One of the most difficult types of expenses to gain deductions for is entertainment expenses, and understandably so. Businessmen often claim all kinds of expenses by calling them “entertainment expenses”. Little surprise that entertainment expenses deductions always get flagged for audits. So if you’re interested in claiming entertainment expenses deductions successfully, listen up. I’m going to give you some tips on what REALLY works.
One of the main things to understand is that entertainment expenses for customers or potential customers are treated differently by the IRS than for your own staff.
Generally your expenses for customers or potential customers can only be legitimately classified as “entertainment” if the main purpose of the expense would be the active conduct of business. This means that you must be attempting to make a sale or otherwise be conducting business with the clear objective of getting some business benefit out of the deal. For example, if you organize the soft launch party of your new product, show a demonstration of it, give away free samples and take orders, then it would be considered an entertainment expense. But if you just go for dinner with customers or even prospective customers for maintaining goodwill, it is not an entertainment expense according to the IRS.
Here’s a subtle tip that many people do not know. You are not allowed to claim just any leisure event (fishing trip, ball game, sporting event etc) or entertainment expense (meals, parties, trips etc) even if you are with your customers because the IRS does not view such events as “doing business”. But you can attach such an activity to a business event. For example, if you meet with a potential customer and pitch him your product and then take him to a cocktail party, you can claim such an expense as “entertainment”.
Another criterion that makes your entertainment claim legitimate is the amount you claim. According to IRS rules, it must not be “extravagant”. Although the term “extravagant” is not clearly defined and what’s extravagant to one business would be different from another, it is quite clear that you should be seen to try to keep a lid on your spending.
On the other hand, when it comes to expenses for your staff members, the IRS classifies this as entertainment expenses and can be deducted 100%. So you can have a company dinner for your staff and it is completely deductible. But if you allow your staff members to bring their guests, then the amount of entertainment expenses you may deduct is only the proportion that pertains to your staff members, not their guests.
Finally, you must verify your entertainment expenses with official receipts if they are at least $75. For those that cost less, you should still have written records of amount spent, dates and place.