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Meal and entertainment tax rules

Britannia Restaurant
Cunard QM2. Britannia Restaurant, under Creative Commons license, on Flickr

Special rules for Meals and Entertainment

Congress decided there was a higher chance for fraud or errors in deducting meals and entertainment. Consequently, Congress enacted Section 274 of the Internal Revenue Code in 1962 creating special meal and entertainment tax rules. There have been quite a few changes to Section 274 but this post will only cover the current rules. Beyond the normal documentation to claim any business deduction Congress added these additional documentation requirements:

  • The amount of each separate expense
  • The date of the event
  • The name, address or location, and designation of the type of activity. For example, dinner or theater, if that information is not apparent from the other information.
  • The business reason for the expense or the nature of the expected business benefit. Include the nature of any business discussion or activity before during and immediately after.
  • The occupation or other information relating to the person(s) attending. Include their name(s), title(s), or other designations, sufficient to establish business relationship to the taxpayer.

Leave something out, IRS will deny the deduction and the courts will uphold the IRS. Congress allowed no leeway for IRS or the courts. A perfect example where Congress needs to allow IRS and the courts some discretion. If you agree, please contact your Representative and Senator.

Per Diem rules

Per Diem expenses must be documented the same as all other meal expenses. If the Per Diem exceeds the federal amount then the employee has to return the excess, or the entire amount, not just the excess, must be included in the employee’s wages.

Conclusion

To sum this post up, want a deduction for meals and entertainment then keep the proper documentation. This is a brief summary of the rules so please contact us for more details or post a question or other comment in reply to this post.

 

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LLC often best for business on side?

So you are employed full-time and want to start a business on the side. You also want some liability protection and in your full-time job make close to or over the Social Security wage limit (i.e. you will owe little or no more Social Security tax on your side business income).

A Limited Liability Company (LLC) may be your best choice. As its name says, your liability is limited compared to the liability you would have as a sole proprietor. Not all types of businesses receive the same liability protection and an LLC cannot typically protect you against liability for your own personal intentional acts. You should check with your attorney so you understand the amount of liability protection you will get.

Another advantage of a single member (owner) LLC is that by default it is ignored for tax purposes and is considered (for most purposes) as just another activity of its owner. So for a single member LLC (SMLLC) owned by a person, the default is to tax the SMLLC as a sole proprietorship. No separate income tax filing is required, just one or more additional forms added to your personal 1040. For a corporation, the SMLLC income and expenses are typically just added to all the other activities of the corporation and reported on the same forms.

If you choose to operate as a multiple member LLC, a corporation, or a partnership then the entity has to file a separate tax return. There are a few limited exceptions to the separate filing requirement for a multiple member LLC when the only owners are spouses but this post will not address them. In addition, if you choose to operate as a corporation, then the corporation will need to put you on payroll and pay you a reasonable salary. This means payroll tax returns with IRS, W-2 filing with Social Security, state payroll tax filings and perhaps workers compensation insurance depending on your state. If you have other employees, adding yourself is not a lot of extra work but if it is just you then look forward to a lot of additional paperwork and additional taxes.

Your corporation has to withhold and match your Social Security taxes as though it is your only employer. So if you are already paying the maximum Social Security taxes, creating a corporation forces the company to pay extra Social Security taxes in its match. You get your additional Social Security taxes credited against your income taxes but the company does not get its match back.

If your business is your main livelihood, a SMLLC taxed as a sole proprietorship may not be your best choice. However, one of the beauties of an LLC is that IRS allows an LLC to elect to be taxed like a corporation. So your SMLLC can start out taxed as a sole proprietorship and later change to be taxed like a corporation. The election to be taxed as a corporation can be arranged to be tax-free and it usually is tax-free. On the other hand, starting as a corporation and then wanting to switch to an LLC not taxed as a corporation is a taxable event. How much tax depends on your circumstances.

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One reason to form an LLC instead of a Corporation

There are other advantages and disadvantages for each entity type. Today I will discuss just one advantage of a Limited Liability Company (LLC) over a corporation. First a little background.

By default an LLC with one owner is ignored as a separate entity. The one owner LLC’s income and deductions are reported on its owner’s income tax return. When there are two or more owners, an LLC is taxed by default as a partnership. But these are the defaults. Quite a while back IRS decided to let LLCs (and some other entities) choose how to be taxed. So an LLC can elect, by filing a form with IRS in a timely manner, to be taxed as a regular corporation (by filing Form 8832) or as an S corporation (by filing Form 2553).

If you want your new company to be taxed as a corporation, why not just form a corporation? Good question. Generally a corporation has to have an annual stockholders meeting even if there is only one stockholder. The stockholder(s) need to elect the board of directors and approve some corporate actions. The board of directors needs to have a meeting and elect officers. The board occasionally meets to approve certain actions. For example, the board may need to approve the company changing banks, the salary of officers, bonuses, and transactions between the company and its stockholders.

The meetings may sound simple but the company must send out notice to eligible participants several days to weeks before the meeting. As an alternative, the corporation can get everyone to sign off waiving advance notice. Then the meetings have to be documented in the company minutes. Generally, even a company owned by one stockholder has to have these meetings and prepare minutes. That is a lot of paperwork to get agreement with yourself. Failure to follow these corporate rules may make it easier for someone suing the company to “pierce the corporate veil” and get at the stockholder(s) personal assets.

On the other hand, LLCs generally do not require annual meetings, minutes and so forth. The LLC can certainly require these steps if it so chooses and if you have a lot of LLC members then it is probably a good idea. However, if only one person is the owner, is it really necessary? Only crazy people will sue themselves because they do not agree with something they themselves did.

Therefore, creating an LLC to be taxed as a corporation can save some administrative paperwork versus forming a corporation.

 Please consult an attorney before acting on anything in this post.