When it comes to celebrating the end of the year, it’s natural to throw a holiday party for employees, clients, potential clients, and friends. You want to share successes, tout on exceptional performances, shmooze hopeful clientele, and thank repeat patrons. It makes sense that party expenses would be deductible. Not so fast, jack. The IRS has some guidelines for those party deductions. If you want to stay out of the audit room, but still maximize the subtraction column when your taxes come due then read on about these holiday party deductions.
Office Party Tax Deductions: Know Who is Deductible
Employees, clients, potential clients, friends; holiday tax deductions apply differently to them all. A party that is thrown solely for employees (and employees families) is likely 100% tax deductible; as long as it isn’t deemed too extravagant. The IRS does not give a number that indicated extravagance; instead, auditors base the number on what seems reasonable. Thousands of dollars spent at a large company makes sense, whereas a smaller company would spend less. That’s not to say you can’t throw a great bash for the people that help you stay in business but use common sense. Spending exorbitant amounts of money for one soiree could raise some red flags. As a guideline, make sure that the amount spent on this one event is not a major portion of your total yearly expenses.
Prospective Clients to the Party
If you invite customers or prospective clients to the party, your expenses and deductions get a little more complicated. It is permissible to deduct 50% of the cost spent on non-employees, however, in order to do so, the party will have to feature a substantial business activity. In other words, the purpose of the gathering must be primarily for a business presentation, reveal, or the like (as opposed to entertainment). For example, having an annual meeting around the holidays with presentations would be considered a substantial business activity, whereas a five minute “we killed it this year” speech during the middle of a dance party would not. The discussion can happen immediately before, during, or immediately following the event, but the key word here is “substantial”. For more information, see IRS Publication 463.
If you decide to invite friends to your company Christmas party (friends that are neither clients, prospective clients, employees, or employee’s families) then you are not allowed any deduction. Think of it as throwing a party for your friends out of your personal account; this is how the IRS views it.
Keep a Guest List
No matter who you decide to invite to your holiday party, be sure to keep a guest list. This will help, should you ever get audited. You can prove who attended and which costs are deductible. The guest list should be totaled by customers, employees, and friends if an allocation of the expense is to be used. You can do this by asking your guests to sign in at a registration table, you can have them sign up for a raffle, have them wear name tags that you collect at the end of the evening, or write their name on a Christmas ornament and hang it on a tree, which you later collect.
Whichever way you decide to keep track of attendance, make sure that your bookkeeper is aware of the allocations and division of expenses. Your tax professional should also be apprised of this transaction separately from other entertainment expenses that you incur during the year in order for it to show up properly on the tax return.
Save the Invitation
Again, documentation is key. Keep a copy of the invitation and file it away with the tax expenses. If you have clients attending, make sure you note the business presentation that will be made. If you can, make an itinerary and file that away as well. It’s also a good idea to video your presentation to keep in case of an audit. It might make a nice marketing piece as well!
It goes without saying that your accountant should keep all other paperwork (receipts, invoices, etc.) associated with the party. Make sure to deliver them to your bookkeeper and accounting personnel.
Celebrate Your People
This isn’t an accounting tip, so much as an HR suggestion. When brainstorming ideas for the holiday party, know your employees. If they are jeans and t-shirt kind of people, they may want to eat a casual lunch and play card games with their families. If they’re the more sophisticated types, a fancy dinner and smooth jazz band may be the ticket. Just remember to have fun! This is a celebratory time of year; what’s more, you want your employees to feel doted upon. Appreciation can go a long way throughout the year and now is a perfect time to show it (and get the tax deduction).