As an entrepreneur, I know the importance of maintaining and growing a client base. In some industries, it's everything. Especially for small businesses, having engaged clients can mean the difference between a successful trajectory and closing up shop.
Since tax reform eliminated business expense deductions for entertainment--with the exception of meals--you may be feeling the pinch of engaging your clients. And, while the 20 percent pass-through deduction can help offset some of the consequences (unless, of course, you operate a C corporation), corporate budgets may be in for big changes this year.
What Small Business Wwners Can Expect From the New Tax Law
If you've been in business for a long time, you may remember the heyday of client entertainment tax deductions. Business-related entertainment expenses have moved from completely deductible, to 80 percent deductible, then 50 percent deductible, and now we're left with only meals--so long as they aren't extravagant--at 50 percent.
That's right: the Tax Cuts and Jobs Act gutted what's considered deductible for client entertainment including amusement, recreation, and lavish meals. And it's not just clients you can't entertain anymore; this new rule applies to suppliers, vendors, employees, and more. So, the removal of this deduction could have a major impact on your bottom line.
Impact on Corporate Budgets
To make sure you are on top of the new tax rules, you may need to implement some changes in your accounting department so that your expense reporting processes are consistent with the new regulations. For instance, you'll need to get a separate invoice for food and beverage if you are at an event that combines a meal with entertainment, or you won't be able to deduct any part of the outing.
Simply put, if you plan an outing with your clients at a baseball game, the food and drinks will be 50 percent deductible assuming they're not extravagant; the tickets will not. Keep in mind that the new guidance defines non-deductible entertainment expenses as anything that provides amusement or recreation, and this includes evenings at a cocktail lounge or nightclub.
Big picture, you could be facing a shift from conventional entertainment expenses to another form of marketing or public relations that may be more beneficial to your company. Advertising and promotional expenses are still deductible, so it's likely that many companies will be pursuing these avenues instead. Beware: the advertising and promotional expenses have a grey area between being fully deductible or requiring amortization, where you would deduct them over a period of several years.
Aside from that, you can still deduct half of the cost of business meals, so your entertainment may swing toward meal-based entertainment. But rather than straightforward entertainment, a little shoptalk will need to be part of the evening as well. However, if you have a strong sense that this wouldn't appeal to your clients, then the best option is to stick with traditional entertainment.
How to Mitigate the Effects on Client Engagement
When it comes to your clients, you'll need to use data-based trial and error approaches to see where your dollars have the greatest effect. Instead of wining and dining, track to see if advertising is an adequate replacement. The important part is to consider the makeup of your client base carefully and what would help keep them engaged. The creativity that enabled you to become an entrepreneur will come in handy here. Or, as a last resort, you could continue these activities as long as you are aware you'll be picking up the tab fully, with no tax benefit.
Since entertaining your clients is more expensive, you'll need to keep a close eye on what truly adds value for your clients. And take some time to research where your marketing and expense dollars are best spent, revise your budget accordingly, and spend only on high-return activities. Taking steps now to ensure you aren't caught off guard by the eliminated expense deductions will set you up for future success.