When Are Leisure Expenses Deductible?

Leisure expenses like vacations or hobbies are personal costs and not tax-deductible. The Internal Revenue Service (IRS) draws a clear line between personal enjoyment and legitimate business activities. However, some expenses that appear to be for leisure can qualify for a tax deduction when incurred in a business context. Understanding these rules is necessary to identify when a personal expense may be a deductible business cost.

Deductibility of Business Meals and Entertainment

The Tax Cuts and Jobs Act of 2017 (TCJA) eliminated the deduction for most entertainment expenses. Costs for taking a client to a sporting event, golf outing, or theatrical performance are not deductible, even if business is discussed. The law disallows expenses for entertainment, amusement, or recreation.

The primary exception is for business meals, which are typically 50% deductible. For a meal to qualify, the expense cannot be lavish or extravagant, and the taxpayer or an employee must be present. The meal must be with a current or potential business customer, client, or similar business contact.

A distinction exists between non-deductible entertainment and deductible meals. For example, if you take a client to a baseball game, the ticket cost is non-deductible. However, if you buy food and drinks, 50% of that cost may be deductible if it is stated separately from the ticket cost on the receipt.

Certain meals may qualify for a 100% deduction, though these exceptions are narrowly defined. For example, the cost of a company-wide holiday party or a summer picnic for all employees and their families is generally fully deductible. Meals provided on the business’s premises for the convenience of the employer may also be fully deductible under specific conditions.

Distinguishing a Business from a Hobby

The ability to deduct expenses depends on whether an activity is a for-profit business or a hobby. This distinction determines if you can deduct losses. Under the “hobby loss rule,” deductions for a hobby are limited to the income it generates, and you cannot use hobby losses to offset other income.

The IRS uses several factors to evaluate if a taxpayer has a genuine profit motive, looking at the facts and circumstances of each case. Key considerations include carrying on the activity in a businesslike manner by maintaining accurate records. The time and effort the taxpayer expends on the activity is another factor.

An expectation that assets used in the activity may appreciate in value can indicate a profit motive. The taxpayer’s history of income or losses is another consideration, though losses during a start-up phase are common for businesses. The taxpayer’s financial status and personal pleasure derived from the activity are also part of the evaluation.

Consider a photographer who takes photos on weekends and occasionally sells a print online but lacks a business plan or separate bank account; this is likely a hobby. If they generate $500 in income and have $1,000 in expenses, they can only deduct $500. In contrast, a photographer with a business plan, advertising, and a separate business account demonstrates a profit intent, making their expenses fully deductible.

Allocating Mixed-Purpose Travel Expenses

When a trip combines business and leisure, deducting travel expenses depends on the trip’s primary purpose. For domestic travel, if the primary reason for the trip is business, the full cost of transportation like airfare is deductible. The primary purpose is based on factors like the amount of time spent on business versus personal activities.

At the destination, expenses for lodging and meals must be allocated between business and personal days, as only costs from business days are deductible. For example, on a five-day trip with three business days, the entire round-trip airfare is deductible. However, only the lodging and 50% of the meal costs for those three business days are deductible.

The rules for foreign travel are more stringent. For travel outside the U.S., you may have to allocate transportation expenses between business and personal days, even if the trip’s primary purpose is business. There are exceptions, such as when the trip is for a week or less or when the personal portion is less than 25% of the total time.

Required Recordkeeping for Substantiation

To claim any business expense deduction, taxpayers must maintain adequate records to substantiate their claims. The IRS requires contemporaneous records, meaning documentation created at or near the time of the expense. Without proper documentation, an otherwise valid deduction may be disallowed by the IRS.

For any expense, you must maintain records that prove the following elements:

• The amount of the expense
• The date and place of the expense
• The business purpose of the expense
• The business relationship of the person(s) involved in the activity

For meals, this means noting who was present and what business was discussed.

Acceptable documentation includes receipts, canceled checks, and bills. Maintaining a detailed log or account book is also a best practice. A log entry for a business meal, for instance, should include the date, location, amount, the name of the person entertained, and the business topic discussed.