It is important to separate the fees billed for services and reimbursements of client expenses because the repayment of client advances will not constitute taxable income when received. This is treated as the repayment of a loan. Any client advances that are not repaid by the client may be written off as a bad debt in the year in which they become uncollectible. The proper treatment of expenses for business meals and client entertainment is an area of particular concern in a legal practice. Generally, no deduction can be taken for the cost of meals or other forms of entertainment or recreation unless the cost is either directly related to the active conduct of a trade or business or if the expense is for entertainment directly before or after a substantial and bona fide business discussion.
Entertainment includes sporting events, plays, dinners, and concerts.
Given the importance of client entertainment to most legal practices, make sure that there is a business purpose and substantial business discussions during the entertainment, and document the business purpose at the time of the event. Beginning in tax year 1994, only 50 percent of the meal or entertainment expense is deductible, with several exceptions. For example, if meal expenses are incurred on behalf of a client and reimbursable by the client pursuant to the fee arrangement, the 50 percent deduction will apply to the client reimbursing the expenses. The amount of meal and entertainment expense included in client reimbursable expenses should be indicated on the invoice so that the client can properly account for these items. Alternatively, where meal and entertainment expenses are not reimbursable by a client, the impact of the reduction will be borne by the lawyer.