Business Gift-tax Considerations
Always Remember the Rules of DeductibilityThe holidays are upon us, and many practices or individual physicians feel it is important to show appreciation to their customers, employees, and business contacts. Gifts can be a great way to stay top of the mind through what can be a slow season. If it wasn’t difficult enough to find that perfect business gift to send the right message, businesses also want to be sure that the gifts will be tax-deductible.
There are several factors to consider in determining whether the IRS will allow the deduction.
For any business expense to be deemed tax-deductible, it must be ordinary and necessary in relation to the business and reasonable in amount. Ordinary is defined as customary or usual. It is not required to be a usual occurrence for the taxpayer, just within the trade or industry. A necessary expense is one that is appropriate and helpful, but need not be essential to the business. The IRS uses this language in order to disallow reporting personal expenses or excessive expenditures for the purpose of decreasing taxable income.
Business gift deductions are limited in dollar amount by the IRS, and that limit is a mere $25 per recipient. Incidental costs that do not add value to the item, such as shipping, are not included. So that taxpayers do not try to circumvent the threshold, gifts cannot be split between spouses, who are treated as one entity for this purpose even if they have separate business reasons for giving the gifts. In addition, gifts to separate members of a family will be aggregated for the limitation, unless there is an independent business connection with each of them. A gift given to a corporation is not limited in dollar amount as long as the gift was not intended to be used by a particular person or limited class of people. If you were wondering why your office is full of gift baskets around the holidays, this is why.
The line can be blurry as to what should be classified as a gift versus a promotional expense versus an entertainment expense. Promotional items include those that cost less than $4 each, have the name of the business clearly on them, and are identical to others generally distributed by the business. This classification would include the pens, calendars, and bobbleheads bearing the name of pharmaceutical companies which we all have in our desk drawers. Entertainment expenses are considered by the IRS to have both a business and personal benefit, and thus they are limited to 50% deductible. Entertainment items might include tickets to a sporting event or concert. If the event is attended by both the gift giver and recipient, then the event must be classified as entertainment. If the event is not attended by a member of the business giving the tickets, then the choice is open to classify the tickets as either a gift, limited to the $25, or entertainment, limited to the 50%.
Businesses should be especially careful with gifts made to employees. Where the cash or non-cash gift is payment for services, the value will be considered wages and will be taxable to the employee. The IRS will assume all gifts are for services unless established otherwise. Sales incentives should be included in the employee’s gross wages and are subject to withholdings. Non-cash items are added to income at their fair market value. There are special exceptions made for safety or length-of-service awards, but these must meet certain other restrictions. Nominal items such as gift certificates for specific items or Thanksgiving turkeys given to employees are excluded. However, a $25 grocery-store gift card would not meet this exception.
It should also be noted that the IRS maintains recordkeeping requirements to substantiate the deductibility of business gifts. The cost, description, date, and business purpose of the gift, as well as the name and other information about the recipient that would establish their relationship to the taxpayer, must be included in the record of the expense. In the case where the gift was given to a business, the names of the indirect recipients do not need to be recorded, just a general note about the class of recipients such as ‘the employees of ABC corporation.’
Why does the IRS care how generous you are? While the reasonableness of the dollar limitation in the current market is debatable (the amount has remained unchanged since 1963), the purpose is clear. Like most IRS restrictions, the regulations come on the heels of misconduct. Upon audit, business owners have attempted to mask illegal payments such as kickbacks and bribes by classifying them as gifts. Personal presents for a taxpayer’s spouse and children have been passed through corporations. Expensive cars and other non-cash payments for services have been excluded from income. Consequently, business gifts are classified with entertainment expenses as items the IRS deems particularly susceptible to abuse.
When picking out your business gifts this holiday season, remember these rules of deductibility — and, of course, it’s the thought that counts.
Charlotte Cathro is a tax manager with the Holyoke-based certified public accounting firm Meyers Brothers Kalicka, P.C.