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1040ez2012 3. 1040ez2012   SIMPLE Plans Table of Contents Topics - This chapter discusses: Useful Items - You may want to see: SIMPLE IRA PlanWho Can Set Up a SIMPLE IRA Plan? Who Can Participate in a SIMPLE IRA Plan? How To Set Up a SIMPLE IRA Plan Notification Requirement Contribution Limits When To Deduct Contributions Where To Deduct Contributions Tax Treatment of Contributions Distributions (Withdrawals) More Information on SIMPLE IRA Plans SIMPLE 401(k) Plan Topics - This chapter discusses: SIMPLE IRA plan SIMPLE 401(k) plan Useful Items - You may want to see: Publications 590 Individual Retirement Arrangements (IRAs) 3998 Choosing A Retirement Solution for Your Small Business 4284 SIMPLE IRA Plan Checklist 4334 SIMPLE IRA Plans for Small Businesses Forms (and Instructions) W-2 Wage and Tax Statement 5304-SIMPLE Savings Incentive Match Plan for Employees of Small Employers (SIMPLE)–Not for Use With a Designated Financial Institution 5305-SIMPLE Savings Incentive Match Plan for Employees of Small Employers (SIMPLE)–for Use With a Designated Financial Institution 8880 Credit for Qualified Retirement Savings Contributions 8881 Credit for Small Employer Pension Plan Startup Costs A savings incentive match plan for employees (SIMPLE plan) is a written arrangement that provides you and your employees with a simplified way to make contributions to provide retirement income. 1040ez2012 Under a SIMPLE plan, employees can choose to make salary reduction contributions to the plan rather than receiving these amounts as part of their regular pay. 1040ez2012 In addition, you will contribute matching or nonelective contributions. 1040ez2012 SIMPLE plans can only be maintained on a calendar-year basis. 1040ez2012 A SIMPLE plan can be set up in either of the following ways. 1040ez2012 Using SIMPLE IRAs (SIMPLE IRA plan). 1040ez2012 As part of a 401(k) plan (SIMPLE 401(k) plan). 1040ez2012 Many financial institutions will help you set up a SIMPLE plan. 1040ez2012 SIMPLE IRA Plan A SIMPLE IRA plan is a retirement plan that uses SIMPLE IRAs for each eligible employee. 1040ez2012 Under a SIMPLE IRA plan, a SIMPLE IRA must be set up for each eligible employee. 1040ez2012 For the definition of an eligible employee, see Who Can Participate in a SIMPLE IRA Plan , later. 1040ez2012 Who Can Set Up a SIMPLE IRA Plan? You can set up a SIMPLE IRA plan if you meet both the following requirements. 1040ez2012 You meet the employee limit. 1040ez2012 You do not maintain another qualified plan unless the other plan is for collective bargaining employees. 1040ez2012 Employee limit. 1040ez2012   You can set up a SIMPLE IRA plan only if you had 100 or fewer employees who received $5,000 or more in compensation from you for the preceding year. 1040ez2012 Under this rule, you must take into account all employees employed at any time during the calendar year regardless of whether they are eligible to participate. 1040ez2012 Employees include self-employed individuals who received earned income and leased employees (defined in chapter 1). 1040ez2012   Once you set up a SIMPLE IRA plan, you must continue to meet the 100-employee limit each year you maintain the plan. 1040ez2012 Grace period for employers who cease to meet the 100-employee limit. 1040ez2012   If you maintain the SIMPLE IRA plan for at least 1 year and you cease to meet the 100-employee limit in a later year, you will be treated as meeting it for the 2 calendar years immediately following the calendar year for which you last met it. 1040ez2012   A different rule applies if you do not meet the 100-employee limit because of an acquisition, disposition, or similar transaction. 1040ez2012 Under this rule, the SIMPLE IRA plan will be treated as meeting the 100-employee limit for the year of the transaction and the 2 following years if both the following conditions are satisfied. 1040ez2012 Coverage under the plan has not significantly changed during the grace period. 1040ez2012 The SIMPLE IRA plan would have continued to qualify after the transaction if you had remained a separate employer. 1040ez2012    The grace period for acquisitions, dispositions, and similar transactions also applies if, because of these types of transactions, you do not meet the rules explained under Other qualified plan or Who Can Participate in a SIMPLE IRA Plan, below. 1040ez2012 Other qualified plan. 1040ez2012   The SIMPLE IRA plan generally must be the only retirement plan to which you make contributions, or to which benefits accrue, for service in any year beginning with the year the SIMPLE IRA plan becomes effective. 1040ez2012 Exception. 1040ez2012   If you maintain a qualified plan for collective bargaining employees, you are permitted to maintain a SIMPLE IRA plan for other employees. 1040ez2012 Who Can Participate in a SIMPLE IRA Plan? Eligible employee. 1040ez2012   Any employee who received at least $5,000 in compensation during any 2 years preceding the current calendar year and is reasonably expected to receive at least $5,000 during the current calendar year is eligible to participate. 1040ez2012 The term “employee” includes a self-employed individual who received earned income. 1040ez2012   You can use less restrictive eligibility requirements (but not more restrictive ones) by eliminating or reducing the prior year compensation requirements, the current year compensation requirements, or both. 1040ez2012 For example, you can allow participation for employees who received at least $3,000 in compensation during any preceding calendar year. 1040ez2012 However, you cannot impose any other conditions for participating in a SIMPLE IRA plan. 1040ez2012 Excludable employees. 1040ez2012   The following employees do not need to be covered under a SIMPLE IRA plan. 1040ez2012 Employees who are covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees' union and you. 1040ez2012 Nonresident alien employees who have received no U. 1040ez2012 S. 1040ez2012 source wages, salaries, or other personal services compensation from you. 1040ez2012 Compensation. 1040ez2012   Compensation for employees is the total wages, tips, and other compensation from the employer subject to federal income tax withholding and the amounts paid for domestic service in a private home, local college club, or local chapter of a college fraternity or sorority. 1040ez2012 Compensation also includes the employee's salary reduction contributions made under this plan and, if applicable, elective deferrals under a section 401(k) plan, a SARSEP, or a section 403(b) annuity contract and compensation deferred under a section 457 plan required to be reported by the employer on Form W-2. 