When you know the employee entertainment rules, you can party with your employees and deduct 100 percent of the cost. In this blog post, you will learn the following:
- What it takes 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
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 may also qualify for the 100 percent entertainment 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.
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
- highly compensated employees (employees who are paid more than $130,000 in 2021);
- anyone, including you, who owns at least a 10 percent interest in your business (this is called a “10 percent owner”); or
- any members of the families of 10 percent owners, 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 account for more than 50 percent of the use of the entertainment facility, or in the case of a party, a majority of the attendees must come from the untainted employee group.
Documentation tip. You can measure “primary” by days of use, time of use, the 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.
Easy-to-Meet Business Purpose Requirement
As you may remember, 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.
What’s your ordinary and necessary reason for partying with your employees? 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 has.
Documentation
You must document your 100 percent deductible employee entertainment expenses, just as you must document other expenses.
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. This test is easy to meet, but like all deductions, you can’t nail it down without writing it down. 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 company picnic in the non-restaurant business meals category and lose 50 percent of the deduction when you file your tax return. “Employee welfare benefits” has a logical ring to it as a chart of accounts category for the 100 percent employee entertainment deductions. It also matches a category in most business tax returns.
Takeaways
You have to appreciate that the tax code favors your employee outings and grants you a 100 percent tax deduction for such outings.
Make sure you document that your outings primarily benefit the employees and not the tainted group. Also, make sure to put the expenses into a chart of accounts category where you will realize the full 100 percent deduction.
The opportunities for employee entertainment are excellent. If you would like to discuss this further, please give me a call on my direct line at 509-543-7600 or send a request HERE.
June 2021
This blog does not provide legal, financial, accounting, or tax advice. This blog provides practical information on the subject matter. The content on this blog is “as is” and carries no warranties. TaxMedics does not warrant or guarantee the accuracy, reliability, and completeness of the content on this blog. Please contact us directly to discuss how this information may be used based on your actual facts and circumstances.