Yes…you read it correctly. There are a lot of benefits for the small business owner in the Tax Cuts and Jobs Act, but this isn’t one of them. It truly is a major blow to small and big business, and the cost of doing business just went up.
Example. Tom is an insurance agent and small business consultant. He takes one of his clients golfing and out to lunch to give guidance on a business transaction and sell an insurance policy.
Write-off? Nope. Because the activity occurred in 2018, Tom gets no deduction and arguably the meal isn’t a write-off either.
First, all small businesses and entrepreneurs are affected; no one is exempt from this provision in the new tax law. Sole-proprietors, S-Corporations, LLCs and C-Corporations – all beware.
So long as an expense was directly related to (or, in some cases, even associated with), the active conduct of a trade or business, you were allowed a deduction for an activity generally considered to be entertainment, amusement, or recreation. The limit was up to 50% of the expense, but it was still something and oftentimes worth the expense to do some business while ‘entertaining’.
No deduction period, is allowed for:
- Any activity generally considered to be entertainment, amusement or recreation
- Membership dues to any club organized for recreation or social purposes
- A facility, or portion thereof, used in connection with the above items
That means no more deduction for a round of golf, theater tickets, spa visit, sports tickets, skybox, fishing, hunting, show tickets, etc… This is a big deal!!
Do you know how much business is transacted on the golf course, in the sky box, or over a mud bath at the spa? As a tax professional I’ll tell you- a lot! What happened to courting a new client and trying to get to know each other a little before closing the big deal? Entertaining is a huge part of doing business. I think this is a terrible provision in the new law and should be changed. Don’t forget to let your elected official know in 2025 (That’s right, more than likely no changes in the law until then). Ughh!!
I think this new provision will also have an impact on the entertainment business. You can’t tell me that sporting events, season passes to the theater, or golf course won’t feel the impact. Business is a huge part of entertainment and vise-versa. Yes, Hollywood may even think that the GOP had it in for them, but of course a lot of politicians golf too so who knows!!
Are meals affected too?
Meals are also significantly impacted under the new legislation! Believe it or not, some tax professionals are arguing that business meals with clients or prospects are no longer deductible and completely gutted from the legislation when it comes to a business meal and night out on the town.
Essentially, experts are arguing that business meals were previously deductible because they were directly related to IRC Section 274(a) and were deducted as being “directly related” to, or “associated” with the entertainment expense. However, believe it or not, professionals are arguing that the elimination of the entertainment expense means that those client meals out are gone too.
Entertainment deductions that survived
If there is any good news, there are a few ways to write off entertainment expense under IRC Section 274(e). Mind you, these are very unique types of expenses and in my experience, most businesses won’t find these useful, but here they are:
- Entertainment, amusement and recreation expenses you treat as compensation to your employees in their wages (essentially put the cost in their W-2. Employees will love that)
- Expenses for recreation, social, or similar activities, including facilities, primarily for employees, and it can’t be highly compensated employees (hence the skybox problem)
- Expenses for entertainment goods, services, and facilities that you sell to customers…I call that cost of goods sold- thanks.
Bottom line, as you consider the new tax reform as a whole, there may certainly be a 20% deduction for ‘pass-thru businesses’ or a 21% tax rate for C-Corporations, but the cost of doing business just went up as well and your line item for entertainment has disappeared. Where the government giveth, the government taketh away!
Most importantly, stay tuned as we see the advent of specific IRS regulations and implementation of the new law. Of course, a slew of audits and court cases will follow that will further give us guidance regarding the new provisions. It’s not over yet…well, at least it’s in effect until 2025 and then a future Congress will have to take it up and deal with it.
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Mark J. Kohler is a CPA, Attorney, co-host of the Radio Show “Refresh Your Wealth” and author of the new book “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You” and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP.