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Management Counsel
MANAGEMENT COUNSEL: LAW PRACTICE 101 By: Lyndsey L. Lee
Lewis Thomason, P.C.
THE GIFT OF THE BUSINESS EXPENSES DEDUCTION FOR HOLIDAY GIFTS
Holiday gift-giving can be a great way for attorneys and law firms to show appreciation and maintain goodwill. To add to the holiday cheer, holiday gift giving has long been accepted as an ordinary and necessary business practice with a corresponding business expense deduction.1 But the federal tax laws do not take a holiday break, and while the Internal Revenue Code gives some business owners a gift in the form of a business expense deduction for gifts given by the business, this “gift” in the Code is limited.
Is the cost of this gift a deductible business expense?
The taxpayer (the business giving the gift) generally may deduct the cost of the gift as an ordinary and necessary business expense, so long as the gift is connected with the taxpayer’s opportunity to generate business income.2 Importantly, however, the deduction is limited to a total of $25.00 per individual gift-recipient per taxable year.3 Branded swag does not count toward this $25.00 limit though, so long as: (i) the individual item of swag costs the taxpayer no more than $4.00, (ii) the name of the taxpayer is clearly and permanently imprinted on the item, and (iii) the item is one of a number of identical items generally distributed by the taxpayer.4
Also excluded from the $25.00 limit are incidental costs such as for customary engraving on jewelry, or for packaging, insurance, and mailing or other delivery.5 But, the related cost is only “incidental” if it does not add substantial value to the gift. Say, for example, a business purchases a $25.00 gift basket, adds a $30.00 gift certificate to it, and spends $20.00 on delivering it to an individual recipient. In that case, the business may be entitled to a deduction of up to $25.00 for the cost of the gift and up to $20.00 for the incidental delivery cost, but would not be entitled to a deduction for the full $55.00 that the gift basket and the gift certificate cost the business.
Keep in mind though that the IRS has strict rules about the documentation taxpayers must maintain to substantiate their deductions. To deduct a gift as a business expense, the taxpayer must maintain adequate records or sufficient evidence of: (1) the cost of the gift, (2) the date and description of the gift, (3) the business purpose of the gift, and (4) the identity and business relationship of the specific person receiving the gift.6 This final requirement – that the taxpayer document the individual recipient of the gift – is crucially important, but unfortunately often overlooked by taxpayers.7
What if I give a gift to another business instead of an individual?
Because the Code focuses on gifts to individuals, the $25.00 limit does not apply to gifts to corporations or other business entities, so long as the gift is intended for the benefit of the recipient business generally and not for the benefit of any individual employee, stockholder, or other owner of the recipient business.8 Conversely, if the gift is intended for the eventual personal use or benefit an individual employee, stockholder, or other owner of the recipient business, it generally will be considered a gift made indirectly to the individual and, thus, still subject to the $25.00 limit.
Unsurprisingly, however, the nuance between a gift made to a business for its benefit and a gift made to the business for the benefit of one of its employees, stockholders, or other owners can be a difficult one to navigate. For instance, if a taxpayer gifts show tickets to a closely held corporation9 for eventual use by any one of the stockholders of the corporation, the tickets are considered indirect gifts to the individual who eventually uses the tickets.10 Conversely, however, if the same taxpayer gifts the same tickets to a corporation for the eventual use by any one of a large number of employees or customers of the recipient corporation, the gifts generally will be treated as one to the corporation instead of the individuals and, thus, not subject to the $25.00 limit. A closer reading of the regulation suggests that the determining test is whether under the circumstances of the case, it is reasonably practicable for the taxpayer to ascertain the ultimate recipient of the gift.
Finally, just as the Code allows for forgiveness from the $25.00 limit when you give to a corporation, it expects additional substantiation in return. In Leschke v. Commissioner, the tax court refused to allow a deduction for gift certificates given to 28 corporate customers when the taxpayer documented only the name of the corporate recipient and not whether the corporations were small, closely held corporations with a few employees.11
While it is easy to get wrapped up in the spirit of the holidays and the joys of gift-giving during this time of the year, keeping these general principles in mind can help extend the joy all the way through tax season. And, as always, if you have questions about a potential deduction or your substantiation requirements, do yourself and your CPA a favor and talk it over with them first!
1 Leschke v. Comm’r, T.C. Memo 2001-18 (collecting cases). 2 Bruns v. Comm’r, T.C. Memo 2009-168 (citing Brown v. Comm’r, T.C. Memo 1984120 and ). 3 26 U.S.C. § 274(b)(1). 4 26 U.S.C. § 274(b)(1)(A). 5 26 C.F.R. § 1.274-3(c). 6 26 U.S.C. § 274(d). 7 See Bruns, T.C. Memo 2009-168 (disallowing a deduction when the taxpayer kept receipts for purchased gifts, but failed to note to whom the gift was given). 8 26 C.F.R. § 1.274-3(e)(2). 9 Generally, one in which at any time during the last half of the taxable year more than 50% in value of the corporation’s outstanding stock is owned, directly or indirectly, by 5 or fewer individuals. 26 U.S.C. § 856(h)(1)(A). 10 26 C.F.R. § 1.274-3(e)(2). 11 See Leschke, T.C. Memo 2001-18.
