“It’s the most wonderful time of the year…” Or so at least one seasonal song would have us believe. I can’t argue with that sentiment since it truly is a time for family and friends to gather and renew their acquaintances at the myriad of holiday gatherings that will take place over the next month. Retailers love this time of year, and it is certainly a time to pause and let your business associates know how much you value them.
As wonderful as the next month might be, businesses must be careful to avoid going overboard on gifting. You might ask yourselves how a business could ever give too much to a valuable client, but the Internal Revenue Service is not confused on the difference between generosity and deductibility.
What does a quarter buy these days? When I speak of a quarter, I am talking about a quarter of $100 – or $25. That is the limit on the deductibility of business gifts given directly or indirectly to business acquaintances. The rules can be a little tricky. For example, assume you want to give three cheese baskets costing $25 each to your good customer Frank. Since Frank also has a wife and a child, you decide to give a cheese basket to each and congratulate yourself for your ingenuity. Unfortunately, if you don’t have a direct business relationship with Frank’s wife and son, the $75 deduction won’t fly and you can still only deduct $25.
On the other hand, if you give three cheese baskets to the company that are intended to go to Frank and two other executives with whom you do have direct business relationships, you will be able to deduct the full $75.
How do you feel about the theater? More to the point, how do your good clients feel about the theater? Let’s say The Nutcracker is playing locally on Dec. 24 and you have clients that love that production. Unfortunately, each ticket costs $100. If you give your clients a ticket as a gift, you are already out $75 from a deduction standpoint based on the $25 rule. On the other hand, if you treat the tickets as entertainment, you can deduct one-half the cost, or $50.
A big part of the season is entertainment. Sometimes this means intimate dinners with individuals, but more often this means large scale parties with groups of clients or customers. What’s the difference? On the surface, there is not much difference. Intimate dinners with key customers and parties for large groups of customers both fall under the 50 percent deductibility rule. There are, however, a few obstacles when it comes to meeting the general deductibility tests. To be deductible, the party must be:
- Directly related to the active conduct of your trade or business (i.e. have some discussion related to your business)
- Associated with a business discussion that immediately precedes of follows the party
Since you are dealing with business partners or clients, meeting these conditions might seem easy; however, the presence of cocktails, hors d'oeuvres and similar items create an immediate presumption that the entertainment is a social event and not business related. If you choose to have the party at a private residence, the issue becomes cloudier by moving the venue to a place that is not typically associated with business.
You can overcome these presumptions by placing appropriate business literature throughout the venue and discussing issues of business importance to your client invitees. Just make sure that you document the discussions in case the IRS later questions the deduction.
Of course, intimate business dinners with clients at restaurants where you normally entertain clients, along with appropriate documentation, makes it easier to substantiate a business purpose and deductibility of the entertainment expense.
Employee holiday parties are typically 100 percent deductible as long as they are not lavish. Small token gifts to employees also would generally be deductible. However, if you give cash gifts to your employees, including gift cards, these are generally considered compensation and would be includible in the employees’ W-2s.
Generosity and Taxes
In the end, you would be hard-pressed to find any clients who do not appreciate your generosity – and that’s as it should be. On the other hand, the Internal Revenue Code in the United States is not founded on the principle of generosity, which might make it hard for you to treat your customers the way you believe they deserve.
If you have any questions regarding the deductibility of your holiday gifting desires, give us a call. We will be happy to guide you to the best possible tax consequences for you and your company.
Have a joyous and safe holiday season.