While one cup of coffee is not going to trigger an audit, in the last few years, there have been significant changes to the amounts and categories of meals and entertainment deductions that will be allowed. Starting in 2018, the Tax Cuts and Jobs Act (TCJA) and the passing of a provision in 2020 to the Consolidated Appropriations Act (CAA). Then In late 2020, the IRS announced that small businesses would see an audit increase of 50% for 2021. Staying abreast of these changes is vital since these deductions are one of the big red flags to trigger an IRS audit. Tax audits can be stressful and scary, but they are avoidable and easily prepared if you are diligent throughout the year.
Changes to meal deductions
To boost business spending at restaurants following the pandemic, Congress added a provision to the Consolidated Appropriations Act (CAA) passed in December 2020 that makes the cost of business-related meals served in a restaurant 100% deductible—but only for 2021 and 2022. Previously, deductions for business meals at restaurants were limited to 50%
Meals that can be deducted
You have a busy day, running from client to client in your home city. You grab coffee and bagel for breakfast, food truck for lunch, and have dinner at a chain restaurant while typing up notes from your meetings. You used your business credit card for all these purchases, considering them a business meal. After all, you made the expense in the course of your business day. The IRS disagrees. According to the IRS:
Business meals that are 100% deductible now and 50% after 2022:
- Dinner with a client with work discussion
- Employee meals while traveling for business
- Drinks, snacks, and other food items supplied for the office
- Catered food for a board meeting
- Meals you purchase while traveling for business
- Food provided for employees who are working late
- Eating lunch out with a few employees
Business meals that are always 100% deductible:
- A holiday party for the entire company
- A community event where you provide free food to the general public
- A fundraising event where the proceeds go to a charitable organization
- Food provided as part of employee’s taxable compensation (must be included on W-2)
- A dinner out where at least half of all your employees are present
Limited entertainment deductions
Starting in 2018, the Tax Cuts and Jobs Act (TCJA) permanently eliminated deductions for most business-related entertainment expenses. Gone are the days of nights on the town and golf trips being a business deduction. Moreover, while you can deduct the cost of food and beverages consumed in conjunction with an entertainment event, the food and drinks must be purchased separately from the entertainment or stated separately on the bill to qualify for a deduction.
The IRS defines entertainment as “any activity generally considered to provide entertainment, amusement, or recreation.” Additionally, any cost in renting out what the IRS calls an “entertainment facility” such as a yacht, swimming pool, bowling alley, limo, airplane, hotel suite, or villa in a vacation resort for the entertainment of clients are no longer deductible. Also, any membership and club dues related to these activities, such as dues for membership to a country club or golf course.
Businesses can deduct some entertainment expenses
You can deduct meals that happen in conjunction with the entertainment, such as beers and hotdogs purchased at a basketball game. There are two conditions to qualify:
- You must buy food and drinks separately from the entertainment, or
- The cost of the food and beverages must be stated separately on the bill or receipt. Given this requirement, you should always insist on detailed receipts whenever you visit any entertainment venue for business purposes.
Despite the restrictions, businesses can deduct a handful of entertainment expenses. According to the IRS, the following entertainment-related expenses are 100% deductible:
- Reported on your tax return as taxable compensation to your employees.
- Recreational or social activities for your employees, such as a holiday party or a company picnic.
- Expenses related to attending business meetings or conventions of certain exempt organizations, such as business leagues, chambers of commerce, or professional associations.
- Entertainment sold to your customers.
Be prepared for an audit at anytime
The most significant step you can take is to keep the receipts! Some apps can help you cut down on paper and integrate receipts directly into your business accounting software. Then, of course, there are the old-fashioned receipts in an envelope. Have an envelope for each month and then the year. The IRS will want to know the following information about each deduction:
- Date, time, and location: Most receipts have this information but add if not
- Who attended: If the meal is for you alone and not while traveling, these are not deductible. Pay with your personal funds. If you are on a business trip, list yourself. Travel meals are deductible.
- Summary of the meeting: What you were there to discuss or the trip you are on
By keeping track throughout the year, should you be audited, you can quickly and easily provide them with this information.