Some lenders in my office don’t subtract the 50% meals and entertainment because they figure the owner/employees have to eat anyway. Is this a judgment call? It can be a significant amount for our higher income borrowers.
1) Check your guidelines.
2) Understand what is in ‘meals and entertainment’ (and the risk of ignoring the 50% out-of-pocket nondeducted cash outlay).
In the last year, I saw a 1040 Schedule C with $63,000 nondeducted meals and entertainment. Is that an outlay you’d want to ignore?
Half of what is spent on meals and entertainment is deductible. It follows that the other half is not. Meals are deductible if the borrower is traveling or if the meal is business related.
Entertainment 1 is deductible if it is an ordinary 2 and necessary 3 expense to entertain a client, customer or employee and the expenses meet the directly-related 4 or the associated 5 test. It cannot be lavish and extravagant. (And no, that is not well defined.)
If your borrower is being honest and forthright with their tax return (and all of your clients are, right?) then they are asserting that these expenses are needed to do their business successfully. That really does not sound like ‘they gotta eat anyway’. Let’s flesh out the definitions:
- Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation, and includes meals provided to a customer or client.
- 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, although not necessarily required, for your business.
- Directly-related. Entertainment
- took place in a clear business setting, or
- main purpose of entertainment was
- the active conduct of business, and
- you did engage in business with the person during the entertainment period, and
- you had more than a general expectation of getting income or some other specific business benefit.
- is associated with your trade or business, and
- directly precedes or follows a substantial business discussion.
I know, it would be nice not to have another thing to find and subtract. The key is to count it against the borrower if it is significant and needed to conduct business. Your bank or credit union needs a consistently applied guideline to, well, guide you.