1040ez2012 If you are self-employed, compensation is your net earnings from self-employment (line 4 of Short Schedule SE or line 6 of Long Schedule SE (Form 1040)) before subtracting any contributions made to the SIMPLE IRA plan for yourself. 1040ez2012 How To Set Up a SIMPLE IRA Plan You can use Form 5304-SIMPLE or Form 5305-SIMPLE to set up a SIMPLE IRA plan. 1040ez2012 Each form is a model savings incentive match plan for employees (SIMPLE) plan document. 1040ez2012 Which form you use depends on whether you select a financial institution or your employees select the institution that will receive the contributions. 1040ez2012 Use Form 5304-SIMPLE if you allow each plan participant to select the financial institution for receiving his or her SIMPLE IRA plan contributions. 1040ez2012 Use Form 5305-SIMPLE if you require that all contributions under the SIMPLE IRA plan be deposited initially at a designated financial institution. 1040ez2012 The SIMPLE IRA plan is adopted when you have completed all appropriate boxes and blanks on the form and you (and the designated financial institution, if any) have signed it. 1040ez2012 Keep the original form. 1040ez2012 Do not file it with the IRS. 1040ez2012 Other uses of the forms. 1040ez2012   If you set up a SIMPLE IRA plan using Form 5304-SIMPLE or Form 5305-SIMPLE, you can use the form to satisfy other requirements, including the following. 1040ez2012 Meeting employer notification requirements for the SIMPLE IRA plan. 1040ez2012 Form 5304-SIMPLE and Form 5305-SIMPLE contain a Model Notification to Eligible Employees that provides the necessary information to the employee. 1040ez2012 Maintaining the SIMPLE IRA plan records and proving you set up a SIMPLE IRA plan for employees. 1040ez2012 Deadline for setting up a SIMPLE IRA plan. 1040ez2012   You can set up a SIMPLE IRA plan effective on any date from January 1 through October 1 of a year, provided you did not previously maintain a SIMPLE IRA plan. 1040ez2012 This requirement does not apply if you are a new employer that comes into existence after October 1 of the year the SIMPLE IRA plan is set up and you set up a SIMPLE IRA plan as soon as administratively feasible after your business comes into existence. 1040ez2012 If you previously maintained a SIMPLE IRA plan, you can set up a SIMPLE IRA plan effective only on January 1 of a year. 1040ez2012 A SIMPLE IRA plan cannot have an effective date that is before the date you actually adopt the plan. 1040ez2012 Setting up a SIMPLE IRA. 1040ez2012   SIMPLE IRAs are the individual retirement accounts or annuities into which the contributions are deposited. 1040ez2012 A SIMPLE IRA must be set up for each eligible employee. 1040ez2012 Forms 5305-S, SIMPLE Individual Retirement Trust Account, and 5305-SA, SIMPLE Individual Retirement Custodial Account, are model trust and custodial account documents the participant and the trustee (or custodian) can use for this purpose. 1040ez2012   A SIMPLE IRA cannot be a Roth IRA. 1040ez2012 Contributions to a SIMPLE IRA will not affect the amount an individual can contribute to a Roth or traditional IRA. 1040ez2012 Deadline for setting up a SIMPLE IRA. 1040ez2012   A SIMPLE IRA must be set up for an employee before the first date by which a contribution is required to be deposited into the employee's IRA. 1040ez2012 See Time limits for contributing funds , later, under Contribution Limits. 1040ez2012 Credit for startup costs. 1040ez2012   You may be able to claim a tax credit for part of the ordinary and necessary costs of starting a SIMPLE IRA plan that first became effective in 2013. 1040ez2012 For more information, see Credit for startup costs under Reminders, earlier. 1040ez2012 Notification Requirement If you adopt a SIMPLE IRA plan, you must notify each employee of the following information before the beginning of the election period. 1040ez2012 The employee's opportunity to make or change a salary reduction choice under a SIMPLE IRA plan. 1040ez2012 Your decision to make either matching contributions or nonelective contributions (discussed later). 1040ez2012 A summary description provided by the financial institution. 1040ez2012 Written notice that his or her balance can be transferred without cost or penalty if they use a designated financial institution. 1040ez2012 Election period. 1040ez2012   The election period is generally the 60-day period immediately preceding January 1 of a calendar year (November 2 to December 31 of the preceding calendar year). 1040ez2012 However, the dates of this period are modified if you set up a SIMPLE IRA plan in mid-year (for example, on July 1) or if the 60-day period falls before the first day an employee becomes eligible to participate in the SIMPLE IRA plan. 1040ez2012   A SIMPLE IRA plan can provide longer periods for permitting employees to enter into salary reduction agreements or to modify prior agreements. 1040ez2012 For example, a SIMPLE IRA plan can provide a 90-day election period instead of the 60-day period. 1040ez2012 Similarly, in addition to the 60-day period, a SIMPLE IRA plan can provide quarterly election periods during the 30 days before each calendar quarter, other than the first quarter of each year. 1040ez2012 Contribution Limits Contributions are made up of salary reduction contributions and employer contributions. 1040ez2012 You, as the employer, must make either matching contributions or nonelective contributions, defined later. 1040ez2012 No other contributions can be made to the SIMPLE IRA plan. 1040ez2012 These contributions, which you can deduct, must be made timely. 1040ez2012 See Time limits for contributing funds , later. 1040ez2012 Salary reduction contributions. 1040ez2012   The amount the employee chooses to have you contribute to a SIMPLE IRA on his or her behalf cannot be more than $12,000 for 2013 and 2014. 1040ez2012 These contributions must be expressed as a percentage of the employee's compensation unless you permit the employee to express them as a specific dollar amount. 1040ez2012 You cannot place restrictions on the contribution amount (such as limiting the contribution percentage), except to comply with the $12,000 limit. 1040ez2012   If you or an employee participates in any other qualified plan during the year and you or your employee have salary reduction contributions (elective deferrals) under those plans, the salary reduction contributions under a SIMPLE IRA plan also count toward the overall annual limit ($17,500 for 2013 and 2014) on exclusion of salary reduction contributions and other elective deferrals. 