When we travel on business, we are required to track our expenses. ( OK,  only if we expect to deduct these costs as legal expenses.)  Typically, that means that we keep our receipts and prepare an expense report. (Substantiation is required by IRC 274 (d).)

We need to segregate the costs between food, entertainment, hotel, travel, and the like. Entertainment expenses need to include the name of the guest, the place, and the reason for the event, so we can deduct these costs.

But, we really only get to deduct half these costs. Because the Internal Revenue Code [IRC Section 274(n)(1)] stipulates that only 50% of the costs are deductible. Unless, one is an employee and is to be reimbursed as such by the employer.

Then, as long as the employee submits an expense report and gets reimbursed, the travel costs are not deductible, but neither is  the reimbursement is not taxable,  to the employee. But, the employer is going to be stuck with only 1/2 of those food and entertainment costs being deductible.

On the other hand, when we incur costs on behalf of clients, we bill them directly for these expenses. And, we do not include the reimbursement costs as part of our revenue, nor do we get the deductions for those costs. (Our clients get the deduction- or really just 1/2 of it- as a result.) It also means that these funds are not subject to any potential gross receipts taxes, since they are not revenue, but simply reimbursements for costs expended on behalf of our clients.

We, and other employers, also have certain arrangements with certain employees. Our regional office managers are afforded expense account allowances. These allowances are considered 1099 wages, and the employees are required to maintain their own records and deduct their costs, as required by law. Any excess payments are, indeed, taxable to the employee; any shortage is deductible to the employee, subject to the 2% employee expense limitations.

We use these arrangements for select managers who are responsible for maintaining business; instead of requesting permission for each meal or event, they have an allotment available. And, they are required to properly account for these expenses (to the IRS, so that the expense allowance does not get included as taxable income to them).

Why would an employee agree to such an arrangement? Because these costs often involve entertaining at a private club. This club offers them other benefits- such as golf, tennis, swimming, camp for the kids. Those do not benefit us and would not be deductible at all to us. But, the employee can use expense account funds to pay the dues and then deduct the costs for meals, golf or tennis with clients, etc. (Most clubs will provide sufficient documentation.)

Remember- food and entertainment are legal business expenditures for a business (or self-employed person)- but are deductible only for 50% of the costs incurred. The only exception is when the food costs are for all the employees of the firm (like a company picnic or an awards dinner; then these specific costs are fully deductible.)

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