This section explains different types of entertainment expenses that you may be able to deduct.

Entertainment. Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation. Examples include entertaining guests at nightclubs; at social, athletic, and sporting clubs; at theaters; at sporting events; on yachts; or on hunting, fishing, vacation, and similar trips.

Entertainment also may include meeting personal, living, or family needs of individuals, such as providing meals, a hotel suite, or a car to customers or their families.

A meal as a form of entertainment. Entertainment includes the cost of a meal you provide to a customer or client, whether the meal is a part of other entertainment or by itself. A meal expense includes the cost of food, beverages, taxes, and tips for the meal. To deduct an entertainment-related meal, you or your employee must be present when the food or beverages are provided.

You cannot claim the cost of your meal both as an entertainment expense and as a travel expense.

Meals sold in the normal course of your business are not considered entertainment.

Deduction may depend on your type of business. Your kind of business may determine if a particular activity is considered entertainment. For example, if you are a dress designer and have a fashion show to introduce your new designs to store buyers, the show generally is not considered entertainment. This is because fashion shows are typical in your business. But, if you are an appliance distributor and hold a fashion show for the spouses of your retailers, the show generally is considered entertainment.

Taking turns paying for meals or entertainment. Expenses are not deductible when a group of business acquaintances take turns picking up each others' meal or entertainment checks without regard to whether any business purposes are served.

Lavish or extravagant expenses. You cannot deduct expenses for entertainment that are lavish or extravagant. An expense is not considered lavish or extravagant if it is reasonable considering the facts and circumstances. Expenses will not be disallowed just because they are more than a fixed dollar amount or take place at deluxe restaurants, hotels, nightclubs, or resorts.

Allocating between business and nonbusiness. If you entertain business and nonbusiness individuals at the same event, you must divide your entertainment expenses between business and nonbusiness. You can deduct only the business part. If you cannot establish the part of the expense for each person participating, allocate the expense to each participant on a pro rata basis.

Example. You entertain a group of individuals that includes yourself, three business prospects, and seven social guests. Only 4/11 of the expense qualifies as a business entertainment expense. You cannot deduct the expenses for the seven social guests because those costs are nonbusiness expenses.

Trade association meetings. You can deduct entertainment expenses that are directly related to and necessary for attending business meetings or conventions of certain exempt organizations. These organizations include business leagues, chambers of commerce, real estate boards, trade associations, and professional associations. The expenses of your attendance must be related to your active trade or business. These expenses are subject to the 50% limit on entertainment expenses.

Entertainment tickets. Generally, you cannot deduct more than the face value of an entertainment ticket, even if you paid a higher price. For example, you cannot deduct service fees you pay to ticket agencies or brokers or any amount over the face value of the tickets you pay to scalpers.

Exception for events that benefit charitable organizations. Different rules apply when the cost of a ticket to a sports event benefits a charitable organization. You can take into account the full cost you pay for the ticket, even if it is more than the face value, if all of the following conditions apply.

1. The event's main purpose is to benefit a qualified charitable organization.
2. The entire net proceeds go to the charity.
3. The event uses volunteers to perform substantially all the event's work.

The 50% limit on entertainment does not apply to any expense for a package deal that includes a ticket to such a charitable sports event.

Example 1. You purchase tickets to a golf tournament organized by the local volunteer fire company. All net proceeds will be used to buy new fire equipment. The volunteers will run the tournament. You can deduct the entire cost of the tickets as a business expense if they otherwise qualify as an entertainment expense.

Example 2. You purchase tickets to a college football game through a ticket broker. After having a business discussion, you take a client to the game. Net proceeds from the game go to colleges that qualify as charitable organizations. However, since the colleges also pay individuals to perform services, such as coaching and recruiting, you can only use the face value of the tickets in determining your business deduction. Also, your deduction is subject to the 50% limit.

Table 2. When Are Entertainment Expenses Deductible?

Skyboxes and other private luxury boxes. If you rent a skybox or other private luxury box for more than one event at the same sports arena, you generally cannot deduct more than the price of a nonluxury box seat ticket.

To determine whether a skybox has been rented for more than one event, count each game or other performance as one event. For example, renting a skybox for a series of playoff games is considered renting it for more than one event. All skyboxes you rent in the same arena, along with any rentals by related parties, are considered in making this determination.

Related parties include:

1. Family members (spouses, ancestors, and lineal descendants),
2. Parties who have made a reciprocal arrangement involving the sharing of skyboxes,
3. Related corporations,
4. A partnership and its principal partners, and
5. A corporation and a partnership with common ownership.

Example. You pay $3,000 to rent a 10-seat skybox at Team Stadium for three baseball games. The cost of regular nonluxury box seats at each event is $20 a seat. You can deduct (subject to the 50% limit) $600 [(10 seats x $20 each) x 3 events].

Food and beverages in skybox seats. If expenses for food and beverages are separately stated, you can deduct these expenses in addition to the amounts allowable for the skybox, subject to the requirements and limits that apply. The amounts separately stated for food and beverages must be reasonable. You cannot inflate the charges for food and beverages to avoid the limited deduction for skybox rentals.

