As a small business owner, you may find yourself giving gifts to clients and customers in the course of your business, particularly around the holidays. While you can deduct the cost of certain gifts as a business expense, there are substantial limitations on what you can deduct.
For purposes of this discussion, a gift is any item that's excluded from gross income of the recipient under the gift tax laws. If an item is excluded from gross income under any other provision, then it's not considered to be a gift. For example, because scholarships are excluded from income under another tax law provision, they are not considered gifts. Similarly, most "gifts" to an employee will be treated as taxable compensation for the employee, which is deductible for your business under the normal rules for employees' pay.
Dollar limitation. Your business can deduct only $25 (or less) for business gifts you give to any one person during your tax year. This means that any number of your employees, co-owners, or business partners may give a client business gifts. However, the deduction will be limited to $25 per recipient.
Any expense over $25 can not be deducted—it simply comes out of your pocket (or the profits of the business.) So, if you give a client a $50 dollar watch as a gift, you can only deduct $25. In addition, if you and your spouse both give gifts, you're both going to be treated as one taxpayer. Consequently, the deduction both you and your spouse, together, will be able to claim is $25 per recipient. This is true even if you have separate businesses, are separately employed, and each of you has an independent connection with the gift recipient.
Direct and indirect gifts. The $25 limit for business gifts includes both direct and indirect gifts. Figuring out if you gave a direct gift is a pretty straightforward. If you give a fruit basket to each of ABC Corporation's 10 employees, then you made a direct gift to each one of them. Determining whether you made an indirect gift is trickier because, in an audit situation, the IRS will want to know who received the gift, and also who was actually intended to benefit from the gift.
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You give your client's live-in relative, Aunt Mabel, a single ticket for a basketball game. Now, at the time you gave her the ticket, you probably had a pretty good idea that she would ultimately give the ticket to your client who is an avid basketball fan. Do you think the IRS will classify this as an indirect gift to your client? You can bet on it.
However, if you have bona fide business dealings with Aunt Mabel (let's say she is also a very good customer of your business) and you know that she is also a basketball fan, then the gift would probably not be considered an indirect gift.
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Gifts made 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 are considered to have been made to the individual or individuals who actually benefit from the gifts.
However, if the gift is not intended for the eventual personal use or benefit of a particular individual or a limited class of individuals, and it is not practical for you to determine who actually used the gift, the gift will not be considered to be made to an individual and the $25 limit will not apply. On the other hand, the 50 percent limit on deductible entertainment expenses may apply if the gift could be considered entertainment (such as a gift of tickets to a sporting event).
Incidental costs. The $25 limit for business gifts doesn't include incidental costs - for example, packaging, insurance, and mailing costs ,gift-wrapping, or the cost of engraving jewelry. Related costs are considered incidental only if they don't add some kind of substantial value to a gift. For example, if you send your client a fruit basket as a gift, there are two components of the gift: the fruit and the basket. If the basket has a substantial value as compared to the value of the fruit, the cost of the basket is not incidental and it must be included in the $25 limit. On the other hand, if the "basket" is simply a cardboard trap with a cellophane covering, then the cost is incidental and doesn't have to be included in the $25 limit.
Items excepted from the gift limitations. Key chains or pens with your business name on them that you distribute to customers or clients are generally not considered gifts and are not subject $25 limit for business gifts provided they fit into one of these categories:
- 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
- signs, display racks, or other promotional material to be used on the business premises of the recipient
Entertainment gifts. What happens if you give tickets to a play or sporting event to a customer or client? Is this a gift expense or an entertainment expense? The general rule is that any item that could be considered either a gift or an entertainment expense must be considered an entertainment expense. However, if you give the tickets and do not attend the event yourself, you have the choice of determining whether an item is either a gift or entertainment expense. If you go with the client, you must treat the cost of the tickets as an entertainment expense - you have no choice.
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Tip
Taking into account the $25 limit for gifts and the 50 percent limitation on entertainment expenses, it's generally better to treat a ticket expense as entertainment when it is over $50.
For example, you gave a client ballet tickets that cost $140. If you deduct them as a gift expense, your deduction is limited to $25. However, if you deduct them as an entertainment expense, your deduction is $70. Conversely, if you gave a client tickets to a movie premiere that cost $30, you would get a bigger deduction by claiming a gift expense ($25 as opposed to $15 for an entertainment expense).
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Food gifts. What about food-related gifts? Should you treat their cost as a meal expense or a gift expense? There is a special exception in the tax rules that says, if you give a customer or client packaged food or beverages that you intend them to use at a later date, you should treat the cost as a gift expense, not a meal expense.