Entertainment Expenses as Business Expenses: What Should Business Owners Keep in Mind?

Entertainment expenses refer to costs incurred for food or beverages. These are therefore considered living expenses, which generally preclude tax deductions. Ultimately, the majority of restaurant visits are not tax-deductible. However, there are two exceptions where entertainment expenses may be deducted as business expenses. To ensure that business owners can actually take advantage of these exceptions, various provisions of tax law must be observed. As tax advisors, we naturally know how the tax authorities treat entertainment expenses. We have summarized this information for you in this article.

The Basics: Entertainment Expenses as Business Expenses

As previously noted, there are two exceptions that allow entertainment expenses to be classified as business expenses. These exceptions are found in the Income Tax Act. Based on this, entertainment expenses can be deducted as business expenses provided the expenses are incurred in connection with entertaining individuals for business purposes. The second exception applies to non-business-related but generally operational entertainment expenses. In the following paragraphs, we will address both of these exceptions and explain the requirements for a deduction.

Definitional Delineation of Entertainment Expenses

Before we can examine the tax deduction, we must define the concept of entertainment expenses. From a tax perspective, a certain distinction must be made here. Entertainment expenses generally refer to costs incurred for food, beverages, and other luxury items. Incidental costs associated with the primary hospitality service are also included in entertainment expenses. These may include, for example, coat check fees or tips. The hospitality does not always have to take place in a restaurant. Purchasing food and beverages at a supermarket or having them delivered by a delivery service can also be classified as entertainment expenses. From a tax perspective, however, it is important that the hospitality—that is, the food and drink—is the primary focus. A classic example that is not recognized as a hospitality expense is a visit to a nightclub. In this context, it is irrelevant that drinks are served. The focus in this case is misplaced. So-called “gifts” are also not considered hospitality expenses. This includes offering coffee, soft drinks, or pastries. Product tastings at a manufacturing facility are also not considered entertainment. These basic classifications are essential for deducting expenses as entertainment expenses and thus as business expenses.

Entertaining Individuals for Business Purposes

As briefly noted above, entertainment expenses incurred for a business purpose can be claimed as business expenses. A business purpose is always present when the entertainment serves the business relationship or is intended to establish such a relationship. This typically involves entertaining customers, suppliers, sales representatives, job applicants, and consultants. Expenses for any accompanying persons may also be business-related. It is important to note that entertaining guests at one’s own home is generally not recognized as a business expense. There are only very specific exceptions to this rule. Entertainment expenses related to private events, such as a birthday, are also problematic. In these cases, you can at least expect the tax authorities to scrutinize the expenses more closely or to disallow the entertainment costs.

In the context of business-related hospitality, there is a so-called deduction limit of 70 percent. Accordingly, only 70% of the entertainment expenses can be claimed for tax purposes. The idea is that the remaining 30% are considered private expenses that would have to be spent on private food consumption anyway.

Entertainment expenses for general business purposes

For entertainment expenses related to general business purposes, the deduction limit does not apply. The full amount of the entertainment expenses can be claimed. So, when is an occasion considered to be for general business purposes? The only exception that is not considered business-related is the hosting of the company’s own employees. This applies, for example, to a company event or a Christmas party. In some cases, the costs for employees’ family members may also be included.

Reasonableness of Entertainment Expenses

If entertainment expenses are recognized under these conditions, it might be acceptable to spend a bit more. You might consider a luxury restaurant, for instance. Unfortunately, tax law throws a wrench in the works here with the concept of “reasonableness.” Costs that can be considered unreasonable are not deductible. The question arises as to what constitutes reasonable entertainment. This decision must be made on a case-by-case basis based on the specific circumstances. It is clear that you do not have to take your business partners to a fast-food joint just to qualify for a tax deduction. However, how expensive it can be depends on what is generally considered reasonable and the prevailing industry standards. Therefore, it is generally advisable to exercise restraint in such situations to avoid disputes with the tax authorities. If entertainment expenses are deemed unreasonable, they cannot be claimed for tax purposes.

Observe documentation and record-keeping requirements

As a rule, the tax office requires appropriate documentation for expenses. This also applies to entertainment expenses. Business owners should therefore always ensure they have appropriate documentation and comply with record-keeping requirements. In this context, the amount and the business purpose must be documented in writing in a timely manner. There are standard forms available that include the location, date, participants, occasion, and amount of the expenses. It is important that the documentation be signed by the taxpayer. It is also necessary to retain any invoices along with the records and submit them to the tax authorities. Furthermore, it is important to note that all food and beverages consumed must be listed individually. Additionally, all participants in the meal must be listed by name. An error in the record-keeping may result in the costs not being recognized as business expenses.

Tax Consulting in Düsseldorf and Oberhausen

Provided you adhere to the guidelines outlined in this article, you can easily deduct entertainment expenses as business expenses as an entrepreneur. Finally, we must point out that deviations and special provisions may always arise in tax law and certain individual cases. If you have any questions or feel uncertain about how to handle entertainment expenses, you should consult a tax advisor. Of course, you can also delegate all tax-related tasks to a tax advisor, who will ensure the proper handling of entertainment expenses in this context. Nevertheless, the preliminary work—that is, correctly filling out the documentation—must always be done by you as the business owner. Therefore, you should internalize the information from this article and keep it in mind going forward.

Are you looking for a tax advisor in Düsseldorf or Oberhausen? With our offices, we at Trimborn . Partner are the ideal point of contact for business owners. We assist you with all tax-related questions and concerns. You’ll benefit from our expertise in tax law and avoid mistakes on your tax return. Contact us to schedule a consultation.