Directly-Related Test

To meet the directly-related test for entertainment expenses (including entertainment-related meals), you must show that:

1. The main purpose of the combined business and entertainment was the active conduct of business,
2. You did engage in business with the person during the entertainment period, and
3. You had more than a general expectation of getting income or some other specific business benefit at some future time.

Business is generally not considered to be the main purpose when business and entertainment are combined on hunting or fishing trips, or on yachts or other pleasure boats. Even if you show that business was the main purpose, you generally cannot deduct the expenses for the use of an entertainment facility. See Entertainment facilities earlier in this chapter.

You must consider all the facts, including the nature of the business transacted and the reasons for conducting business during the entertainment. It is not necessary to devote more time to business than to entertainment. However, if the business discussion is only incidental to the entertainment, the entertainment expenses do not meet the directly-related test.

You do not have to show that business income or other business benefit actually resulted from each entertainment expense.

Clear business setting. If the entertainment takes place in a clear business setting and is for your business or work, the expenses are considered directly related to your business or work. The following situations are examples of entertainment in a clear business setting.

1. Entertainment in a hospitality room at a convention where business goodwill is created through the display or discussion of business products.
2. Entertainment that is mainly a price rebate on the sale of your products (such as a restaurant owner providing an occasional free meal to a loyal customer).
3. Entertainment of a clear business nature occurring under circumstances where there is no meaningful personal or social relationship between you and the persons entertained. An example is entertainment of business and civic leaders at the opening of a new hotel or play when the purpose is to get business publicity rather than to create or maintain the goodwill of the persons entertained.

Expenses not considered directly related. Entertainment expenses generally are not considered directly related if you are not there or in situations where there are substantial distractions that generally prevent you from actively conducting business. The following are examples of situations where there are substantial distractions.

1. A meeting or discussion at a nightclub, theater, or sporting event.
2. A meeting or discussion during what is essentially a social gathering, such as a cocktail party.
3. A meeting with a group that includes persons who are not business associates at places such as cocktail lounges, country clubs, golf clubs, athletic clubs, or vacation resorts.

Associated Test

Even if your expenses do not meet the directly-related test, they may meet the associated test.

To meet the associated test for entertainment expenses (including entertainment-related meals), you must show that the entertainment:

1. Is associated with your trade or business, and
2. Directly precedes or follows a substantial business discussion (defined later).

Figure A. Does the 50% limit apply to Your Expenses?

Generally, any ordinary and necessary expense is associated with the active conduct of your trade or business if you can show that you had a clear business purpose for having the expense. The purpose may be to get new business or to encourage the continuation of an existing business relationship.

Substantial business discussion. Whether a business discussion is substantial depends on the facts of each case. A business discussion will not be considered substantial unless you can show that you actively engaged in the discussion, meeting, negotiation, or other business transaction to get income or some other specific business benefit.

The meeting does not have to be for any specified length of time, but you must show that the business discussion was substantial in relation to the meal or entertainment. It is not necessary that you devote more time to business than to entertainment. You do not have to discuss business during the meal or entertainment.

Meetings at conventions. You are considered to have a substantial business discussion if you attend meetings at a convention or similar event, or at a trade or business meeting sponsored and conducted by a business or professional organization. However, your reason for attending the convention or meeting must be to further your trade or business. The organization that sponsors the convention or meeting must schedule a program of business activities that is the main activity of the convention or meeting.

Directly before or after business discussion. If the entertainment is held on the same day as the business discussion, it is considered to be held directly before or after the business discussion.

If the entertainment and the business discussion are not held on the same day, you must consider the facts of each case to see if the associated test is met. Among the facts to consider are the place, date, and duration of the business discussion. If you or your business associates are from out of town, you must also consider the dates of arrival and departure, and the reasons the entertainment and the discussion did not take place on the same day.

Example. A group of business associates comes from out of town to your place of business to hold a substantial business discussion. If you entertain those business guests on the evening before the business discussion, or on the evening of the day following the business discussion, the entertainment generally is considered to be held directly before or after the discussion. The expense meets the associated test.

Expenses for spouses. You generally cannot deduct the cost of entertainment for your spouse or for the spouse of a customer. However, you can deduct these costs if you can show that you had a clear business purpose, rather than a personal or social purpose, for providing the entertainment.

Example. You entertain a customer. The cost is an ordinary and necessary business expense and is allowed under the entertainment rules. The customer's spouse joins you because it is impractical to entertain the customer without the spouse. You can deduct the cost of entertaining the customer's spouse as an ordinary and necessary business expense. If your spouse joins the party because the customer's spouse is present, the cost of the entertainment for your spouse is also an ordinary and necessary business expense.

50% Limit

In general, you can deduct only 50% of your business-related meal and entertainment expenses. (If you are subject to the Department of Transportation's "hours of service" limits, you can deduct a higher percentage. See Individuals subject to "hours of service" limits, later.) The 50% limit applies to employees or their employers, and to self-employed persons (including independent contractors) or their clients, depending on whether the expenses are reimbursed. Figure A summarizes the general rules explained in this section.

