relationship to taxpayer.
There are four rules which must be followed for an expense to qualify as a business meal and entertainment deduction:
1. Ordinary and necessary – all business expenses must be “ordinary and necessary” in carrying on the business to be deductible.
2. Directly related or associated with the business. To meet the “directly related” test, the activity’s main purpose must be to actively conduct business; business must be conducted during the activity; and the taxpayer must have more than a general expectation of receiving income or some other business benefit at some future time.
It is not necessary to devote more time to business than entertainment. However, if the business discussion is only incidental to the entertainment, the expense is not directly related.
To meet the “associated with” test, the activity must be associated with the active conduct of the taxpayer’s trade or business and business purpose must be shown, and the activity must take place directly before or after a substantial business discussion.
3. Substantiate the expense with adequate records. An account book, expense report or similar record along with documentary evidence (receipts, canceled checks or bills) is adequate to support a deduction. The following information should be included:. Amount; date and duration; place and type of meal or entertainment, including address of establishment or facility; business purpose; and names of all participating and how they are business related.
4. Deduction limitation. If the expense meets the qualifications above, it is limited to a 50 percent deduction. The following are exceptions to the limit and may be 100 perceant deducted:
• Advertising. Meals, entertainment or recreational facilities provided to the general public to advertise or promote goodwill.
• Meals and entertainment sold to customers if you are in the business of furnishing meals and entertainment.
Charitable sports event. If the net proceeds of a ticket (including a meal) goes to an event with the main purpose of benefiting a qualified charitable organization and the event uses volunteers to perform substantially all the event’s work
• Nonemployee prizes and awards. Sales promotion awards reported to nonemployees on a Form 1099
• Meals and entertainment for the benefit of employees. Recreational, social or entertainment gatherings that primarily benefit other than highly compensated employees (company picnics, holiday parties etc.)
• De minimis fringe benefits. Coffee and soft drinks or subsidized meals provided on the employer’s business premises.
• Employee meals furnished on the employer’s premises for the employer’s convenience.
Certain entertainment expenses are not deductible:
• Club dues and membership fees. Dues for membership in any club organized for business, pleasure, recreation or other social purpose are not deductible (includes country clubs, golf and athletic clubs, luncheon or dinner clubs, and hotel or airline clubs).
• Cost of entertainment tickets over face value. Amounts paid over a ticket’s face value along with any fees paid to a ticket agency are not deductible
• Skyboxes and other private luxury boxes. If rented for more than one game or performance, only the cost of regular non-luxury box seats may be deducted. Any separately stated food and beverage for the skyboxes is deductible under the meals and entertainment rules above.
• Lavish or extravagant expenses. Deductions are not allowed for expenses that are considered unreasonable considering the circumstances.
• Michael J. Flood, CPA, MST is a partner with Caufield & Flood in Crystal Lake. He can be reached at 815-455-9538 or via email at Michaelf@cfcpas.com or through the website CFCPAS.com.