Pub 463

You may be able to deduct business-related entertainment expenses you have for entertaining a client, customer, or
employee.

To be deductible, the expense must be both ordinary and necessary. An ordinary expense is one that is common and
accepted in your field of business, trade, or profession. A necessary expense is one that is helpful and appropriate for
your business. An expense does not have to be indispensable to be considered necessary.

In addition, the entertainment expense must meet one of two tests:

1. Directly-related test, or
2. Associated test.

You must also meet recordkeeping requirements.

Even if you meet all the requirements for claiming a deduction for entertainment expenses, the amount you can deduct
may be limited. Generally, you can deduct only 50% of your unreimbursed entertainment expenses. This limit is
discussed later under 50% Limit.

Club dues and membership fees. You cannot deduct dues (including initiation fees) for membership in any club
organized for business, pleasure, recreation, or other social purpose. This rule applies to any membership organization
if one of its principal purposes is to conduct entertainment activities for members or their guests, or to provide
members or their guests with access to entertainment facilities, discussed later.

The purposes and activities of a club, not its name, will determine whether or not you can deduct the dues. You cannot
deduct dues paid to country clubs, golf and athletic clubs, airline clubs, hotel clubs, and clubs operated to provide
meals under circumstances generally considered to be conducive to business discussions.

Entertainment facilities. Generally, you cannot deduct any expenses for the cost of using an entertainment facility. This
includes expenses for depreciation and operating costs such as rent, utilities, maintenance and protection.

An entertainment facility is any property you own, rent, or use for entertainment. Examples include a yacht, hunting
lodge, fishing camp, swimming pool, tennis court, bowling alley, car, airplane, apartment, hotel suite, or home in a
vacation resort.

Out-of-pocket expenses. You can deduct out-of-pocket expenses, such as for food and beverages, catering, gas, and
fishing bait, that you provided during entertainment at a facility. These are not expenses for the use of an entertainment
facility. However, these expenses are subject to the directly-related and associated tests, and the 50% limit, all
discussed later.

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 business 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 sold in the normal course of your business is not
entertainment. Generally, to deduct an entertainment-related meal, you or your employee must be present when the food
or beverages are provided.

A meal expense includes the cost of food, beverages, taxes, and tips for the meal.

No double deduction allowed for meals. You cannot claim the cost of your meal as an entertainment expense if you are
also claiming the cost of your meal as a travel expense.

Deduction may depend on your type of business. Your kind of business may determine if a particular activity
constitutes 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 to the extent they 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 merely because they are more than a fixed dollar amount or take place
at deluxe restaurants, hotels, nightclubs, or resorts.

Allocating between business and nonbusiness expenses. 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. For example, if you entertain a group of individuals that includes yourself, three
business prospects, and seven social guests, only 4/11 of the expense qualifies for the deduction. You cannot deduct the
expenses for the seven social guests because those costs are considered 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. The amount you can deduct for entertainment tickets is generally limited to the face value of the
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:

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

The 50% limit on entertainment does not apply to any expense covered by a package deal involving a ticket to such a
charitable sports event.

Example 1. A golf tournament is organized by the local volunteer fire company with all of the net proceeds from the
event going to the acquisition of new fire equipment. The volunteers will run the tournament. You can deduct the entire
cost of tickets to this event 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 deduction. Also, your deduction is subject to the 50% limit.

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, your deduction is generally limited to the price of a nonluxury box seat ticket.

In determining whether a skybox has been rented for more than one event, each game or other performance counts as
one event. Renting a skybox for a series of games, such as the World Series, counts as renting it for more than one
event. In addition, all skyboxes that 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 X Stadium for three baseball games. The cost of regular
nonluxury box seats at each event is $20 a seat. The allowable amount (subject to the 50% limit) is $600 [(10 seats ╫
$20 each) ╫ 3 events].

Food and beverages in skybox seats. If expenses for food and beverages are separately stated, these expenses can be
deducted 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 circumvent the limited deduction for skybox rentals.

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, it is not directly related.

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. Expenses generally are not considered directly related when entertainment
occurs where, because of substantial distractions, there is little or no possibility of engaging in the active conduct of
business. Examples are:

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.

You may prove that the entertainment is directly related by showing that you engaged in a substantial business
discussion during the entertainment.

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.

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. However, if part of the entertainment expense is for
persons not closely connected with your guests who attended the substantial business discussion, that part of the
expense would not qualify for the associated test.

Substantial business discussion. Whether a business discussion is substantial depends on all the facts of each case.
You must show that you or your representative actively engaged in a discussion, meeting, negotiation, or other business
transaction to get income or some other specific business benefit. You may be able to deduct goodwill entertainment.

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, you must attend the convention or meeting to further your trade or business. In addition, 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. Entertainment that is held on the same day as the business discussion is
considered to be held directly before or after the business discussion. However, 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.

Also, if you or your business associates are from out of town, you must 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 and their spouses 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
business 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 business 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. Furthermore, 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.

In general, you can deduct only 50% of your business-related meal and entertainment expenses. This 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 incurred while:

1. Traveling away from home (whether eating alone or with others) on business.
2. Entertaining business customers at your place of business, a restaurant, or other location.
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 pay or incur 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
incurred 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 rules discussed in this publication.

To determine the actual amount you can deduct if you are an employee, you must apply the 2%-of-adjusted-gross-
income limit on Schedule A (Form 1040).

Example 1. You spend $100 for a business-related meal. If $40 of that amount is not allowable because it is
considered lavish and extravagant, the remaining $60 is subject to the 50% limit. Your deduction cannot be more than
$30 (.50 ╫ $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 ╫ $120).

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

Employee's reimbursed expenses. As an employee, you are not subject to the 50% limit if your employer reimburses
you under an accountable plan and does not treat your reimbursement as wages. Accountable plans are discussed in
chapter 6.

Self-employed. If you are self-employed, your deductible meal and entertainment expenses are generally subject to the
50% limit. However, your expenses are not subject to the 50% limit if you incur these expenses as an independent
contractor, and:

1. Your customer or client reimburses you, or gives you an allowance for these expenses in connection with services you perform, and
2. You provide adequate records of these expenses to your customer or client.

Your client or customer is subject to the 50% limit if he or she can otherwise deduct these 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 tests, 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) pay or incur 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 must prove that your
expenses meet either the directly-related test or the associated test. Your expenses will also be subject to the 50%
limit.

Advertising expenses. You can deduct the cost of providing 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. Expenses under this exception are not subject to the 50% limit.

Sale of meals or entertainment. You can deduct the cost of providing items such as meals, entertainment, goods and
services, or use of facilities, that you actually sell 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. Expenses under this
exception are not subject to the 50% limit.