A few words of caution regarding entertainment expenses
It’s…The Holidays! Many people – including business owners – entertain around the holidays. They throw big parties at home. They host big dinners in restaurants. The difference between “people” and “business owners” is that business owners try to take a tax deduction for these entertaining expenses. The IRS knows this, and has developed a pretty cut-and-dried response.
Essentially, if your guest list includes other business people, your entertainment expenses may be deductible on a pro rata basis. In English, this means you need to add up the total expenses for the party, divide by the total number of guests in attendance, and then multiply by the number of business people in attendance.
Let’s look at an example. You spend $1000 on food, etc., for an open house at your home. You invite 58 people, mostly family and friends, but also including your best customer, your best supplier, your partner, your administrative assistant, the head of purchasing, and your loyal, hard-working accountant. This means, if everybody shows up, there could be 60 people at the party. (You have to include yourself and your spouse.) Alas, 9 guests have prior commitments, and your accountant suddenly has to work late due to one of those infamous accounting emergencies. The final head count is 50 (including yourself and your spouse.) $1000 / 50 people = $20 per person. Your best customer, your best supplier, your partner, your administrative assistant, and the head of purchasing make 5 business people. $20 x 5 business people = $100. Your allowable tax deduction for entertainment is $100.
Simple! But not what you were expecting. Conventional wisdom (aka tax gossip) would have you think all you need to do to deduct the full cost of your open house is invite a business connection…who doesn’t even have to show up. Sadly, when it comes to taxes, conventional wisdom is frequently little more than conventional wishfulness.
We need to look at 2 things in the eyes of the IRS. First, the nature of the party was to celebrate the holiday, that is, there was no specific business purpose. Second, attendance at the party was heavily weighted in favor of family and friends, and obviously the party would have gone on even if the business connections did not show up. Another wrinkle is, had your business connections brought their spouses, the IRS might try to disallow the spousal inclusion in the percentage. Usually, thankfully, you can talk them down from this because it is “conventional” to include, and rude to exclude – but, yes, you might have to specifically state it.
By the way… for federal tax purposes, your 50 person party would actually only give you a $50 deduction because 50% of the $100 would be disallowed.
Nonetheless, go ahead and have that party! Celebrate and have some fun! But keep a guest list as well as all receipts, and do your math properly.
Yes, I know I’m a wet blanket, and as such, unlikely to be invited to any parties. Remember: I’m just trying to keep you out of trouble!