1040ez2012 Catch-up contributions. 1040ez2012   A SIMPLE IRA plan can permit participants who are age 50 or over at the end of the calendar year to also make catch-up contributions. 1040ez2012 The catch-up contribution limit for 2013 and 2014 for SIMPLE IRA plans is $2,500. 1040ez2012 Salary reduction contributions are not treated as catch-up contributions for 2013 or 2014 until they exceed $12,000. 1040ez2012 However, the catch-up contribution a participant can make for a year cannot exceed the lesser of the following amounts. 1040ez2012 The catch-up contribution limit. 1040ez2012 The excess of the participant's compensation over the salary reduction contributions that are not catch-up contributions. 1040ez2012 Employer matching contributions. 1040ez2012   You are generally required to match each employee's salary reduction contributions on a dollar-for-dollar basis up to 3% of the employee's compensation. 1040ez2012 This requirement does not apply if you make nonelective contributions as discussed later. 1040ez2012 Example. 1040ez2012 In 2013, your employee, John Rose, earned $25,000 and chose to defer 5% of his salary. 1040ez2012 Your net earnings from self-employment are $40,000, and you choose to contribute 10% of your earnings to your SIMPLE IRA. 1040ez2012 You make 3% matching contributions. 1040ez2012 The total contribution you make for John is $2,000, figured as follows. 1040ez2012 Salary reduction contributions ($25,000 × . 1040ez2012 05) $1,250 Employer matching contribution ($25,000 × . 1040ez2012 03) 750 Total contributions $2,000     The total contribution you make for yourself is $5,200, figured as follows. 1040ez2012 Salary reduction contributions ($40,000 × . 1040ez2012 10) $4,000 Employer matching contribution ($40,000 × . 1040ez2012 03) 1,200 Total contributions $5,200 Lower percentage. 1040ez2012   If you choose a matching contribution less than 3%, the percentage must be at least 1%. 1040ez2012 You must notify the employees of the lower match within a reasonable period of time before the 60-day election period (discussed earlier) for the calendar year. 1040ez2012 You cannot choose a percentage less than 3% for more than 2 years during the 5-year period that ends with (and includes) the year for which the choice is effective. 1040ez2012 Nonelective contributions. 1040ez2012   Instead of matching contributions, you can choose to make nonelective contributions of 2% of compensation on behalf of each eligible employee who has at least $5,000 (or some lower amount you select) of compensation from you for the year. 1040ez2012 If you make this choice, you must make nonelective contributions whether or not the employee chooses to make salary reduction contributions. 1040ez2012 Only $255,000 of the employee's compensation can be taken into account to figure the contribution limit in 2013 ($260,000 in 2014). 1040ez2012   If you choose this 2% contribution formula, you must notify the employees within a reasonable period of time before the 60-day election period (discussed earlier) for the calendar year. 1040ez2012 Example 1. 1040ez2012 In 2013, your employee, Jane Wood, earned $36,000 and chose to have you contribute 10% of her salary. 1040ez2012 Your net earnings from self-employment are $50,000, and you choose to contribute 10% of your earnings to your SIMPLE IRA. 1040ez2012 You make a 2% nonelective contribution. 1040ez2012 Both of you are under age 50. 1040ez2012 The total contribution you make for Jane is $4,320, figured as follows. 1040ez2012 Salary reduction contributions ($36,000 × . 1040ez2012 10) $3,600 2% nonelective contributions ($36,000 × . 1040ez2012 02) 720 Total contributions $4,320     The total contribution you make for yourself is $6,000, figured as follows. 1040ez2012 Salary reduction contributions ($50,000 × . 1040ez2012 10) $5,000 2% nonelective contributions ($50,000 × . 1040ez2012 02) 1,000 Total contributions $6,000 Example 2. 1040ez2012 Using the same facts as in Example 1, above, the maximum contribution you make for Jane or for yourself if you each earned $75,000 is $13,500, figured as follows. 1040ez2012 Salary reduction contributions (maximum amount allowed) $12,000 2% nonelective contributions ($75,000 × . 1040ez2012 02) 1,500 Total contributions $13,500 Time limits for contributing funds. 1040ez2012   You must make the salary reduction contributions to the SIMPLE IRA within 30 days after the end of the month in which the amounts would otherwise have been payable to the employee in cash. 1040ez2012 You must make matching contributions or nonelective contributions by the due date (including extensions) for filing your federal income tax return for the year. 1040ez2012 Certain plans subject to Department of Labor rules may have an earlier due date for salary reduction contributions. 1040ez2012 When To Deduct Contributions You can deduct SIMPLE IRA contributions in the tax year within which the calendar year for which contributions were made ends. 1040ez2012 You can deduct contributions for a particular tax year if they are made for that tax year and are made by the due date (including extensions) of your federal income tax return for that year. 1040ez2012 Example 1. 1040ez2012 Your tax year is the fiscal year ending June 30. 1040ez2012 Contributions under a SIMPLE IRA plan for the calendar year 2013 (including contributions made in 2013 before July 1, 2013) are deductible in the tax year ending June 30, 2014. 1040ez2012 Example 2. 1040ez2012 You are a sole proprietor whose tax year is the calendar year. 1040ez2012 Contributions under a SIMPLE IRA plan for the calendar year 2013 (including contributions made in 2014 by April 15, 2014) are deductible in the 2013 tax year. 1040ez2012 Where To Deduct Contributions Deduct the contributions you make for your common-law employees on your tax return. 1040ez2012 For example, sole proprietors deduct them on Schedule C (Form 1040) or Schedule F (Form 1040); partnerships deduct them on Form 1065; and corporations deduct them on Form 1120 or Form 1120S. 1040ez2012 Sole proprietors and partners deduct contributions for themselves on line 28 of Form 1040. 1040ez2012 (If you are a partner, contributions for yourself are shown on the Schedule K-1 (Form 1065) you receive from the partnership. 1040ez2012 ) Tax Treatment of Contributions You can deduct your contributions and your employees can exclude these contributions from their gross income. 