With budgets tight, every dollar matters—especially for small businesses. Recently, some business owners have taken to social media to complain about “no-shows.” Whether you run a salon or an accounting firm, chances are that sometimes folks make appointments and then don’t bother to attend.
And it adds up.
Across all industries, the average no-show rate is about 10-15%. For a small business earning $250,000 per year, that’s a five-figure hole.
And the pandemic has exacerbated the problem in some industries. OpenTable reported that 30% of Americans said they didn’t show up for a reservation in the past year.
While it’s always annoying to be stood up, there’s a more serious issue: What happens to that “lost” revenue? Business owners often wonder whether the time that was squandered could be deductible.
It seems like a fair question since you can often quantify the actual value of the missed time. For example, if my billable rate is $400 per hour and I schedule an hour for a client who doesn’t show up, then in theory, I’ve lost $400, right? Or if a customer skips out on a $100 haircut appointment, that looks like a $100 loss.
And maybe it feels like that. But for federal tax purposes, it doesn’t work like that. A missed opportunity to make money is not deductible—even if it’s the result of a no-show.
Some taxpayers have suggested that you can change the outcome simply by swapping out your accounting method. Notwithstanding that the IRS has some pretty strict rules on switching accounting methods—you must be consistent in the application of your accounting method—it will not change the result.
For cash-based taxpayers, income isn’t reported until it’s actually received. If you’ve never received income for a no-show, you can’t subsequently deduct it. There is no magic trick to transform that “lost” income into a tax break.
Accrual-basis taxpayers typically report income when work is performed and invoices are issued. It’s true that if you’ve accounted in advance for the no-show as income, it can subsequently be deducted if you don’t get paid. However, while that might result in a timing advantage, it doesn’t give you an additional tax benefit.
In both instances, the net result—zero—is the same. There’s no “extra” deduction for a no-show, or not getting paid.
While the “lost” revenue may not result in a tax break, the costs that you actually incur are deductible—even if those costs are related to unpaid bills and no-shows. For example, if I paid someone—a stenographer, a notary, or an employee—to attend a meeting where the client does not show up, those costs are deductible even if I don’t have income from that meeting to offset the costs.
Similarly, the money that you pay to keep the lights on in the office, or funds that you spend on promotional materials, are deductible even if they don’t immediately lead to revenue. The staff and the rent that you pay remain business expenses even if you have a no-show—or five.
The deductibility of business expenses hinges on two questions:
- Is this for business use?
- Is it an ordinary (common and accepted in your industry) and necessary (helpful and appropriate for your trade or business) expense?
The answer to both of those questions should be yes to claim an expense as a business-related tax deduction under Section 162 of the tax code—assuming no exceptions apply.
Net Operating Losses
But that raises another issue for business owners. Suppose I scheduled seven appointments this month, and because of the pandemic slowdown, only one person showed up. As a result, my expenses may far outweigh the revenue that I generated, and I lose money. What then?
For tax purposes, if you incur more expenses than revenue in a taxable year, you may be able to claim a loss. A net operating loss, or NOL, occurs in business when your ordinary and necessary expenses exceed your business income.
NOLs can be tricky—and lately, they’ve been a bit of a moving target. As a result of the CARES Act, you can carryback NOLs that occurred during 2018, 2019, and 2020 for five years.
A carryback is just what it sounds like: You can apply current year losses to earlier years where tax was owed, resulting in a reduction of tax for those years—and a refund. With a carryforward, you do the opposite: You apply the loss to future years, resulting in a reduction of tax for those years. It’s not haphazard: Ordering rules apply.
The CARES Act change was significant because prior law didn’t allow for carryback. Taxpayers who could offset difficult pandemic years with earlier, profitable years benefited both from a change in rates and the chance to put money back into their pockets immediately. Unfortunately, unless there’s a change in the law, most NOLs for the tax year 2021 or later must be carried forward.
But be careful. While losses that you can carry forward or back feel like a boon from a tax perspective, you don’t want to report consistent, unexplained losses. That’s especially true for sole proprietors and others who file a Schedule C: The IRS has made it clear that it considers profit motive a primary consideration for individual taxpayers when determining whether you’re running a trade or business, or simply engaged in a hobby. The IRS notes in Section 1.183-2(b)(6) that “where losses continue to be sustained beyond the period which customarily is necessary to bring the operation to profitable status such continued losses, if not explainable, as due to customary business risks or reverses, may be indicative that the activity is not being engaged in for profit.”
In other words, the IRS expects you to make some money eventually. As a rule of thumb, to be considered a bona fide business, an individual taxpayer should be able to show a profit for at least three of the last five tax years. If the IRS believes that you’re not operating as a business—and rather as a hobby—then your excess losses would be disallowed.
Outside of tax and accounting, if no-shows are a recurring problem, consider a few practical steps.
Take another look at your intake or reservation process. The easier it is to cancel bookings in advance, the more likely clients are to keep you informed.
When setting expectations, some businesses make clear that they will charge a cancellation fee for no-shows. Typically, that fee is a percentage of the cost of services since you may not be able to legally charge for the full amount. If you opt to charge a no-show fee, make sure that it’s provided to the client upfront, in writing, and in compliance with the laws in your state.
You can also consider a softer approach, like an automatic reminder system. For example, my online calendaring system sends customized emails and reminders for appointments. Email and text messaging systems may also allow for clients to easily confirm or cancel reservations in advance.
In most industries—including tax—dependable, repeat customers drive revenue and growth. When that pipeline is interrupted, even temporarily, it can cause real economic harm. Knowing what steps you can take to be proactive, and what you can do to mitigate the tax consequences, can be the lifeline you need.
This is a weekly column from Kelly Phillips Erb, the TaxGirl. Erb offers commentary on the latest in tax news, tax law, and tax policy. Look for Erb’s column every week from Bloomberg Tax and follow her on Twitter at @taxgirl.