20.18 Directly Related Dining and Entertainment

The directly related test limits the deduction of dining and entertainment costs at restaurants, nightclubs, on yachts, at sporting events, on hunting trips, and during social events.

The directly related test for dining and entertainment costs may be met in one of three ways: (1) under the generally related test; (2) as expenses incurred in a clear business setting; or (3) as expenses incurred for services performed. If dining or entertainment fails to meet the directly related tests, it may qualify under the goodwill entertainment rules (20.19), which require the holding of a business discussion before or after the entertainment.

Generally related test.

Under this test, you must show a business motive for the dining or entertainment and business activity during the entertainment. You must show that you had more than a general expectation of getting future income or other specific business benefit (other than goodwill). Although you do not have to prove that income or other business benefit actually resulted from the expense, such evidence will help support your claim. What type of business activity will an IRS agent look for? The agent will seek proof that a business meeting, negotiation, or discussion took place during the period of dining or entertainment. It is not necessary that more time be devoted to business than to entertainment. What if you did not talk business? You must prove that you would have done so except for reasons beyond your control.

Clear business setting test.

Expenses incurred in a clear business setting meet the directly related test provided also that you had no significant motive for incurring the expenses other than to further your business. Entertainment of people with whom you have no personal or social relationship is usually considered to have occurred in a clear business setting. For example, entertainment of business representatives and civic leaders at the opening of a new hotel or theatrical production to obtain business publicity rather than goodwill is considered to be entertainment in a clear business setting. Also, entertainment that involves a price rebate is considered to have occurred in a clear business setting, as, for example, when a hotel owner provides occasional free dinners at the hotel for a customer who patronizes the hotel.

The cost of a hospitality room displaying company products at a convention is also a directly related expense.

Entertainment occurring under the following circumstances or in the following places is generally not considered as directly related:

• You are not present during the entertainment.
• The distractions are substantial, as at nightclubs, sporting events, or during a social gathering such as a cocktail party.
• You meet with a group that includes persons other than business associates at cocktail lounges, country clubs, golf and athletic clubs, or at vacation resorts.

Planning Reminder

Scheduling Entertainment and Business Discussions

A business discussion generally must take place the same day as the dining or entertainment. If not, and your deduction is questioned, you must give an acceptable reason for the interval between the discussion and the dining or entertainment. IRS regulations recognize that a day may separate a business meeting and the entertainment of an out-of-town customer. He or she may come to your office to discuss business one day and you provide entertainment the next day, or you provide the entertainment on the first day and discuss business the day after.

The IRS does not estimate how long a business discussion should last. But it does warn that a meeting must involve a discussion or negotiation to obtain income or business benefits. It does not require that more time be devoted to the meeting than to the entertainment.

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Services performed test.

An expense is directly related if it was directly or indirectly made for the benefit of an individual (other than an employee) either as taxable compensation for services he or she rendered or as a taxable prize or award.