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Don’t overindulge on business meals

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in Small Business Tax,Small Business Tax Deduction Strategies

The days of the three-martini lunch are long gone, but business people can still deduct meal expenses that meet certain requirements.

Strategy: Don’t try to circumvent the rules. The IRS is a stickler when it comes to claiming and proving entertainment and meal deductions.

In particular, the IRS won’t allow you to simply reciprocate expenses with business associates so that you can each claim multiple deductions.

Here’s the whole story: The tax law generally limits deductions for qualified business entertainment and meal expenses to 50% of the cost. For example, if you treat two clients to lunch and the tab for the three of you comes to $100, you may deduct only $50. If you’re paying the expenses out of your own pocket, it is deductible as a miscellaneous expense, subject to a floor of 2% of your adjusted gross income (AGI).

To be deductible, meals must be “directly related to” or “associated with” your business.  The directly related requirement is limited to meals taking place in a clear business setting (e.g., a hospitality suite at a hotel convention). Generally, it’s easier to qualify for deductions based on meals that are associated with your business, which includes ones held before or after a substantial business meeting.

Keep these rules in mind when you schedule get-togethers with clients and business associates. When possible, arrange meals to precede or follow a substantial business discussion. Note: If spouses or significant others come along, the costs attributable to them also count toward the 50% limit.  

But be aware that you simply can’t “trade” deductible lunches with business cohorts. In other words, you’re not allowed to take an associate to lunch one day and have him or her reciprocate the next day and so on.

Both the IRS and the courts have consistently denied deductions for these reciprocal meals. In one such case, deductions for daily business luncheons claimed by partners in a law firm were disallowed. The costs were treated as nondeductible expenses even though the partners engaged in substantial business discussions before and after. (J.D. Moss Jr., CA-7, 758 F.2d 211, 3/27/85)

Tip: Finally, deductions aren’t allowed for meals that are “lavish or extravagant.”

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