Clear Business Setting Test

What is a ‘Clear Business Setting Test’

A clear business setting test is a test that is performed to determine whether dining and entertainment expenses can be deducted on corporate tax returns.

BREAKING DOWN ‘Clear Business Setting Test’

The clear business setting test is used to verify that companies have no motive for deducting expenses other than to further the business. For example, if a company was to hold an event, the sole reason for hosting the event should be to increase business revenues. Inviting any personal acquaintances or family members to the event could negate the ability to deduct these expenses. This test may also be called the associated test or the directly related test.

Qualifying expenses should directly relate to increasing or prolonging business. These expenses can include some team building events for existing employees as long at they meet all other required qualifications. Businesses need to be wary of attempting to claim events and expenses that do not qualify as they could open them up to the potential for fines or possibly even jail time.

These expenses must also be considered typical for the profession, cannot be overly elaborate and cannot be combined with other deductions such as travel deductions. Anyone looking to determine if expenses qualify as business expenses should check the Internal Revenue Services (IRS) website or consult with a certified tax professional.

An Example of a Clear Business Setting Test

For example, consider the trucking company XYZ Trucks. XYZ Trucks is trying to obtain new clients, and the company decides to buy a large block of tickets to a major league baseball game. The company invites decision makers from several manufacturing companies in the area that they have been working with to try and keep their working relationships pleasant. They also invite prospective clients in the hopes of converting them into new clients. The plan is to naturally stimulate conversation between the two groups so that the existing clients talk about how pleased they are with the trucking company. XYZ Trucking only purchased a handful of seats and provided snacks and lunch during the tailgating prior to the game. This event passes the clear business setting test.

However, if the head of XYZ Trucking had decided that he would host his son’s 16th birthday party during this time as well, using the tailgating event to feed his friends and family members and paying for tickets for 15 of his son’s closest friends, this would no longer pass the clear business test. The company would be unable to use this as a business expense because the purpose of the event has now changed from retaining and gaining clients to a family party. None of these costs would be deductible by those terms.

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