You take your employees to a hotel meeting room for an all-day intensive training. You buy them lunch. The cost of the training lunch creates a 50 percent tax deduction. You take your employees and their spouses and children to the local country club, where they play golf, play tennis, swim, and enjoy lunch, dinner, and snacks. The cost of the country club meals and activity produces a 100 percent tax deduction.
In this blog, you will learn the following:
- What it means to qualify an employee party for the 100 percent deduction.
- What types of employee entertainment qualify for this 100 percent deduction.
- How tax law defines entertainment that’s primarily for the benefit of employees.
*We have touched on meal deductions under the TCJA, you can read about that here!
Big Tax Deduction for Employee Entertainment
The IRS says that the following types of entertainment qualify for the 100 percent employee entertainment tax deduction:
- Holiday parties, annual picnics, and summer outings
- Maintaining a swimming pool, baseball diamond, bowling alley, or golf course.
The IRS makes it clear that the above are examples, and that other types of entertainment also qualify for the 100 percent deduction. The tax code states that “expenses for recreational, social, or similar activities (including facilities, therefore) primarily for the benefit of employees” qualify for the 100 percent deduction.
The 100 Percent in Action
Here is how the full tax court treated a case that’s broader in scope than one involving a holiday party or summer picnic. During one year, American Business Service Corporation rented a powerboat 41 times at a cost of $1,000 a day for daylong recreational cruises for its employees and their guests. The company had roughly 100 employees, but the boat would accommodate only about 30 people at a time.
All employees, including owners, managers, and rank-and-file personnel, were eligible to take these cruises, but they had to sign up in advance on a first-come, first served basis. The court allowed the full $41,000 deduction for the 41 cruises because of the cruises
- were primarily for the employees,
- did not discriminate in favor of the owners and highly compensated employees,
- were documented as to who cruised and when, and
- passed the “ordinary and necessary” business purpose test.
What About You
What things do you do, or could you do, primarily for the benefit of your employees? You will learn below that the word “primarily” means “more than 50 percent.” Thus, a cruise in the harbor with your two non-family-member employees is primarily for the benefit of the employees. Let’s say you have a beach home. Suppose that during the year, your employees use the beach home on more days than you use the beach home. Presto! With an ordinary business-use reason, which we discuss later, you have a beach-home deduction.
Who Are These Employees?
Technically, the law requires that the entertainment expenses be primarily for the benefit of employees other than a “tainted group.” The tainted group consists of a highly compensated employee (an employee who is paid more than $125,000 in 2019); anyone, including you, who owns at least a 10 percent interest in your business (this is called a “10 percent owner”); or any member of the family of a 10 percent owner, i.e., brothers and sisters (including half brothers and half sisters); spouses; ancestors (parents, grandparents, etc.); and lineal descendants (children, grandchildren, etc., including adoptees).
As the business owner, you belong to the tainted group. That’s not a big deal. You just need to make sure that partying with the employees is primarily for the benefit of the employees.
“Primary” Means “More Than 50 Percent”
In tax law, the words “primary” and “primarily” mean “more than 50 percent.” For employee recreation, that means the untainted group of employees has to have more than 50 percent use of the entertainment facility, or in the case of a party, a majority of the attendees come from the untainted employee group. Documentation tip. You can measure “primary” by days of use, time of use, number of employees, or any other reasonable method. Regardless of how you measure use, the keys to your deductions are the records that prove the uses.
Business Purpose Requirement—Easy to Meet
The Tax Cuts and Jobs Act eliminated deductions for business entertainment, but not for entertainment primarily for the benefit of employees. You still need to satisfy the overriding standard for business expense deductions, which is the ordinary and necessary business purpose test. Fortunately, this test is easy to pass. Basically, an ordinary and necessary expense simply means an expense that is “appropriate and helpful” for your business. To meet the test, the expense does not have to happen often or be a recurring expense.
Your reason might be as simple as improving employee morale and loyalty to your business. Or you may want to ensure that your business is more fun and has better working conditions than the competition.
You must document your 100 percent deductible employee entertainment expenses, just as you must document other entertainment. Documentation tip. When recording the expenses for an employee party, outing, or other types of entertainment, be sure to note your business reason for the entertainment.
- If it’s an annual event to improve employee morale and loyalty, write that down.
- If there’s a more specific reason, such as an office party to celebrate a fat new contract, write that down.
The point is, you need a reason, and you need to write it down. The test is easy to meet, but like all deductions, you can’t nail it down without writing it down.
Chart of Accounts
In your chart of accounts, make sure you have a category for the 100 percent deductible employee functions. Without a category, you could mistakenly put the summer picnic in the business meals category and lose 50 percent of the deduction when you file your tax return. Employee welfare benefits as a chart of accounts category has a logical ring to it as a location for the 100 percent employee entertainment deductions.
You have to appreciate that the tax code favors your employee outings and grants them a 100 percent tax deduction. Make sure you document that your outings primarily benefit the employees and not the owner and highly compensated group. Also, make sure to put the expenses into a chart of accounts category where you will realize the full 100 percent deduction.