As the calendar flips from October to November, we find ourselves moving into the gift giving season; the time of year when we want to thank our customers for their loyalty and our employees for their hard work. I hope your business has been successful enough for you to be very generous this year.
With that said, I don’t want to be a Grinch dampening your holiday spirit, but I feel that I should alert you to the tax pitfalls of the holiday season.
Gifts to Customers and Vendors
If you give gifts on behalf of yourself (as a sole proprietor) or your company to customers or vendors in the course of your trade or business, you can deduct all or part of the cost as a business expense on your tax return. The catch is that the IRS limits the tax deductible portion of the cost to $25 per person per year. So if you give a gift to a company with the intention that a particular person will be the sole beneficiary, then your tax deductible amount is limited to $25.
For example, if you purchase an $80 gift basket for your best customer and send it to the company president, your tax deductible amount for that gift is going to be $25. But if you send that same gift basket to the company with the intention that it will be shared among all of the employees, then as long as your customer has four or more employees, the entire cost of the gift will be deductible. The important thing here will be to document the nature of the gift basket and the name and address to which it was sent.
And be aware that the limitation is per person per year. So if you send Bill of Bill’s Electronics a $50 bottle of wine for his birthday in July and then send him an $80 gift basket in December, your maximum deduction for those two gifts is $25.
If you also give a gift to a member of a customer or vendor’s family, the gift is generally considered to be an indirect gift to the customer or vendor unless you have a direct, bona fide, independent business relationship with the family member. So sending the wine to Bill and then sending the gift basket to his wife (who you don’t have a business relationship with) is not going to get you more of a deduction.
If a partnership gives gifts, the partnership and the partners are treated as one taxpayer. So again, if you and your partner give that $50 bottle of wine to Bill, you won’t be able to deduct the entire cost on your tax return. The IRS will limit you to one $25 deduction.
One caveat to this limitation is that if you give a gift of entertainment (like tickets to a theater performance or sporting event) and you do not go with the recipient, then the IRS gives you the choice of declaring the cost of the tickets as either a gift expense or an entertainment expense, whichever would be more advantageous for your business. Entertainment expenses are subject to different, and sometimes better, limitations.
Gifts to Employees
The issue with gifts to employees is not just one of expense deductibility but also taxability – to the employee.
Cash in any amount is always taxable to the employee. This means that you must withhold all applicable taxes from the employee’s check and also pay the employer’s share of such taxes. But that also means that the amount is fully deductible by your business so you don’t need to worry about the $25 limitation.
Gift certificates and gift cards are also considered by the IRS to be taxable to an employee because they are considered cash equivalents. So if you opt to give gift certificates or gift cards, you must add the value of the certificate or card to the employee’s next paycheck as a non-cash item and withhold the appropriate taxes. In this case, you may want to consider grossing up the amount so that your employee does not bear the brunt of the taxes. For example, if you give an employee a $50 gift card, the realized amount may only be $30 because of the taxes that are required to be withheld.
If you choose to give a non-cash gift other than a gift certificate or card, remember that the limitation on the tax deductibility of gifts discussed above also applies to gifts given to employees. In addition, you also have to consider the taxability of the gift to the employee. For example, if you decide to give each of your five employees a cashmere sweater valued at $130, your tax deductible amount would be limited to $125 ($25 x 5) and you would then have to add a non-cash item of $130 to each employee’s next paycheck and withhold the appropriate taxes on that amount.
But the IRS does allow you to exclude the value of a de minimis gift to an employee from the employee’s pay. A de minimis gift is any property or service that you provide to an employee that is “small in value compared to the amount of total compensation.”
The IRS does not provide a specific value or limit on what it considers to be de minimis. So although you may have heard some people say it is $25 or even $75, I would advise you not to put too much stock in an exact dollar amount. IRS Publication 15-B provides a few examples of de minimis gifts:
- Holiday gifts, other than cash, with a low fair market value
- Flowers or fruit provided under special circumstances
- Occasional tickets for theater or sporting events
- Occasional parties or picnics for employees and their guests
So, if you give food or merchandise of nominal value to your employees at holiday time, you can deduct the full cost of these items not as a gift expense, but as a nonwage business expense (maybe call it “employee appreciation”). This could be in the form of a luncheon held at your office or nearby restaurant or a similar gift given to every employee like a journal, a pair of movie tickets or a holiday turkey.
It’s Better to Give Than to Receive
Despite the draw backs, gift giving at holiday time is a great way to show appreciation. If you want to minimize the tax implications to all parties, consider a companywide gift or event rather than individual gifts. Also, a contribution made to a bona fide charitable organization in the name of your company or a customer would be a nice gesture.
Keeping it inexpensive but personal is also a nice touch. So instead of passing out sweatshirts with the company logo emblazoned on them, consider a holiday turkey, a holiday wreath, or better yet, how about an additional paid day off.
Your guidance on this subject is really helpful. Thanks for the info. Merry Christmas