Written by: Cindy Smith, CPA, CFE
Since we’re getting closer to the holiday season, a lot of our business clients will be giving gifts to customers, vendors, employees, and other business associates. Before you go shopping, you might want to consider the IRS rules and limitations in the deductibility of gifts. In general, the tax rules limit the deduction for business gifts given directly or indirectly to a person to $25 per person per year — a limitation that hasn’t been raised in decades. There is no limit to how many people you can give business gifts to, nor on how much you spend for those gifts, but your business gift deduction is limited to $25 per recipient. However, there are exceptions to the rules and the most common ones are as follows:
Gifts to a business entity vs. an individual: The $25 limit only applies to gifts directly or indirectly given to an individual. Thus, gifts given to a company for use in the business aren’t subject to the limit. For example, if you give a gift basket to an entire company, you can deduct the full amount. However, if the gift is intended for a particular person or group of people within the company, then it is limited to $25 per person.
Gifts to a married couple: If you have a business connection with both spouses and the gift is for both of them, the $25 limit doubles to $50.
Gifts vs. entertainment expense: If you take a customer to a sporting or theater event, and go with them to the event, the rule is that you must treat the cost as an entertainment expense, subject to the entertainment expense rules. In that case, the $25 limitation doesn’t apply. However, as an entertainment expense, you may deduct only 50 percent of the cost.
However, if you give a customer tickets to a theater or sporting event and don’t go with them, you have a choice. You can treat the cost of the tickets as either a gift expense or an entertainment expense, whichever is to your advantage. For instance, suppose you gave a customer two tickets to a sporting or theater event for his or her personal use that had a total value of $30, and don’t attend the event yourself. By treating the tickets as a gift, you may deduct $25 of the expense. If you treated it as an entertainment expense, your deduction would be limited to 50% of $30, or $15. However, if you paid $100 for a ticket with a $60 face value, you would be better off treating it as an entertainment expense. This way you would be able to deduct 50% of $60, or $30. If you treated the ticket as a gift, your deduction would be limited to $25.
Gifts to employees: If an employer distributes cash, a check, or a gift certificate to an employee, the value of the gifts is considered additional wages or salary, regardless of the value. You must add the amount of the gift to the employee’s W2.
If, as a means of promoting goodwill, an employer gives an employee a gift of tangible items, such as hams, turkeys or other merchandise, the value of the gift isn't included in the employee’s income. It is, however, subject to the $25 limit.
Incidental expenses: The $25 limit does not include incidental costs, such as packaging, gift-wrapping, engraving, or mailing costs. Costs are considered incidental if they don’t add substantial value to a gift.
Promotional items: Many businesses give customers small promotional items such as key chains, pens, and notepads. Items that cost $4 or less, have your company name clearly and permanently imprinted on them, and are widely distributed may be deducted without limitation, regardless how many you give to an individual.
As you can see, there are several exceptions to the $25 rule, so it’s important that the qualifying expenses be tracked separately (typically by charging them to a separate account in your accounting records) so that the correct deduction can be claimed. Also, to obtain any deduction for a business gift, you must have documentation supporting the gift’s cost and a description of it, the date it was purchased, the business purpose of the gift, and the business relationship to the taxpayer of the person receiving the gift.
If you have any questions regarding the types of gifts or if you need assistance in how to properly account for them in your financial records, please call us for assistance.