Travel and entertainment expenses for business have always been deductible. These expenses are considered an integral part of businesses maintaining client relationships and developing new potential clients. After all, business is about maintaining current clients and obtaining new ones. Therefore, the tax deductions for these expenses have been and now are permitted as legal business expense tax deductions.
The Tax. Reform Act of 1986
It became apparent under the Jimmy Carter administration that some of these legal tax deductions were being abused. Consequently, Congress decided to change the tax law. At first Congress wanted to forbid any business from taking a deduction for any alcoholic drinks. But on second thought1 Congress decided not to do this. In addition, Congress still thought that excessive deductions for alcoholic drinks should not be permitted nor should excessive entertainment expenses be permitted. For example; front row tickets to the Super Bowl or the World Series when paying scalper prices would not be an appropriate expense. So, Congress decided to exclude 50 percent of all entertainment and business meals expenses. Congress called this the "three martini" business lunch rule, a name that has stuck and can be found in basic tax textbooks and in various business articles.
Therefore, instead of limiting the definition of a tax deduction Congress decided to limit all meal and entertainment expenses to 50 percent of expenditures. Under the Tax Reform Act of 1 986, a business can still allow clients or potential clients to have "three martinis" at lunch but the tax deduction would be limited to 50 percent. The actual law can be found in The Internal Revenue Code Section 274.
As to tax deductible entertainment expenses, the tax code does not differentiate between what entertainment is acceptable and what is not. If one takes a client or potential client to the symphony it should be deductible as an entertainment expense. If one goes to a baseball game, that too would be deductible. But what if one takes a client to a wrestling match? The answer is that the tax code does not judge the quality of entertainment. As long as it is a legal activity, it can be a tax deduction.
This article will discuss selected U.S. Tax Court cases involving travel, meal and entertainment expenses. Cases will be cited from court decisions and the actual IRS code. The cases cited may seem to be, and in many cases are, contradictive. Most cases selected for analysis have occurred since the "Tax Reform Act of 1986" but some older cases were selected to demonstrate the historically contentious nature of business expense deductions claimed by corporate and individual taxpayers.
It can be tempting for a corporation or business owner to claim unsubstantiated travel, meal and entertainment expenses as business expense deductions. The non-deductible portion of travel expenses, and meal and entertainment expenses subject to the 50 percent reduction rule represent a dollar for dollar reduction in the gross income, thereby reducing taxable income.
Throughout the research of applicable cases it, became apparent that when travel, meal and entertainment expenses were disallowed by the courts, it almost always involved a lack of proper substantiation on the part of the taxpayer, whether corporate or individual, under IRS Code, Section 274(d). This paper will present multiple cases demonstrating this fact. Although this is only a small sampling of cases available for study, it provides a good understanding of some of the pitfalls involved in claiming business expense deductions and substantiating business expenses.
This article will attempt to provide the reader with guidance on how each of the cases involving disallowed deductions could have been properly handled and reported by the taxpayer in order to avoid unnecessary penalties or assessments of additional tax liability.
Churchill Downs Inc. …