While wining and dining, mind your business

Published February 4, 2007

The little piles of credit card receipts on the desks of many small business owners can mean only one thing: They're trying to figure out how much of their 2006 lunches, dinners and entertainment expenses can be deducted on their tax returns.

Meals and entertainment are a popular tax deduction with businesses. A company can deduct 50 percent of the cost of meals and entertainment expenses incurred in the course of doing business.

But these are deductions that should be taken only with discretion. Accountants say the IRS is particularly wary of meal and entertainment expenses because of the possibility of abuse, and they think the government is likely to question any numbers on a tax return that seem out of line.

Mark Toolan, a certified public accountant in Exton, Pa., said business owners need to ask themselves about each expense, "is it reasonable, is it ordinary?" And, he warned, "it cannot be lavish."

Toolan said a critical part of taking deductions for meals and entertainment is being sure you have the proper substantiation for each expense. That way, if the IRS does inquire about your expenses, you'll be able to back up your claim.

The problem for many business owners is that record-keeping, while an important part of doing business, is something that can become slapdash while they're trying to juggle everything else.

"People try to overlook it, or do it after the fact," Toolan said, recommending to owners, "do it as you go along" through the course of a year.

Credit card receipts or restaurant checks are an easy way to substantiate an entertainment expense, since they contain the date, amount and place.

Many business owners also input their expense information into the software they use to keep their books - some expense-tracking software will also export the data into tax preparation applications. That'll make the process easier during tax season - but you'll still need to hold on to your receipts in case the IRS has questions.

What constitutes a deductible meal or entertainment expense is complex. For a business to be able to deduct the cost of dinner or an event, it has to fall within the realm of, as Toolan noted, an ordinary and reasonable expense.

The easiest and most clear-cut example is taking a client out to lunch and discussing the services you'll provide. The tab is certainly deductible. But if, for example, you own a dry cleaning business and take an average customer - who's also a friend - out to a very expensive dinner, there's a good chance it wouldn't stand up to IRS scrutiny.

"It comes down to common sense. . . . There has to be a business purpose," Toolan said.

Fast Facts:


Tracking expenses

The essential parts to substantiating a meal or entertainment expense:

- The date that the meal or event took place.

- The amount spent, including tax and tip.

- Where it took place.

- What the business purpose was for the occasion - for example, if you were trying to land a new customer.

- An explanation of the business relationship between you and the person or people you entertained, including names and companies - anything that would explain why you'd be meeting with them to discuss business.