Parties and other events are a great way to engage and reward employees and customers, and it’s also an opportunity to find tax deductions. The rules keep changing, though, so you’ll want to make sure you understand them – and the documentation you’ll need – in order to stay on the right side of the law.
FIRST THINGS FIRST – STAY UP TO DATE
It’s common for blogs on tax topics to say, “this is not tax advice,” but in this case, it’s particularly appropriate. This topic has been a (relatively) fast-moving target lately, and many blog posts about it are outdated. Tax laws for business-related entertainment and meals changed significantly in 2017 and changed again with some temporary rule modifications in 2020. So, make sure the information you are using (including this blog post) is up to date and that you have discussed it with your accountant.
COMPANY PARTIES
The good news is that events for employees can be 100% deductible – including entertainment – but there are several boxes to check before that is the case.
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Events should be infrequent. The IRS specifically cites holiday parties, annual picnics, and summer outings, but those are just a few examples. You have a fair amount of leeway to fund employee events as long as they are infrequent and meet the rest of the guidelines below.
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Events can’t be just for the big bosses. The tax breaks in this area are designed to support the rank-and-file, so to speak, rather than the big brass. So, the law requires that the majority of the attendees not:
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Earn more than $135,000 for 2022 (this usually increases each year)
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Own at least a ten percent interest in the business
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Be a member of the family of a 10% owner – and the definition of family is extensive.
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All employees should be invited. Most interpretations of the law are that it is discriminatory to invite only certain employees, e.g. a party for the sales department is not a deductible “employee party.”
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The event must be for an “ordinary and necessary business purpose.” There are plenty of such reasons to hold employee parties and events – morale building or team building, for example. But for documentation purposes, it’s important to clarify that purpose before holding the event.
If all these conditions are met, then your company party or event should generally be 100% deductible, including entertainment, which ordinarily is no longer a deductible business expense.
You’ll need to document carefully and extensively though, just to be safe:
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Document the reason for the event as noted above. Consider sending out invitations that specifically identify it as a business event.
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Document the attendees. Employees and their spouses and significant others. Children if they were invited. Owners, their families, and highly compensated employees, who – again – should numerically be fewer than “regular” employees and their families.
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Document the costs (of course). Entertainment, food, drinks, and other costs. Also keep in mind that inexpensive (<$25) are also deductible for employees.
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Make a specific category in your Chart of Accounts. To ensure that you don’t mistakenly lump employee event expenses into your general business expenses and lose part of the deduction, add a category such as “100% deductible employee events” to your Chart of Accounts.
MIXED PARTIES
For some businesses, it may be appropriate to invite customers or clients to employee events. Things become a little less clear-cut here, so you’ll want to be sure you are up to date on current tax law and talk about it with your accountant, but a good rule of thumb is that you can deduct 50% of the costs for these attendees. If you thought you should be careful with documentation for employees, you’ll want to be even more careful with documentation for clients.
CONCLUSION
Parties and other events are great opportunities to build camaraderie and a sense of team or family among employees, and to foster goodwill with clients. But the tax rules for such events are strict and require careful planning and navigation to ensure you can claim your deductions with confidence.