Tax Rules on Holiday Gift Giving for Small Businesses

The holiday season is fast approaching and it’s the perfect time for small business owners to express their appreciation for employees and clients alike. Handing out small gifts is an excellent way to thank your customers for their business and solidify professional relationships. There’s also an added benefit since you can deduct some of the cost from your taxable income at the end of the year. The IRS has strict guidelines for determining what qualifies as a deductible gift expense that business owners need to keep in mind when doing their holiday shopping.

The $25 Rule

Gift expense deductions are limited to a specific dollar amount. As of 2014, business owners can only write off gifts that are valued at $25 or less per person. Anything over that amount can’t be deducted but there is no cap on the number of gifts you can give during the year. If you make more than one gift to the same person, their total combined value cannot exceed the $25 limit.

Incidental expenses, including packaging, gift-wrapping, engraving and shipping, are typically not used to determine the cost of a gift for tax purposes. Extra costs are deemed incidental if they don’t add substantially to the gift’s value. Items that cost less than $4 are generally not considered gifts if your business’s name is clearly imprinted on the article and it’s one of several that are distributed to multiple people. In either case, these costs would not be deductible as gifts (but may be deductible as advertising).

The $25 limit is only applicable to gifts made to individuals. Business owners who make gifts to the company as a whole can deduct them in any amount, so long as it’s reasonable. For instance, if you were have a gift basket delivered to a client’s business for all of its employees to share, you could deduct the full cost since it’s not designated for a specific person.

Direct and Indirect Gifts

In addition to enforcing a monetary limit on gifts, the IRS also makes a distinction between direct and indirect giving. A direct gift is one that you give to someone else without having to pass through a third party. An indirect gift is one that’s given to a colleague, client or employee through someone else, such as a friend or family member. It’s important to keep this difference in mind to avoid inadvertently impacting the recipient’s annual gift limit.

If you and your spouse both make business gifts, they’re treated equally for tax purposes. Regardless of whether you own a business together or separately, the $25 rule still applies for each gift you give individually or jointly. The purpose is to prevent married filers from doubling up on gift expense deductions.

Gift-Giving and Incentives

There are certain situations where you may be able to write off larger gifts by categorizing them as incentives or compensation on your taxes. The federal Tax Court has ruled previously that gifts to employees which qualify as sales incentives are deductible if they are considered to be ordinary and necessary expenses related to the cost of running the business. If you’re not sure whether a gift you’re contemplating is eligible, it’s vital that you speak with a tax professional before completing the purchase.

Gifts vs. Entertainment Expenses

Deducting gift expenses becomes slightly more problematic when the gift in question isn’t something tangible. Tickets to a concert or sporting event, for example, could be treated as a gift or an entertainment expense when filing your taxes. Under the current rules, gifts are 100 percent deductible up to $25 but you can only write off up to 50 percent of the cost for entertainment expenses.

When you’re purchasing things like tickets or movie passes or even a vacation package, you have to run the numbers to determine which option yields the biggest payoff. Just keep in mind that if you attend the event with the person that you’ve gifted the tickets to, it would normally be considered a business entertainment expense, regardless of the cost.

When Gift Expense Deductions Become Problematic

Claiming tax deductions for your small business can be tricky if you’re unclear on what the rules are. Including a gift expense that doesn’t qualify or failing to maintain accurate records could lead to trouble with the IRS if you’re ever selected for an audit. When your filing is called into question because of issues relating to gift expense deductions, consulting a tax expert is the right move. If you’re concerned about the accuracy of your return, contact experienced tax attorney Jessica Grace at (612) 326-5291 for assistance.