The 50% limit applies to business meals or entertainment expenses you have while:

1. Traveling away from home (whether eating alone or with others) on business,
2. Entertaining customers at your place of business, a restaurant, or other location, or
3. Attending a business convention or reception, business meeting, or business luncheon at a club.

Covered expenses. Taxes and tips relating to a business meal or entertainment activity are included in the amount that is subject to the 50% limit. Expenses such as cover charges for admission to a nightclub, rent paid for a room in which you hold a dinner or cocktail party, or the amount paid for parking at a sports arena are subject to the 50% limit. However, the cost of transportation to and from a business meal or a business-related entertainment activity is not subject to the 50% limit.

Separating costs. If you have an expense for goods and services consisting of meals, entertainment, and other services (such as lodging or transportation), you must allocate that expense between the cost of meals and entertainment and the cost of the other services. You must have a reasonable basis for making this allocation. For example, you must allocate your expenses if a hotel includes one or more meals in its room charge, or if you are provided with one per diem amount to cover both your lodging and meal expenses.

Application of 50% limit. The 50% limit on meal and entertainment expenses applies if the expense is otherwise deductible and is not covered by one of the exceptions discussed later.

The 50% limit also applies to activities that are not a trade or business. It applies to meal and entertainment expenses you have for the production of income, including rental or royalty income. It also applies to the cost of meals included in deductible educational expenses.

When to apply the 50% limit. You apply the 50% limit after determining the amount that would otherwise qualify for a deduction. You first have to determine the amount of meal and entertainment expenses that would be deductible under the other rules discussed in this publication.

Example 1. You spend $100 for a business-related meal. If $40 of that amount is not allowable because it is lavish and extravagant, the remaining $60 is subject to the 50% limit. Your deduction cannot be more than $30 (.50 x $60).

Example 2. You purchase two tickets to a concert and give them to a client. You purchased the tickets through a ticket agent. You paid $150 for the two tickets, which had a face value of $60 each ($120 total). Your deduction cannot be more than $60 (.50 x $120).

Exceptions to the 50% Limit

Generally, business-related meal and entertainment expenses are subject to the 50% limit. Figure A can help you determine if the 50% limit applies to you.

Expenses not subject to 50% limit. Your meal or entertainment expense is not subject to the 50% limit if the expense meets one of the following exceptions.

1 - Employee's reimbursed expenses. If you are an employee, you are not subject to the 50% limit on expenses for which your employer reimburses you under an accountable plan. Accountable plans are discussed in chapter 6.

2 - Self-employed. If you are self-employed, your deductible meal and entertainment expenses are not subject to the 50% limit if all three of the following requirements are met.

1. You have these expenses as an independent contractor.
2. Your customer or client reimburses you or gives you an allowance for these expenses in connection with services you perform.
3. You provide adequate records of these expenses to your customer or client. (See chapter 5.)

In this case, your client or customer is subject to the 50% limit on the expenses.

Example. You are a self-employed attorney who adequately accounts for meal and entertainment expenses to a client who reimburses you for these expenses. You are not subject to the directly-related or associated test, nor are you subject to the 50% limit. If the client can deduct the expenses, the client is subject to the 50% limit.

If you (the contractor) have expenses for meals and entertainment related to providing services for a client but do not adequately account for and seek reimbursement from the client for those expenses, you are subject to the directly-related or associated test and to the 50% limit.

3 - Advertising expenses. You are not subject to the 50% limit if you provide meals, entertainment, or recreational facilities to the general public as a means of advertising or promoting goodwill in the community. For example, the expense of sponsoring a television or radio show is deductible, as is the expense of distributing free food and beverages to the general public.

4 - Sale of meals or entertainment. You are not subject to the 50% limit if you actually sell meals, entertainment, goods and services, or use of facilities to the public. For example, if you run a nightclub, your expense for the entertainment you furnish to your customers, such as a floor show, is a business expense.

5 - Charitable sports event. You are not subject to the 50% limit if you pay for a package deal that includes a ticket to a qualified charitable sports event. For the conditions the sports event must meet, see Exception for events that benefit charitable organizations under Entertainment tickets, earlier.

Individuals subject to "hours of service" limits. You can deduct a higher percentage of your meal expenses if the meals take place during or incident to any period subject to the Department of Transportation's "hours of service" limits. The percentage is 60% for 2000, and it gradually increases to 80% by the year 2008.

Individuals subject to the Department of Transportation's "hours of service" limits include the following persons.

1. Certain air transportation workers (such as pilots, crew, dispatchers, mechanics, and control tower operators) who are under Federal Aviation Administration regulations.
2. Interstate truck operators and bus drivers who are under Department of Transportation regulations.
3. Certain railroad employees (such as engineers, conductors, train crews, dispatchers, and control operations personnel) who are under Federal Railroad Administration regulations.
4. Certain merchant mariners who are under Coast Guard regulations.

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