1040ez2012 SIMPLE IRA plan contributions are not subject to federal income tax withholding. 1040ez2012 However, salary reduction contributions are subject to social security, Medicare, and federal unemployment (FUTA) taxes. 1040ez2012 Matching and nonelective contributions are not subject to these taxes. 1040ez2012 Reporting on Form W-2. 1040ez2012   Do not include SIMPLE IRA plan contributions in the “Wages, tips, other compensation” box of Form W-2. 1040ez2012 You must, however, include them in the “Social security wages” and “Medicare wages and tips” boxes. 1040ez2012 You must also include them in box 12. 1040ez2012 Mark the “Retirement plan” checkbox in box 13. 1040ez2012 For more information, see the Form W-2 instructions. 1040ez2012 Distributions (Withdrawals) Distributions from a SIMPLE IRA are subject to IRA rules and generally are includible in income for the year received. 1040ez2012 Tax-free rollovers can be made from one SIMPLE IRA into another SIMPLE IRA. 1040ez2012 However, a rollover from a SIMPLE IRA to a non-SIMPLE IRA can be made tax free only after a 2-year participation in the SIMPLE IRA plan. 1040ez2012 Generally, you or your employee must begin to receive distributions from a SIMPLE IRA by April 1 of the first year after the calendar year in which you or your employee reaches age 70½. 1040ez2012 Early withdrawals generally are subject to a 10% additional tax. 1040ez2012 However, the additional tax is increased to 25% if funds are withdrawn within 2 years of beginning participation. 1040ez2012 More information. 1040ez2012   See Publication 590 for information about IRA rules, including those on the tax treatment of distributions, rollovers, required distributions, and income tax withholding. 1040ez2012 More Information on SIMPLE IRA Plans If you need help to set up or maintain a SIMPLE IRA plan, go to the IRS website and search SIMPLE IRA Plan. 1040ez2012 SIMPLE 401(k) Plan You can adopt a SIMPLE plan as part of a 401(k) plan if you meet the 100-employee limit as discussed earlier under SIMPLE IRA Plan. 1040ez2012 A SIMPLE 401(k) plan is a qualified retirement plan and generally must satisfy the rules discussed under Qualification Rules in chapter 4, including the required distribution rules. 1040ez2012 However, a SIMPLE 401(k) plan is not subject to the nondiscrimination and top-heavy rules discussed in chapter 4 if the plan meets the conditions listed below. 1040ez2012 Under the plan, an employee can choose to have you make salary reduction contributions for the year to a trust in an amount expressed as a percentage of the employee's compensation, but not more than $12,000 for 2013 and 2014. 1040ez2012 If permitted under the plan, an employee who is age 50 or over can also make a catch-up contribution of up to $2,500 for 2013 and 2014. 1040ez2012 See Catch-up contributions , earlier under Contribution Limits. 1040ez2012 You must make either: Matching contributions up to 3% of compensation for the year, or Nonelective contributions of 2% of compensation on behalf of each eligible employee who has at least $5,000 of compensation from you for the year. 1040ez2012 No other contributions can be made to the trust. 1040ez2012 No contributions are made, and no benefits accrue, for services during the year under any other qualified retirement plan sponsored by you on behalf of any employee eligible to participate in the SIMPLE 401(k) plan. 1040ez2012 The employee's rights to any contributions are nonforfeitable. 1040ez2012 No more than $255,000 of the employee's compensation can be taken into account in figuring matching contributions and nonelective contributions in 2013 ($260,000 in 2014). 1040ez2012 Compensation is defined earlier in this chapter. 1040ez2012 Employee notification. 1040ez2012   The notification requirement that applies to SIMPLE IRA plans also applies to SIMPLE 401(k) plans. 1040ez2012 See Notification Requirement in this chapter. 1040ez2012 Credit for startup costs. 1040ez2012   You may be able to claim a tax credit for part of the ordinary and necessary costs of starting a SIMPLE 401(k) plan that first became effective in 2013. 1040ez2012 For more information, see Credit for startup costs under Reminders, earlier. 1040ez2012 Note on Forms. 1040ez2012   Please note that Forms 5304-SIMPLE and 5305-SIMPLE can not be used to establish a SIMPLE 401(k) plan. 1040ez2012 To set up a SIMPLE 401(k) plan, see Adopting a Written Plan in chapter 4. 1040ez2012 Prev  Up  Next   Home   More Online Publications
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The 1040ez2012

1040ez2012 2. 1040ez2012   Entertainment Table of Contents Directly-Related Test Associated TestMeetings at conventions. 1040ez2012 50% LimitExceptions to the 50% Limit What Entertainment Expenses Are Deductible?A meal as a form of entertainment. 1040ez2012 Deduction may depend on your type of business. 1040ez2012 Exception for events that benefit charitable organizations. 1040ez2012 Food and beverages in skybox seats. 1040ez2012 What Entertainment Expenses Are Not Deductible?Out-of-pocket expenses. 1040ez2012 You may be able to deduct business-related entertainment expenses you have for entertaining a client, customer, or employee. 1040ez2012 The rules and definitions are summarized in Table 2-1 . 1040ez2012 You can deduct entertainment expenses only if they are both ordinary and necessary and meet one of the following tests. 1040ez2012 Directly-related test. 1040ez2012 Associated test. 1040ez2012 Both of these tests are explained later. 1040ez2012 An ordinary expense is one that is common and accepted in your trade or business. 1040ez2012 A necessary expense is one that is helpful and appropriate for your business. 1040ez2012 An expense does not have to be required to be considered necessary. 1040ez2012 The amount you can deduct for entertainment expenses may be limited. 1040ez2012 Generally, you can deduct only 50% of your unreimbursed entertainment expenses. 1040ez2012 This limit is discussed later under 50% Limit. 1040ez2012 Directly-Related Test To meet the directly-related test for entertainment expenses (including entertainment-related meals), you must show that: The main purpose of the combined business and entertainment was the active conduct of business, You did engage in business with the person during the entertainment period, and You had more than a general expectation of getting income or some other specific business benefit at some future time. 1040ez2012 Business is generally not considered to be the main purpose when business and entertainment are combined on hunting or fishing trips, or on yachts or other pleasure boats. 