The holiday season is finally upon us. As is customary each year, many businesses will begin announcing their plans for the annual company holiday party. In addition to finalizing their budgets, business owners need to understand what costs they can and cannot deduct as the IRS is known to scrutinize these expenses.
Are entertainment expenses deductible?
Similar to meals and lodging, entertainment expenses are generally fifty percent deductible. However, there are two types of entertainment expenses as defined by the IRS: those that are 1) directly and 2) indirectly related to the business. Directly related means that the sole purpose of the entertainment was for business and the expectation was for money to be generated during the meeting. Indirectly means that there was entertainment associated with business such as attending a sports contest or a theatrical performance. In this instance, generally you can only deduct the expense if there was a significant business discussion that occurred during the entertainment event.
What about holiday parties?
Holiday parties may fall under one of the exceptions which allow businesses to deduct more than the 50% limit. If the party is for the employees of the business and their families, it is actually 100% deductible per IRS publication 463. Even if members of the general public are invited, it is still fully deductible. However, friends invited to the party won’t qualify. Also, customer related party expenses will still only be deductible at the maximum 50% rate.
What documentation do you need to justify the expense?
You need to keep a copy of the invitation and make sure that the business purpose is indicated. It’s also helpful to videotape the party to provide an audit trail to the IRS. In addition, maintain a copy of the guest list with information related to attending customers, employees, and friends. The bookkeeper accounting for the expense should be up to speed on the deduction rules as stated above.
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