Business Gift Expenses

As a small business owner, you may occasionally give gifts to your clients and customers, particularly around the holidays. But did you know that you can only deduct part of the cost of certain gifts as a business expense?

Dollar limitation

Basically, the IRS will let your business deduct only $25 (or less) for business gifts you give to any one person during your tax year. In other words, this $25 maximum deduction is per recipient. Any amount in excess of $25 is disallowed as a business deduction.

For example: If you give your client a $50 dollar watch as a gift, you can only deduct $25. The remaining $25 you paid for the gift is a non-deductible expense.

Combined spousal gifting

If you and your spouse both give gifts, you are treated as one taxpayer and the deduction both you and your spouse, together, will be able to claim is $25 per donee. This is true even if you have separate businesses, are separately employed, and each of you has an independent connection with the gift recipient.

Corporate gifting

If you give gifts to corporations or to business entities which are intended for the personal use or benefit of an individual (such as the president or manager) or a small class of individuals, those gifts are treated as having been made to the individual or individuals who actually benefit from the gifts.

However, if the gift is not intended to be used personally by a particular individual or a limited class of individuals, and you are not able to determine who actually used the gift, the gift will not be treated as having been made to an individual. In this case, the $25 limit will not apply.

On the other hand, if the gift could be treated as an entertainment expense, then the 50% limit on deductible entertainment expenses may apply (such as gifting tickets to a theater or sporting event).

Incidental costs

The $25 limit for business gifts does not include incidental costs -- for example, packaging, insurance, and mailing costs, or the cost of engraving jewelry. Related costs are considered incidental only if they do not add substantial value to a gift.

For example: You send a client a fruit basket as a gift. If the basket has a substantial value as compared to the value of the fruit, the cost of the basket is not incidental and must be included in the $25 limit. On the other hand, the cost of gift wrapping is incidental and does not have to be included in the $25 limit.

Items exempted from the gift limitations

The following items are exempted from the $25 limit for business gifts and their cost is deductible without limitation:

• Items that cost $4 or less, have your name clearly and permanently imprinted on them, and are one of a number of identical items you widely distribute (such as key chains or pens with your business name or logo); or
• Signs, display racks, or other promotional material to be used on the business premises of the recipient.

Gift expense vs. Entertainment expense

The general rule of thumb is that any item that could be treated as either a gift or an entertainment expense must be considered an entertainment expense.

Giving Entertainment Gifts AND NOT Attending with Recipient:
If you give entertainment tickets and do NOT attend the event yourself, you have the choice of determining whether an item is either a gift or entertainment expense.

Giving Entertainment Gifts AND Attending with Recipient:
If you give entertainment tickets and DO attend the event with the client, you must treat the cost of the tickets as an entertainment expense you have no choice.

Food gifts

According to a special exception in the tax rule, if you give a gift of packaged food or beverages that you intend your client to use at a later date, you should treat the cost as a gift expense, subject to the $25 limit.

GIVING GIFTS, AWARDS, & PRIZES TO YOUR EMPLOYEES

Most gifts that you give to your employees are considered to be compensation. This is because the IRS does not believe that employers can act with a detached and disinterested generosity toward their employees.

Gifts to your employees must be treated as taxable wages for payroll tax purposes, unless you can document that a gift is connected with an event that is totally unrelated to your business (such as an employee's wedding). Gifts of property are also treated as taxable wages for payroll tax purposes.

Gifts or meals furnished to encourage goodwill or boost morale must also be treated as taxable wages because they are not considered to be for the employer's convenience. This does not include the occasional holiday or company party.

Christmas gift exception

Christmas gifts are NOT considered taxable wages if the gifts are items of property having nominal value (such as a turkey or a ham).

PLEASE NOTE: This Christmas gift exception does NOT apply to small gifts of cash.

Awards & prizes

Employee prizes and awards are generally considered taxable wages, on the premise that you award them in return for an employee's performance or services.

There are two limited circumstances under which you may be relieved from payroll tax obligations on noncash awards:

• Employee achievement awards of tangible personal property that are awarded because of the employee's length of service (including retirement), productivity, or safety achievement. The awards must be made under a written plan that does not discriminate in favor of highly compensated employees, and which average $400 or less during the year. These types of awards are not taxable wages and are considered "qualified" plan awards.
• Other awards are considered "nonqualified" and no more than $400 in nonqualified awards can be exempt from taxable wages for any one employee. Up to $1,600 in total awards, both qualified and nonqualified, will be exempt from wages for any one employee per year.

For more information, please see the following IRS Publications:
Publication 463, Travel, Entertainment, Gift & Car Expenses: http://www.irs.gov/pub/irs-pdf/p463.pdf