One of the most misunderstood business tax deduction is meals. Many of my clients - including myself like to entertain. Whether it's taking a business client to lunch or throwing a party for our employees - networking and building relationships is important to a small business.
However, sometimes these activities can get expensive and impact the bottom line - unless you have a plan and know how the tax code works.
Some Ground Rules
Meals can be deducted as a business expense if they are directly related or associated with the active conduct of your business. There must also be a valid business purpose for the meal to be a deductible expense. Once you have established the meal is for a valid business purpose, the expense falls into two categories of deductibility: 50% deductible or 100% deductible.
50% Deductible Meals
As a general rule, meals are 50% deductible. You can deduct:
- Meals with customers or potential customers
- Meals with vendors or potential vendors
- Meals with employees
- Meals with partners, shareholders and directors
- Meals during business travel
- Meals while attending a business seminar or convention
All of these meals are deductible if they are directly related to your business and have a valid business purpose.
100% Deductible Meals
Some meals are 100% deductible. As a rule, if the meal includes the majority of the employees, it is 100% deductible. Examples of 100% deductible meals are:
- Expenses for a company picnic or holiday party. Read "Have Your Cake and Eat it too"! for details on how the 100% employee party deduction works!
- Office Snacks - coffee, soft drinks, bottled water, donuts, and similar snacks or beverages provided to employees on the business premises.
- Food made available to the public for free - usually as part of a promotional campaign.
- Meals provided on the employer's premises to more than half of the employees for the convenience of the employer. Example: if you are providing meals to the employees in order to keep them working late, working weekends, or being on call, it is for your convenience to have them at work and the meal is a means of enticement.
- If the meals expense is included as taxable compensation to the employee and included on the W2, then the expense is fully deductible by you.
- If a professional firm bills actual meal expenses separately when invoicing the client and is reimbursed by the client, the meal expenses for that engagement are fully deductible. However, if the meals expense is included in the invoice but is not separately stated at actual cost, then those meal expenses are only 50% deductible.
- Meals and food as part of a charity sporting event benefiting a 501(c)(3) organization are fully deductible. Check out this example: This Spring's Special Tax Tip... How to Deduct Having Fun!
Documentation and Tracking
I can't stress this enough, document the "Who, What, When, Where and Why's". You must keep acceptable documentation (such as a receipt & notes) to prove these expenses. The IRS will disallow expenses that do not have appropriate backup documentation. Most audits are lost because of lack of documentation.
I advise setting up two General Ledger accounts for Meals and Entertainment. One for the 50% deductible meals and one for the 100% deductible meals. This will allow us to properly write off your meals when we are preparing your tax return.