1040ez2012 Even if you show that business was the main purpose, you generally cannot deduct the expenses for the use of an entertainment facility. 1040ez2012 See Entertainment facilities under What Entertainment Expenses Are Not Deductible? later in this chapter. 1040ez2012 You must consider all the facts, including the nature of the business transacted and the reasons for conducting business during the entertainment. 1040ez2012 It is not necessary to devote more time to business than to entertainment. 1040ez2012 However, if the business discussion is only incidental to the entertainment, the entertainment expenses do not meet the directly-related test. 1040ez2012 Table 2-1. 1040ez2012 When Are Entertainment Expenses Deductible? General rule You can deduct ordinary and necessary expenses to entertain a client, customer, or employee if the expenses meet the directly-related test or the associated test. 1040ez2012 Definitions Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation, and includes meals provided to a customer or client. 1040ez2012 An ordinary expense is one that is common and accepted in your trade or business. 1040ez2012 A necessary expense is one that is helpful and appropriate. 1040ez2012 Tests to be met Directly-related test Entertainment took place in a clear business setting, or Main purpose of entertainment was the active conduct of business, and You did engage in business with the person during the entertainment period, and You had more than a general expectation of getting income or some other specific business benefit. 1040ez2012   Associated test Entertainment is associated with your trade or business, and Entertainment is directly before or after a substantial business discussion. 1040ez2012 Other rules You cannot deduct the cost of your meal as an entertainment expense if you are claiming the meal as a travel expense. 1040ez2012 You cannot deduct expenses that are lavish or extravagant under the circumstances. 1040ez2012 You generally can deduct only 50% of your unreimbursed entertainment expenses (see 50% Limit ). 1040ez2012 You do not have to show that business income or other business benefit actually resulted from each entertainment expense. 1040ez2012 Clear business setting. 1040ez2012   If the entertainment takes place in a clear business setting and is for your business or work, the expenses are considered directly related to your business or work. 1040ez2012 The following situations are examples of entertainment in a clear business setting. 1040ez2012 Entertainment in a hospitality room at a convention where business goodwill is created through the display or discussion of business products. 1040ez2012 Entertainment that is mainly a price rebate on the sale of your products (such as a restaurant owner providing an occasional free meal to a loyal customer). 1040ez2012 Entertainment of a clear business nature occurring under circumstances where there is no meaningful personal or social relationship between you and the persons entertained. 1040ez2012 An example is entertainment of business and civic leaders at the opening of a new hotel or play when the purpose is to get business publicity rather than to create or maintain the goodwill of the persons entertained. 1040ez2012 Expenses not considered directly related. 1040ez2012   Entertainment expenses generally are not considered directly related if you are not there or in situations where there are substantial distractions that generally prevent you from actively conducting business. 1040ez2012 The following are examples of situations where there are substantial distractions. 1040ez2012 A meeting or discussion at a nightclub, theater, or sporting event. 1040ez2012 A meeting or discussion during what is essentially a social gathering, such as a cocktail party. 1040ez2012 A meeting with a group that includes persons who are not business associates at places such as cocktail lounges, country clubs, golf clubs, athletic clubs, or vacation resorts. 1040ez2012 Associated Test Even if your expenses do not meet the directly-related test, they may meet the associated test. 1040ez2012 To meet the associated test for entertainment expenses (including entertainment-related meals), you must show that the entertainment is: Associated with the active conduct of your trade or business, and Directly before or after a substantial business discussion (defined later). 1040ez2012 Associated with trade or business. 1040ez2012   Generally, an expense is associated with the active conduct of your trade or business if you can show that you had a clear business purpose for having the expense. 1040ez2012 The purpose may be to get new business or to encourage the continuation of an existing business relationship. 1040ez2012 Substantial business discussion. 1040ez2012   Whether a business discussion is substantial depends on the facts of each case. 1040ez2012 A business discussion will not be considered substantial unless you can show that you actively engaged in the discussion, meeting, negotiation, or other business transaction to get income or some other specific business benefit. 1040ez2012   The meeting does not have to be for any specified length of time, but you must show that the business discussion was substantial in relation to the meal or entertainment. 1040ez2012 It is not necessary that you devote more time to business than to entertainment. 1040ez2012 You do not have to discuss business during the meal or entertainment. 1040ez2012 Meetings at conventions. 1040ez2012   You are considered to have a substantial business discussion if you attend meetings at a convention or similar event, or at a trade or business meeting sponsored and conducted by a business or professional organization. 1040ez2012 However, your reason for attending the convention or meeting must be to further your trade or business. 1040ez2012 The organization that sponsors the convention or meeting must schedule a program of business activities that is the main activity of the convention or meeting. 1040ez2012 Directly before or after business discussion. 1040ez2012   If the entertainment is held on the same day as the business discussion, it is considered to be held directly before or after the business discussion. 1040ez2012   If the entertainment and the business discussion are not held on the same day, you must consider the facts of each case to see if the associated test is met. 1040ez2012 Among the facts to consider are the place, date, and duration of the business discussion. 