Congress recently passed the Tax Cuts and Jobs Act (TCJA). Most people know that the TCJA was the biggest tax overhaul in about 40 years. Some provisions of the TCJA were very favorable to businesses and others were not. For small business owners, it is important to understand how the TCJA affects you and your business. One of the areas business owners may not yet be aware of is the change to the business entertainment expense deduction.
Prior to the TCJA, Business Entertainment Expenses were 50% Deductible
Prior to the TCJA, a 50% deduction was allowed for business entertainment expenses. Basically, as long as the expense was related to your business, you could partially deduct the cost of things like tickets to sporting events, theater tickets, a round of golf, fishing, hunting, and other recreational activities. Small business owners would often use these types of activities to gain some much-needed facetime with both clients and (perhaps more importantly) prospective clients.
Many small business owners have experienced something like the following scenario:
You have a potential client and you know that if you can land this client, it will mean big profits for your company. If you could just get 15 minutes to talk to the client, you could show them the value your company could bring them. Unfortunately, the client is not willing to give you the time of day to make your pitch. Luckily, you have an ace up your sleeve. You happen to know that the client is a huge basketball fan. You buy a couple of tickets to his favorite NBA team, and invite the potential client to accompany you. There’s a chance the client still may not give you his business, but either way you get to deduct 50% of ticket price, so the cost seems worth the risk. He may not necessarily want to hear your pitch, but he wants to see the game, so he agrees. Now you have a foot in the door. You get the opportunity to make your pitch and if all goes well, you’ve got yourself a new client.
How Does the TCJA Affect This Deduction?
Under the TCJA, Business Entertainment Expenses are Not Deductible At All
The TCJA eliminated the business entertainment expense deduction entirely. This is a huge change and it’s an important one, so I’ll say it again, there is now no deduction at all, allowed for entertainment expenses. The TCJA provides a lot of benefits for small business owners, but this is not one of them. It’s also important to note that this change applies equally to all business entities. Whether you own an LLC, S-Corporation, C-Corporation, or sole proprietorship, if you spend money on business entertainment, this change affects you. No businesses are exempt.
Should My Business Spend Money on Entertainment?
Now that there’s no deduction for entertainment expenses, does that mean that it is no longer worth it to entertain clients? Not necessarily. These entertainment expenses still provide the same benefits as far as building goodwill with clients and helping to grow a small business’s client base. The big difference now is that the cost is significantly higher. Whether this change is enough to tip the scales of the cost-benefit analysis depends on the specific circumstances of each small business. Think about the factors involved.
- How important is this client? If this one client’s business can make or break your company, you’re probably willing to invest more into securing (or keeping) their business. If the client doesn’t bring much value to your company, then maybe it isn’t worth the cost.
- Are you willing to lose your entire investment? Remember, now with the TCJA, these costs are NOT DEDUCTIBLE AT ALL. Any money you put into these expenses is at risk. That skybox seating may be impressive, but if you don’t get the client’s business, can your business handle just eating that cost?
- Could you achieve the same result through another means? Entertainment is not the only way to get on a client’s good side. Business meals are still 50% deductible, so maybe instead of taking the client to a baseball game, you go to dinner instead. Just make sure to verify that your meal is deductible.
There is no bright-line answer to the question of whether your business should continue to spend money on entertainment. In the end, you have to make your own decision regarding what’s best for you and your business. When you make your decision, it is important to have the correct information and understand the tax consequences, so you can make an informed decision. Unfortunately, finding that information can be more difficult than you might think.
There’s a Lot of Outdated Information Out There
When you’re looking for advice on how to handle this issue, make sure the information you’re getting is up to date. Since the TCJA went through so quickly, a lot of organizations are still playing catch-up. That means that a lot of the information available on the Internet still references the old law. Your best bet is to get your information from a licensed accountant or tax attorney. If you can’t afford an accountant or tax attorney, or if you just want to do the research for yourself, be very careful to verify the information you find. Start by double checking the date on the source. The TCJA was signed into law on December 22, 2017, and went into effect on January 1, 2018. If your source is dated before then, the information is most likely not applicable.
Suppose the article is written after the TCJA was passed — good to go right? Not necessarily. Just because the source is recent doesn’t mean it’s accurate. Like I said, a lot of organizations are still playing catch-up and they haven’t necessarily adjusted for all the changes made by the TCJA. If they haven’t yet dug into the changes to this particular deduction, they could still be operating on old information.
If this wasn’t confusing enough already, a lot of the information published through April of this year was intended for people filing their 2017 taxes. Since the new law didn’t take effect until January 1, 2018, 2017 taxes still used the old law. That means any advice designed for 2017 taxes is probably not going to incorporate any of the new rules. Consequently, you have to be very careful about which information you’re using, even from the IRS.
IRS audits and tax penalties can be very burdensome for a small business. Don’t just rely on custom when you’re taking your deductions. Make sure you are operating under the current law.