Personal Productivity for Lawyers
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While dating is not a typical business activity, one prospective client asked if he could claim a business deduction for online dating activities including his monthly subscription fee, meals, and entertainment expenses. While every woman he met online ultimately rejected him for a long-term personal relationship, they continued to maintain a friendly business relationship. A few even referred customers to him.
Using this situation as a backdrop, we will cover the basic business entertainment deduction rules if you are an attorney seeking to entertain clients, potential leads, and other sources of business. The rules, detailed in IRS Publication 463, are complex, vague, and, to a degree, rely on the honor system. The interpretation of these rules is complicated further by the elements of personal recreation and pleasure often involved in business entertainment.
Because of this, some will misunderstand or even abuse the rules. But don’t be afraid to take deductions that you are legally entitled to.
By understanding these rules, you can confidently write-off fifty percent of your business entertainment expenses and structure your entertainment activities to make them tax-deductible.1
According to the IRS, entertainment includes any activity generally considered to provide amusement or recreation. Examples include (but are not limited to) entertaining your guests at these places:
- Social, athletic, and sporting clubs
- Sporting events
- Hunting, fishing, vacation, and similar trips
For an entertainment expense to be deductible from your self-employed income, it must pass two tests:
- The “ordinary and necessary business expense” test.
- Either the “directly related test” or the “associated test.”
Dues Are Not Tax-Deductible
Unfortunately, your dues (including initiation fees) for membership in any club organized for business, pleasure, recreation, or other social purposes are not deductible as a business expense. This also includes country club memberships (which Treasury Regulations particularly disapprove of deducting) and your online dating subscription fee.
Ordinary and Necessary Expenses
As mentioned previously, your expense is ordinary if it is customary in the industry. An expense is necessary if it is appropriate and helpful in developing and maintaining a business. An expense will be deemed a nondeductible personal expense if business activities are incidental.
Finally, the expense must be reasonable. This means that the expense must not be overly lavish. It would be unreasonable to spend $44,882 for two ringside tickets to the Pacquiao-Mayweather fight to entertain a client who will pay a maximum of $10,000 in legal fees with no expectation of future business or referrals.
Entertainment deductions — particularly meals — should not be deducted on a regular basis with the same people because it will not be recognized as a reasonable business expense.
In Moss v. Commissioner, attorneys in the same law firm met for lunch daily at a local restaurant to discuss their ongoing cases. On their tax returns, they deducted the costs of the meals as a business expense. The court disallowed the deduction, finding that eating lunch daily is a routine personal expense, even when you discuss business during the meal.
As a solo or small firm attorney, clients generally come from referrals in your network. Therefore, it is customary, appropriate, and helpful to meet with potential clients, colleagues, or referral sources over a meal or an entertainment event to develop trust and rapport.
As for our online dater, while he failed to capture the heart of his dates, he was able to capture their business. Since he can prove that he met referral sources and obtained clients through his dates, he can prove that his expenses — aside from his dues — were ordinary and necessary.
Directly Related Test
There are two ways to prove that an entertainment expense is directly related to the active conduct of your business. One way is to show that the entertainment took place in a clear business setting. This is viewed objectively, so nightclubs, theaters, sporting events, country clubs, or social gatherings, such as cocktail parties, are not considered to be clear business settings.
If the entertainment does not take place in a clear business setting, the directly related test can be met if you can show that you engaged in good faith business activities, and the main purpose of the entertainment was the active conduct of business. That said it is not enough to just show a general expectation of income or a specific business benefit.
As an attorney, it will be harder to prove that your entertainment expense meets the directly related test because said expenses are incurred with a general expectation of income or a specific business benefit. In other words: networking and establishing goodwill.
You may meet potential clients and referral sources for the first time at social gatherings, charity functions, birthday parties, and other places that are not clear business settings.
Therefore, our online dater will fail the directly related test. No one goes on a date at a “clear business setting.” Also, even if an active conduct of business occurred, the main purpose of a date is to get to know a potential romantic partner.
If an entertainment expense fails the directly related test, then you have one more test available to you.
An entertainment expense can be deductible as a business expense for two reasons:
- It is associated with the active conduct of trade or business
- The entertainment event takes place before or after a substantial business discussion. This requirement is met if the entertainment is held on the same day as the business discussion.
The associated test is more flexible than the directly related test. IRS Publication 463 defines how the associated test is applied:
Generally, an 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.
Whether a business discussion is substantial [for the purposes of the associated test] 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.
You will have a better chance at deducting your business related entertainment expenses under the associated test. The associated test permits meeting and discussion to establish goodwill and does not have a time requirement to discuss business. But these expenses may be disallowed as a nondeductible personal expense if they are connected to regular meetings with the same people.
Under the associated test, you may also be able to deduct dating expenses. For instance, if there is no romantic chemistry, you should switch the topic of discussion to business and keep it that way. If there is a possibility of a future business relationship, then any entertainment expenses incurred after the discussion can be tax deductible. That gives our online dater the ability to deduct expenses using the associated test as well.
Finally, if you meet that special someone, can you deduct the entertainment expenses from your dates even though your activities could pass the above tests? I wouldn’t recommend it. The IRS is very suspicious of transactions between related parties. So although you lose the tax deduction, remember you have gained a priceless and nontaxable relationship.
Originally published 04-08-15. Republished 05-06-16.
Featured image: “Revenue Service IRS Finance Taxation Government Concept ” from Shutterstock.
Generally, meal and entertainment expenses under seventy-five dollars do not require a written receipt. Regardless, you should record the amount spent, the time and place of the event, its business purpose, and the business relationship of the individuals involved. ↩