1040ez2012 If you or your business associates are from out of town, you must also consider the dates of arrival and departure, and the reasons the entertainment and the discussion did not take place on the same day. 1040ez2012 Example. 1040ez2012 A group of business associates comes from out of town to your place of business to hold a substantial business discussion. 1040ez2012 If you entertain those business guests on the evening before the business discussion, or on the evening of the day following the business discussion, the entertainment generally is considered to be held directly before or after the discussion. 1040ez2012 The expense meets the associated test. 1040ez2012 50% Limit In general, you can deduct only 50% of your business-related meal and entertainment expenses. 1040ez2012 (If you are subject to the Department of Transportation's “hours of service” limits, you can deduct 80% of your business-related meal and entertainment expenses. 1040ez2012 See Individuals subject to “hours of service” limits , later. 1040ez2012 ) The 50% limit applies to employees or their employers, and to self-employed persons (including independent contractors) or their clients, depending on whether the expenses are reimbursed. 1040ez2012 Figure A summarizes the general rules explained in this section. 1040ez2012 The 50% limit applies to business meals or entertainment expenses you have while: Traveling away from home (whether eating alone or with others) on business, Entertaining customers at your place of business, a restaurant, or other location, or Attending a business convention or reception, business meeting, or business luncheon at a club. 1040ez2012 Included expenses. 1040ez2012   Expenses subject to the 50% limit include: Taxes and tips relating to a business meal or entertainment activity, Cover charges for admission to a nightclub, Rent paid for a room in which you hold a dinner or cocktail party, and Amounts paid for parking at a sports arena. 1040ez2012 However, the cost of transportation to and from a business meal or a business-related entertainment activity is not subject to the 50% limit. 1040ez2012 Figure A. 1040ez2012 Does the 50% Limit Apply to Your Expenses? There are exceptions to these rules. 1040ez2012 See Exceptions to the 50% Limit . 1040ez2012 Please click here for the text description of the image. 1040ez2012 Figure A. 1040ez2012 Does the 50% limit apply to Your Expenses?TAs for Figure A are: Notice 87-23; Form 2106 instructions Application of 50% limit. 1040ez2012   The 50% limit on meal and entertainment expenses applies if the expense is otherwise deductible and is not covered by one of the exceptions discussed later. 1040ez2012   The 50% limit also applies to certain meal and entertainment expenses that are not business related. 1040ez2012 It applies to meal and entertainment expenses you have for the production of income, including rental or royalty income. 1040ez2012 It also applies to the cost of meals included in deductible educational expenses. 1040ez2012 When to apply the 50% limit. 1040ez2012   You apply the 50% limit after determining the amount that would otherwise qualify for a deduction. 1040ez2012 You first have to determine the amount of meal and entertainment expenses that would be deductible under the other rules discussed in this publication. 1040ez2012 Example 1. 1040ez2012 You spend $200 for a business-related meal. 1040ez2012 If $110 of that amount is not allowable because it is lavish and extravagant, the remaining $90 is subject to the 50% limit. 1040ez2012 Your deduction cannot be more than $45 (50% × $90). 1040ez2012 Example 2. 1040ez2012 You purchase two tickets to a concert and give them to a client. 1040ez2012 You purchased the tickets through a ticket agent. 1040ez2012 You paid $200 for the two tickets, which had a face value of $80 each ($160 total). 1040ez2012 Your deduction cannot be more than $80 (50% × $160). 1040ez2012 Exceptions to the 50% Limit Generally, business-related meal and entertainment expenses are subject to the 50% limit. 1040ez2012 Figure A can help you determine if the 50% limit applies to you. 1040ez2012 Expenses not subject to 50% limit. 1040ez2012   Your meal or entertainment expense is not subject to the 50% limit if the expense meets one of the following exceptions. 1040ez2012 1 - Employee's reimbursed expenses. 1040ez2012   If you are an employee, you are not subject to the 50% limit on expenses for which your employer reimburses you under an accountable plan. 1040ez2012 Accountable plans are discussed in chapter 6. 1040ez2012 2 - Self-employed. 1040ez2012   If you are self-employed, your deductible meal and entertainment expenses are not subject to the 50% limit if all of the following requirements are met. 1040ez2012 You have these expenses as an independent contractor. 1040ez2012 Your customer or client reimburses you or gives you an allowance for these expenses in connection with services you perform. 1040ez2012 You provide adequate records of these expenses to your customer or client. 1040ez2012 (See chapter 5 . 1040ez2012 )   In this case, your client or customer is subject to the 50% limit on the expenses. 1040ez2012 Example. 1040ez2012 You are a self-employed attorney who adequately accounts for meal and entertainment expenses to a client who reimburses you for these expenses. 1040ez2012 You are not subject to the directly-related or associated test, nor are you subject to the 50% limit. 1040ez2012 If the client can deduct the expenses, the client is subject to the 50% limit. 1040ez2012 If you (as an independent contractor) have expenses for meals and entertainment related to providing services for a client but do not adequately account for and seek reimbursement from the client for those expenses, you are subject to the directly-related or associated test and to the 50% limit. 1040ez2012 3 - Advertising expenses. 1040ez2012   You are not subject to the 50% limit if you provide meals, entertainment, or recreational facilities to the general public as a means of advertising or promoting goodwill in the community. 1040ez2012 For example, neither the expense of sponsoring a television or radio show nor the expense of distributing free food and beverages to the general public is subject to the 50% limit. 1040ez2012 4 - Sale of meals or entertainment. 1040ez2012   You are not subject to the 50% limit if you actually sell meals, entertainment, goods and services, or use of facilities to the public. 1040ez2012 For example, if you run a nightclub, your expense for the entertainment you furnish to your customers, such as a floor show, is not subject to the 50% limit. 