Tread carefully when deducting travel and entertainment expenses

While technology has given us a greater ability to conduct business virtually, there are still plenty of instances where individuals in professional services organizations need to meet face-to-face with a client or prospective client or work on site at a client’s location. For those occasions when you incur business travel and entertainment expenses, we have compiled a brief summary of the tax rules for these expenses.

Business Meals and Entertainment

The Internal Revenue Service requires the business incurring the expense to meet the following two criteria before allowing a tax deduction:

  1. The expenses must be “ordinary and necessary” to the business
  2. The expenses must be “directly related” or “associated with” the business

An ordinary expense is one that is common and accepted in your business. A necessary expense is one that is helpful and appropriate in your business.

Passing the “directly related” test requires the entertainment to take place in a clear business setting or that the main purpose of the entertainment was the active conduct of business in which you engage in substantial business discussions with the person during the entertainment period with expectation of getting some future business benefit.

Passing the “associated with” test requires that you can demonstrate a clear business purpose for having the expense and that the entertainment occurred either directly before or after a business discussion.

Lastly, for a tax deduction to be allowed by the IRS, the expense incurred must be supported by documentation. Documentation of the expense must include the amount spent, the time and place of the event, and the business relationship of the individuals involved. Any amount paid in excess of $75 requires a receipt or other documentary proof. Once all other requirements for deductibility are met, only 50 percent of the amount qualifies as a deduction.

Business Travel Expenses

Travel expenses are the ordinary and necessary expenses of traveling while you are away from home for your business, job, or profession.

An employee’s tax home refers to the city or area that includes his or her main place of business. If an employee is away from his/her tax home on a business-related trip, travel-related expenses such as airfare, taxis, baggage costs, cleaning costs, telephone, meals, and tips may be deductible.

Personal entertainment while away is not deductible. Therefore, if a business trip combines business and pleasure, an allocation between business and personal expenses is required. The required documentation for travel and associated expenses to be tax-deductible include a receipt, the reason, the time, the location, and the amount of expenses. Travel expense is fully deductible and not subject to the 50 percent limitation that meals and entertainment are subject to, as stated above.

There is no doubt that the tax rules for deducting travel and entertainment expenses are challenging. Organizations that have strong policies and procedures in place will be able to navigate through an IRS audit and mitigate their tax exposure of disallowed expense deductions while avoiding IRS penalties.

Contact us at 215.441.4600 if you have questions or would like to discuss how this topic may impact your business.