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Your expenses for meals and entertainment must be closely related to your business in order to be deductible. In the IRS's view, your expenses may qualify if they meet at least one of the following two tests:
- the directly-related test
- the associated-with test
You can't deduct meal and entertainment expenses to the extent that they are lavish or extravagant — the expenses must be reasonable considering the facts and circumstances.
Directly-related test. If the entertainment takes place in a clear business setting (for example, you provide a hospitality room at a convention) directly to promote your business, the expense satisfies the directly-related-to test. If you can't meet the clear business setting requirement, the expense must meet all of the following requirements:
- You must have more than a vague expectation of deriving some income or other specific business benefit (other than a favorable attitude of the person entertained) from the meal or entertainment. However, you don't need to show that income or some other business benefit actually resulted from each deducted expenditure.
- During the meal or entertainment, you actively engaged in business discussions.
- The main purpose of the combined business and entertainment is the active conduct of business.
What kind of expenses are generally not considered directly related? In situations when entertainment occurs where there are substantial distractions, such as meetings or discussions at night clubs, theaters, or sporting events; meetings or discussions at social gatherings, such as cocktail parties; and situations in which you meet with a group that includes persons other than business associates, for example cocktail lounges, country clubs, golf or athletic clubs, or at vacation resorts. For these types of meal and entertainment expenses, there's a presumption that the directly-related test is not met unless you clearly can show otherwise.
Associated-with test. Meals and entertainment expenses may be deductible under this more lenient test if they meet the following two requirements:
- The expenses are associated with the active conduct of your business.
- The meal or entertainment directly precedes or follows a substantial and bona fide business discussion.
Entertainment that occurs on the same day as the business discussion automatically meets the "directly precedes or follows" requirement. If the entertainment and the business discussion don't occur on the same day, the facts and circumstances of each case are considered. The relevant facts are the place, date, and duration of the business discussion, whether you and your business associate are from out of town (and the dates of arrival and departure), and the reasons the entertainment didn't take place on the same day of the business discussion.
Whether a business discussion (such as a meeting, negotiation, transaction, etc.) is substantial and bona fide depends on the facts and circumstances of each case. If the IRS challenged you on this, you would have to establish that you actively engaged in the business discussion (not the entertainment) for the purpose of obtaining income or some other type of specific business benefit. However, you don't have to show that more time was devoted to business than entertainment.
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