I found this interesting article please read
By Bonnie Lee
Published November 26, 2010
Holiday season is here and what better way to establish goodwill with employees and customers than throwing a rip-roaring holiday party? Besides, you can write it off, right? There is a classification on the tax return for meals and entertainment expense--so why not? Not so fast.
Smug IRS agents love nothing better than quizzing you about your holiday party then joyfully proclaiming, “disallowed!” There are rules. And essentially, the rules say, “If you’re having way too much fun, it’s not a deductible expense.” But let me quit mincing words here and give you the real lowdown.
Rule No.1 Any entertaining you provide must be directly related to the active conduct of your business or associated with a directly-related discussion that preceded or followed the meal or entertainment. This means that giving a party for the sake of establishing goodwill is not enough to make the transaction deductible.
In order to deduct the cost of the party, you must conduct business before, during, or after the party. So we’re talking product demonstration, the debut of a new product or service, or a sales pitch. And the environment must be conducive to conducting business; the IRS believes it is impossible to convince a table-dancing drunk with a lampshade on his head to try your new product.
The IRS once disallowed the write-off of tickets to a baseball game because the loud atmosphere at a ball park does not allow for a comprehensive business discussion.
Rule No. 2 The guest list determines the extent to which you can write off the party. So if you are following Rule No. 1, you have a 100% write off if:
1. The party is open to the general public, or
2. The party is for employees and their spouses
You follow the 50% limitation rules that apply in general to meals and entertainment and write off half the cost if:
1. The party is for customers and prospective customers and/or
2. Independent contractors associated with your firm (they cannot be classified as employees for this purpose).
There is no write off for attendance by family members, even if they are employees or owners. The expense is considered personal and no deduction is allowed. If there is a mix of employees, customers, and family members, allocate the expense and deduct accordingly. For example, if 10 employees and 30 customers attend, and the party costs $400, you may deduct 100% of 25% of the cost (employees) and 50% of the remaining cost (customers). Your deduction works out to $100 (cost allocated to employees) + $150 (cost allocated to customers) for a total write off of $250.
Rule No. 3 The entertainment may not be “lavish or extravagant.” That’s another one of those subjective, gray areas that can be argued all the way up to tax court. But why go there? Keep it simple. If your company grosses $100,000 a year, you likely shouldn’t be helicoptering in your guests.
It’s fine that you follow the rules, but proving you did is another matter. You want to have documentation to prove your case in the event of audit. Here are some tips:
1. Make sure the invitation announces a business purpose. For example: “Come drink in the holiday season and test drive our new cholesterol-free egg beater omelets.”
2. Keep a guest list. Have attendees sign a guest book or track RSVPs so you can prove an accurate allocation of the expense.
3. Take pictures of guests looking at your new products or a video clip of your product demonstration--anything that proves the business purpose.
4. Keep all receipts for all expenses incurred.
5. Maintain all of the above documentation in your tax file.
One final tip: When providing the expenses to your bookkeeper, separate the cost of the party that is 100% deductible to a different category from “Meals and Entertainment.” Track it under “Promotion” or “100% Entertainment” to ensure the full write-off at tax time. Otherwise, your accountant will likely apply the 50% rule to everything under “meals and entertainment” and you will have lost a valuable write-off.