Mixing business with pleasure enables companies to write-off expenses. Understanding deduction and documentation regulationswill help keep you in line with the IRS.

Most business owners want to be as shrewd and tax savvy as possible. They want to take advantage of every available deduction in order to minimize taxes. But there is a danger in being too aggressive, particularly when dealing with entertainment expenses. In my experience, taxpayers who are found by the Internal Revenue Service to be taking impermissible write-offs for these types of expenses come under increased scrutiny by the IRS with respect to their entire tax return.

Consider the experience of one business owner whom my firm recently represented. In 2001, the Internal Revenue Service audited his corporate tax return and disallowed approximately $8,000 of the $15,000 of entertainment expenses taken on the return. Most of the expenses were for dinners, baseball tickets, and shows, and there were very few records other than the receipts showing the expenditure. Since 2001, the corporation has undergone three additional corporate tax audits by the IRS. This taxpayer was obviously targeted as a result of the initial audit.

You can avoid this type of problem by understanding both the deduction rules and the documentation rules. Generally, for an expense to be deductible as a businessexpense, it must be both ordinary and necessaryand related to your business. An “ordinary” expense is one that is common and accepted in your industry. A “necessary” expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.

The rules get a little more specific with respect to entertainment expenses. In order for an entertainment expense to be deductible, it must meet the ordinary and necessary test, and in addition, must meet one of two tests: either the “directly related” test or the “associated” test.

An entertainment expense meets the directly related test if it takes place in a clear business setting or the main purpose of the entertainment is the active conduct of business. You must actually engage in business discussions while the entertainment takesplace. Finally, you must have a general expectation of getting income or some other specific benefit from the entertainment. Thus, taking a customer or a referral source to a ballgame and discussing business during the game would qualify as a business expense, so long as you expected to gain additional customers or business as a result of the time spent with your client or referral source.

An entertainment expense will meet the associated test if the entertainment is associated with your trade or business and the entertainment directly precedes orfollows a substantial business discussion. For example, if you conduct a short seminar for clients followed by a lunch, the cost of the lunch would satisfy the associated test.

Even assuming that you satisfy the requirements described above, your deduction is not secure until you meet the documentation or record keeping requirements associated with the expense. For entertainment expenses, you are required to keep a record of the date of the entertainment, the location or place of the entertainment, the type of entertainment (if it is not otherwise apparent), and a record regarding the nature of the business discussion or activity and the identities of the persons who took part in the business discussion. It’s also a good idea to include in your records information regarding the guest’s occupatio nor other information that shows his or her relation to your business. If you keep a calendar, writing down this information in your calendar is a good way of documenting your expense.

Business entertainment expenses are allowable taxw rite-offs as long as you aren’t too aggressive. So go ahead and mix business with pleasure, just make sure you follow the rules.

Michael P. Coyne is a founding partner of the law firm,Waldheger Coyne, located in Cleveland, Ohio. For moreinformation on the firm, visit www.healthlaw.com, or call440-835-0600.