The tax code does not treat entertainment expenses kindly.
50 percent limitation. First, with certain exceptions, your entertainment expense deduction is limited to 50 percent of your entertainment expenses.1 Second, you must satisfy strict Substantiation requirements discussed below.
Tax law defines entertainment to mean any activity of a type generally thought of as entertainment, amusement, or recreation, including meals for yourself and the person you are entertaining.2
You can deduct entertainment expenses only if they meet either the directly-related test or the associated test.
Directly-related test. You can satisfy the directly related test by establishing that the entertainment took place in a “clear business setting”3 or by establishing the following four requirements:4
You were looking for a specific and immediate business benefit (e.g., a referral), not just general goodwill or a potential benefit at some indefinite future time.
The main purpose of the entertainment was the active conduct of business.
You did engage in business with the person during the entertainment period (or were prevented from doing so by circumstances beyond your control). However, you do not have to show that you devoted more time to business than to entertainment.
The expenditure was allocable to you and the person or persons entertained.
Associated test. Under the “associated” test, the entertainment must:5
Directly precede or follow a substantial business discussion; and
Be associated with your business.
Substantiation requirements. In addition to the standard requirements, the tax code imposes strict substantiation requirements for deducting entertainment expenses. Under these requirements, you must prove the following elements:6
Amount. The amount of each separate expenditure, except that certain items can be aggregated on a daily basis.
Time. The date the entertainment occurred.
Place. The name (if any), address or location, and destination or type of entertainment, e.g., dinner, theater, etc.
Business purpose. The business reason for the entertainment or the type of business benefit you expected (e.g., referrals), and the nature of any business discussion or activity.
Business relationship. Sufficient information about each person entertained to establish the business relationship.
Furthermore, you must record (write down) each element “at or near the time” it occurs.7
Tip. This requirement effectively means you must keep a tax diary.
Finally, you must keep supporting documents, such as receipts, paid bills, or similar for:
Every lodging expense (if applicable), and
Any other expenditure exceeding $75, except for transportation charges (if applicable) when documentary evidence is “not readily available.”8
Documentation tip. Keep all your receipts, regardless of amount.
1 IRC Section 274(n)(1).
2 Reg. Section 1.274-2(b)(1).
3 Reg. Section 1.274-2(c)(4).
4 Reg. Section 1.174-2(c)(3).
5 Reg. Section 1.274-2(d)(1).
6 Reg. Section 1.274-5T(b)(3).
7 Reg. Section 1.274-5T(c)(2).
8 Reg. Section 1.274-5(c)(2).