IRS auditors have great discretion when determining what entertainment expenses meet all qualifications to be deductible by a business. Entertainment expenses are only deductible when they are both ordinary and necessary and meet either the directly-related test or the associated test.
To pass the directly-related test, entertainment expenses must cover events for which the combined business and entertainment purpose was one of the following:
Expenses for entertainment that includes substantial distractions (what good entertainment wouldn't?) do not qualify for deduction under the directly related test. However, these expenses may qualify under the associated test.
The associated test requires that entertainment expenses be associated with the active conduct of trade or business - and that the entertainment in question occur directly before or after a substantial business discussion. A substantial business discussion is a meeting, negotiation, or other business transaction that was held in pursuit of future income or some other specific business benefit.
Whatever avenue to deductibility you take, good documentation is key to meeting the bar set by the IRS. Business expenses for entertainment cannot be estimated after the fact. Receipts and detailed records (taken around the time the expenses were incurred) need to show clearly and consistently: the amount of any expense, along with the time and place, business purpose, and business relationship to the taxpayer of the persons entertained. The quality and completeness of your receipts and records will make the difference.
Reference: Code Section 274 (d), Reg § 1.274-1. Disallowance of certain entertainment, gift and travel expenses, TC Memo 1996-529, TC Memo 1982-403
George R. Kaplan, CPA is Principal of George Kaplan, PC - Certified Public Accountants and Strategic Business Partners. Mr. Kaplan has over 20 years experience providing tax compliance and tax strategies to businesses and their shareholders. For more information, contact George@gkpc.com.