How to properly deduct Meals and Entertainment Expenses!
When it comes to managing expenses as a small business owner, the biggest gray zone for many entrepreneurs are Meals and Entertainment (M&E) deductions. Many business owners are liberal with these write-offs, which can be a recipe for trouble if not handled correctly. To keep you on the right side of the tax man, I want to walk you through what is and is not deductible when it comes to M&E, along with best practices for tracking these expenses.
In the corporate world, M&E expenses often seem like a free-for-all. Many corporations appear to spend freely, from lavish dinners to expensive outings and parties. However, for most large corporations, the amount spent on meals and entertainment is minuscule compared to their overall revenue. It’s a drop in the bucket, so it doesn’t raise any red flags.
But, a large M&E deduction can stand out like a sore thumb for small businesses where every dollar counts. The Canadian Revenue Agency (CRA) looks closely at businesses that show disproportionately high expenses in this area. After all, M&E expenses must be necessary to earn your revenue and reasonable to be deductible.
Let’s dive into what that means and how you can protect yourself.
The Golden Rule: Business Purpose Is Key
Here’s the bottom line: If you’re ordering lunch for yourself, it’s not deductible.
Why? Because it’s a personal expense.
The CRA is clear that meals must have a business purpose. If you buy food for personal consumption using your business account, that amount needs to be classified as a shareholder draw, which will be included in your income in one way or another at tax time.
In order for an expense to qualify as a deduction, the following criteria must be met;
Someone from your business must be present at the meal. This could be you, an employee, or a business partner.
The meal must be attended by a client, employee, customer, consultant, lead, or business partner. In short, it should involve someone relevant to your business operations.
The cost must be reasonable. Yes, you can treat your clients… but don’t expect to write off a $1,000 bottle of champagne. If your bill seems excessive, only a reasonable portion will be deductible.
Best Practices for Meals and Entertainment Write-Offs
If you want to stay out of hot water, keeping detailed records is a must. It’s not just about saving receipts; you need to provide documentation showing the business purpose of the meal. Here are a few tips to help you stay organized and compliant:
Always keep both the credit card slip and the itemized receipt. CRA auditors will want to see exactly what was purchased, not just the total.
Note who the meal was with and why. If you get audited, the CRA could ask you for this information. Consider using a document retention software such as Hubdoc, which integrates with accounting tools like QuickBooks and Xero. It allows you to snap a photo of the receipt and jot down these crucial details.
If you follow these practices, you’ll be ready to justify your expenses if the CRA comes knocking.
The 50% Limitation: What it Means for You
Most of your M&E expenses are tax deductible at 50%. This rule applies to the cost of food, beverages, and related expenses like taxes and tips.
For example, let’s say you take a client out for a meal that costs $100. When tax season rolls around, only $50 of that meal can be deducted from your taxable income. It’s important to note that this 50% limitation applies across the board, even to things like restaurant gift certificates.
But there are exceptions to this rule. In the following scenarios, you are able to deduct the total cost of meals and entertainment.
Exceptions to the 50% Limitation
Some circumstances allow you to write off 100% of your M&E expenses. Here are a few scenarios where the full amount is deductible:
Meals & Entertainment as part of your core business: If your business revolves around M&E (e.g., you own a restaurant or a catering business), you can deduct 100% of the M&E expenses that are directly tied to business activities.
Fundraising events for a registered charity: If you’re sponsoring or hosting a charity event, the full cost of food and beverages may be deductible.
Reimbursement by a client: If you incur meal expenses reimbursed by a client, you can claim a full deduction for those expenses, provided the reimbursement is indicated in your invoice. Note: the 50% limitation will apply to your client when they claim the expense on their taxes.
Meals for employees at remote locations: If your employees work where they can’t reasonably be expected to maintain a domestic residence, you can deduct 100% of the cost of their meals while they are at that location (carrying out business, of course!).
Employer-sponsored events: Hosting an event for your employees? You’re allowed up to six employer-sponsored events per year where you can deduct the total cost of food and entertainment. The key here is that the event must be available to all employees, not just a select few.
Special Considerations for Travel and Events
There are also rules around M&E expenses while travelling. For example, meals and entertainment provided on airplanes, trains, or buses are not subject to the 50% limitation as long as the cost is included in the travel fee. However, this exception doesn’t apply to food and entertainment provided on boats or ferries. In those cases, the 50% limitation does apply.
Regarding events like Christmas parties or team-building days, the cost of food and entertainment can be fully deducted if the event is open to all employees. This even extends to the spouses and children of your employees if they’re invited.
What About Subsidized Meals?
If your business operates a cafeteria or provides subsidized meals to employees, be cautious. While meals provided to all employees may not be subject to the 50% limitation, subsidized meals could result in a taxable benefit for employees if they don’t pay a reasonable charge for them.
A Word of Caution
Remember, claiming M&E deductions isn’t a free-for-all. The CRA scrutinizes these expenses closely because they are often abused. If you’re audited, the CRA will want to see that your expenses meet the necessary criteria and that your deductions are reasonable. This is why proper record-keeping is so important.
Conclusion
Meals and entertainment can be a valuable write-off for your business, but only when done right. Remember the golden rules: there must be a business purpose AND the costs must be reasonable. By staying organized, maintaining detailed records, and understanding the 50% limitation, you’ll be in good shape to claim these deductions without raising any red flags.
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