8751 / What limitations apply to prevent a taxpayer from deducting lavish or extravagant business-related entertainment expenses?

Editor's Note: Under the 2017 tax reform legislation, the previously existing 50 percent deduction for entertainment expenses that are directly connected with a business activity is suspended for 2018-2025. This applies to any activity considered entertainment, recreation or amusement, including membership dues with respect to any club organized for business, pleasure, recreational or social purposes.¹ The 50 percent deduction for meal expenses remains in effect (including meals consumed while travelling for business). The 2017 tax reform legislation also expanded the 50 percent deduction for meals to include expenses associated with providing meals through an eating facility meeting de minimis fringe benefit requirements.² The deduction for meals provided at the convenience of the employer expires after December 31, 2025.³

The prohibition on the deductibility of lavish or extravagant business-related expenses is tied to the notion that the expense must be reasonable in order to be deducted—a determination that is made based on the facts and circumstances of each individual case. Based on this premise, the courts have allowed taxpayers to deduct expenses that might be considered unreasonable in other contexts.

For example, the Tax Court has upheld a taxpayer's deduction for expenses incurred in using a chauffeured Cadillac to provide local transportation for securities analysts and investment advisors in New York.⁴

Conversely, the Tax Court has disallowed deductions for lease payments made on a Rolls Royce by a plastic surgeon. The court's opinion reflects the importance of whether the expense is reasonable, rather than the level of extravagance displayed. In this case, the taxpayer-surgeon claimed that the Rolls Royce was used in advertising and promoting the quality of his services, and that he only used the car for business travel between the hospital and medical conventions. The Tax Court rejected the petitioner's argument that the Rolls Royce would attract customers, finding that it had no reasonable relationship to his skill and performance as a plastic surgeon and that there was no evidence that any patients were attracted based on the leasing of the car.⁵