1040ez2012 5 - Charitable sports event. 1040ez2012   You are not subject to the 50% limit if you pay for a package deal that includes a ticket to a qualified charitable sports event. 1040ez2012 For the conditions the sports event must meet, see Exception for events that benefit charitable organizations under What Entertainment Expenses Are Deductible?, later. 1040ez2012 Individuals subject to “hours of service” limits. 1040ez2012   You can deduct a higher percentage of your meal expenses while traveling away from your tax home if the meals take place during or incident to any period subject to the Department of Transportation's “hours of service” limits. 1040ez2012 The percentage is 80%. 1040ez2012   Individuals subject to the Department of Transportation's “hours of service” limits include the following persons. 1040ez2012 Certain air transportation workers (such as pilots, crew, dispatchers, mechanics, and control tower operators) who are under Federal Aviation Administration regulations. 1040ez2012 Interstate truck operators and bus drivers who are under Department of Transportation regulations. 1040ez2012 Certain railroad employees (such as engineers, conductors, train crews, dispatchers, and control operations personnel) who are under Federal Railroad Administration regulations. 1040ez2012 Certain merchant mariners who are under Coast Guard regulations. 1040ez2012 What Entertainment Expenses Are Deductible? This section explains different types of entertainment expenses you may be able to deduct. 1040ez2012 Entertainment. 1040ez2012   Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation. 1040ez2012 Examples include entertaining guests at nightclubs; at social, athletic, and sporting clubs; at theaters; at sporting events; on yachts; or on hunting, fishing, vacation, and similar trips. 1040ez2012   Entertainment also may include meeting personal, living, or family needs of individuals, such as providing meals, a hotel suite, or a car to customers or their families. 1040ez2012 A meal as a form of entertainment. 1040ez2012   Entertainment includes the cost of a meal you provide to a customer or client, whether the meal is a part of other entertainment or by itself. 1040ez2012 A meal expense includes the cost of food, beverages, taxes, and tips for the meal. 1040ez2012 To deduct an entertainment-related meal, you or your employee must be present when the food or beverages are provided. 1040ez2012    You cannot claim the cost of your meal both as an entertainment expense and as a travel expense. 1040ez2012    Meals sold in the normal course of your business are not considered entertainment. 1040ez2012 Deduction may depend on your type of business. 1040ez2012   Your kind of business may determine if a particular activity is considered entertainment. 1040ez2012 For example, if you are a dress designer and have a fashion show to introduce your new designs to store buyers, the show generally is not considered entertainment. 1040ez2012 This is because fashion shows are typical in your business. 1040ez2012 But, if you are an appliance distributor and hold a fashion show for the spouses of your retailers, the show generally is considered entertainment. 1040ez2012 Separating costs. 1040ez2012   If you have one expense that includes the costs of entertainment and other services (such as lodging or transportation), you must allocate that expense between the cost of entertainment and the cost of other services. 1040ez2012 You must have a reasonable basis for making this allocation. 1040ez2012 For example, you must allocate your expenses if a hotel includes entertainment in its lounge on the same bill with your room charge. 1040ez2012 Taking turns paying for meals or entertainment. 1040ez2012   If a group of business acquaintances takes turns picking up each others' meal or entertainment checks primarily for personal reasons, without regard to whether any business purposes are served, no member of the group can deduct any part of the expense. 1040ez2012 Lavish or extravagant expenses. 1040ez2012   You cannot deduct expenses for entertainment that are lavish or extravagant. 1040ez2012 An expense is not considered lavish or extravagant if it is reasonable considering the facts and circumstances. 1040ez2012 Expenses will not be disallowed just because they are more than a fixed dollar amount or take place at deluxe restaurants, hotels, nightclubs, or resorts. 1040ez2012 Allocating between business and nonbusiness. 1040ez2012   If you entertain business and nonbusiness individuals at the same event, you must divide your entertainment expenses between business and nonbusiness. 1040ez2012 You can deduct only the business part. 1040ez2012 If you cannot establish the part of the expense for each person participating, allocate the expense to each participant on a pro rata basis. 1040ez2012 Example. 1040ez2012 You entertain a group of individuals that includes yourself, three business prospects, and seven social guests. 1040ez2012 Only 4/11 of the expense qualifies as a business entertainment expense. 1040ez2012 You cannot deduct the expenses for the seven social guests because those costs are nonbusiness expenses. 1040ez2012 Trade association meetings. 1040ez2012   You can deduct entertainment expenses that are directly related to and necessary for attending business meetings or conventions of certain exempt organizations if the expenses of your attendance are related to your active trade or business. 1040ez2012 These organizations include business leagues, chambers of commerce, real estate boards, trade associations, and professional associations. 1040ez2012 Entertainment tickets. 1040ez2012   Generally, you cannot deduct more than the face value of an entertainment ticket, even if you paid a higher price. 1040ez2012 For example, you cannot deduct service fees you pay to ticket agencies or brokers or any amount over the face value of the tickets you pay to scalpers. 1040ez2012 Exception for events that benefit charitable organizations. 1040ez2012   Different rules apply when the cost of a ticket to a sports event benefits a charitable organization. 1040ez2012 You can take into account the full cost you pay for the ticket, even if it is more than the face value, if all of the following conditions apply. 1040ez2012 The event's main purpose is to benefit a qualified charitable organization. 1040ez2012 The entire net proceeds go to the charity. 1040ez2012 The event uses volunteers to perform substantially all the event's work. 1040ez2012    The 50% limit on entertainment does not apply to any expense for a package deal that includes a ticket to such a charitable sports event. 1040ez2012 Example 1. 1040ez2012 You purchase tickets to a golf tournament organized by the local volunteer fire company. 1040ez2012 All net proceeds will be used to buy new fire equipment. 1040ez2012 The volunteers will run the tournament. 1040ez2012 You can deduct the entire cost of the tickets as a business expense if they otherwise qualify as an entertainment expense. 1040ez2012 Example 2. 1040ez2012 You purchase tickets to a college football game through a ticket broker. 1040ez2012 After having a business discussion, you take a client to the game. 1040ez2012 Net proceeds from the game go to colleges that qualify as charitable organizations. 1040ez2012 However, since the colleges also pay individuals to perform services, such as coaching and recruiting, you can only use the face value of the tickets in determining your business deduction. 1040ez2012 Skyboxes and other private luxury boxes. 1040ez2012   If you rent a skybox or other private luxury box for more than one event at the same sports arena, you generally cannot deduct more than the price of a nonluxury box seat ticket. 1040ez2012   To determine whether a skybox has been rented for more than one event, count each game or other performance as one event. 1040ez2012 For example, renting a skybox for a series of playoff games is considered renting it for more than one event. 1040ez2012 All skyboxes you rent in the same arena, along with any rentals by related parties, are considered in making this determination. 1040ez2012   Related parties include: Family members (spouses, ancestors, and lineal descendants), Parties who have made a reciprocal arrangement involving the sharing of skyboxes, Related corporations, A partnership and its principal partners, and A corporation and a partnership with common ownership. 1040ez2012 Example. 1040ez2012 You pay $3,000 to rent a 10-seat skybox at Team Stadium for three baseball games. 1040ez2012 The cost of regular nonluxury box seats at each event is $30 a seat. 1040ez2012 You can deduct (subject to the 50% limit) $900 ((10 seats × $30 each) × 3 events). 1040ez2012 Food and beverages in skybox seats. 1040ez2012   If expenses for food and beverages are separately stated, you can deduct these expenses in addition to the amounts allowable for the skybox, subject to the requirements and limits that apply. 1040ez2012 The amounts separately stated for food and beverages must be reasonable. 1040ez2012 You cannot inflate the charges for food and beverages to avoid the limited deduction for skybox rentals. 1040ez2012 What Entertainment Expenses Are Not Deductible? This section explains different types of entertainment expenses you generally may not be able to deduct. 1040ez2012 Club dues and membership fees. 1040ez2012   You cannot deduct dues (including initiation fees) for membership in any club organized for: Business, Pleasure, Recreation, or Other social purpose. 1040ez2012 This rule applies to any membership organization if one of its principal purposes is either: To conduct entertainment activities for members or their guests, or To provide members or their guests with access to entertainment facilities, discussed later. 1040ez2012   The purposes and activities of a club, not its name, will determine whether or not you can deduct the dues. 1040ez2012 You cannot deduct dues paid to: Country clubs, Golf and athletic clubs, Airline clubs, Hotel clubs, and Clubs operated to provide meals under circumstances generally considered to be conducive to business discussions. 1040ez2012 Entertainment facilities. 1040ez2012   Generally, you cannot deduct any expense for the use of an entertainment facility. 1040ez2012 This includes expenses for depreciation and operating costs such as rent, utilities, maintenance, and protection. 1040ez2012   An entertainment facility is any property you own, rent, or use for entertainment. 1040ez2012 Examples include a yacht, hunting lodge, fishing camp, swimming pool, tennis court, bowling alley, car, airplane, apartment, hotel suite, or home in a vacation resort. 1040ez2012 Out-of-pocket expenses. 1040ez2012   You can deduct out-of-pocket expenses, such as for food and beverages, catering, gas, and fishing bait, that you provided during entertainment at a facility. 1040ez2012 These are not expenses for the use of an entertainment facility. 1040ez2012 However, these expenses are subject to the directly-related and associated tests and to the 50% limit , all discussed earlier. 1040ez2012 Expenses for spouses. 1040ez2012   You generally cannot deduct the cost of entertainment for your spouse or for the spouse of a customer. 1040ez2012 However, you can deduct these costs if you can show you had a clear business purpose, rather than a personal or social purpose, for providing the entertainment. 1040ez2012 Example. 1040ez2012 You entertain a customer. 1040ez2012 The cost is an ordinary and necessary business expense and is allowed under the entertainment rules. 1040ez2012 The customer's spouse joins you because it is impractical to entertain the customer without the spouse. 1040ez2012 You can deduct the cost of entertaining the customer's spouse. 1040ez2012 If your spouse joins the party because the customer's spouse is present, the cost of the entertainment for your spouse is also deductible. 1040ez2012 Gift or entertainment. 1040ez2012   Any item that might be considered either a gift or entertainment generally will be considered entertainment. 1040ez2012 However, if you give a customer packaged food or beverages that you intend the customer to use at a later date, treat it as a gift. 1040ez2012   If you give a customer tickets to a theater performance or sporting event and you do not go with the customer to the performance or event, you have a choice. 1040ez2012 You can treat the tickets as either a gift or entertainment, whichever is to your advantage. 1040ez2012   You can change your treatment of the tickets at a later date by filing an amended return. 1040ez2012 Generally, an amended return must be filed within 3 years from the date the original return was filed or within 2 years from the time the tax was paid, whichever is later. 1040ez2012   If you go with the customer to the event, you must treat the cost of the tickets as an entertainment expense. 1040ez2012 You cannot choose, in this case, to treat the tickets as a gift. 1040ez2012 Prev  Up  Next   Home   More Online Publications