The element of surprise and delight is at the heart of being a small business owner. But can it also benefit your tax bill?
Many small business owners like to show appreciation to their clients, customers, and team with thoughtful gifts. After all, you’re building a rapport with your clients and a bond with your team.
Whether in the form of cash, gift cards, or a token of appreciation, gifts come with tax implications that small business owners should take into account.
Below I’ll share everything you need to know about deducting gifts, as well as the rules that may have changed due to the Tax Cuts and Jobs Act.
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Gifts for Team Members
Before you give a gift to an employee, there are two questions you should consider:
- Is this gift taxable to my employee?
- Is this gift a deductible business expense?
The answer to these questions depends on the form and value of the gift.
If the gift is considered taxable income to the employee, you are required to withhold all applicable federal and state income and payroll taxes. You must also pay other employment taxes, such as federal and state unemployment taxes on these amounts.
Team Gift Type 1: Tangible Property
Gifts of property are not considered taxable income to employees as long as they fall under the definition of a “de minimis fringe benefit”.
According to the IRS, a de minimis fringe benefits is a gift “for which, considering its value and the frequency with which it is provided, is so small as to make accounting for it unreasonable and impractical.”
This might include the occasional snacks, coffee, and doughnuts, or holiday or birthday gifts with a low fair market value, such as flowers, fruit, books, etc.
The IRS does not specify a maximum dollar amount for excluding de minimis fringe benefits from an employee’s taxable income, but the business can deduct no more than $25 of a gift to any one person each year, including employees.
For example, say as a gesture of appreciation for working long hours on a project, you buy your employee $100 concert tickets. Only $25 of that gift would be a deductible business expense. The rest would be non-deductible.
Team Gift Type 2: Gift Cards and Certificates
Gift cards and gift certificates are considered taxable income to employees because they can essentially be used like cash. The cost of the gift card is fully deductible to the business, but you must withhold taxes from the employee’s pay for these gifts.
Team Gift Type 3: Awards
You can deduct up to $400 of the cost of employee safety and service awards of tangible personal property (such as a watch) for each employee for each year. Awards are not taxable income to employees, but they must be limited.
For service awards, they cannot be given during the first five years of the employee’s service and no more often than every five years. Safety awards cannot be given to more than 10% of employees during the same year.
The Tax Cuts and Jobs Act of 2017 (TCJA) clarified that awards of tangible personal property cannot include cash, cash equivalents or gift cards, vacation, meals, lodging, theater tickets, sports tickets, stocks, bonds, or similar investments.
When you record gifts to employees in your books, if the gift must be included in the employee’s taxable compensation, post it to the same account to which you’d post their salary, wages, or bonuses. If the gift is not considered compensation, record it under “employee incentives.”
Gifts for Clients
There are little ways to show your appreciation for your star clients. Gifts are just one form of that gratitude.
Client Gift Type 1: Tangible Property
The same rule applies to your client: You can deduct no more than $25 per person, per year for business gifts.
The IRS specifically states that incidental expenses, such as postage, engraving, and gift wrapping are not included in that $25 limit. However, if something adds value to the gift itself, it cannot be considered an incidental.
For example, say you purchase a gift basket for a client that costs $25. Say you also added a $25 bottle of wine to the basket and spent another $20 wrapping and shipping basket. Your deduction would be $45–a maximum of $25 for the gift basket and the wine and an additional $20 for wrapping and shipping.
Client Gift Type 1: Branded Swag
Good news is you don’t have to include branded marketing collateral in that $25 limitation.
Items that cost less than $4, have your company name or logo printed on them, and are one of many identical items you give away on a regular basis are not considered gifts.
Client Gift Type 2: Entertainment
Be careful with deducting gifts that might be considered entertainment expenses. For example, if you give a client tickets to an entertainment event, is that a gift or entertainment?
Generally, if you attend the event with the client (whenever we can do that again), the tickets should be treated as an entertainment expense. If you give tickets to a client and don’t attend the event, it can be considered a gift.
This distinction is important because the TCJA eliminated the deduction for entertainment expenses as of January 1, 2018.
Pro-Tip: Keep Records of Tax Deductible Gifts!
As with most tax deductions, keeping records of what you bought, how much you paid and the business purpose of the gift is key to ensuring you get your deduction.
Say you stop into a local retailer and buy four gift baskets for clients at $25 apiece. If the receipt doesn’t include an itemized list of the gifts purchased and shows the total you paid instead, it’s a good idea to make a note that you purchased four gift baskets at $25 each. On each, also name the clients for whom the gift baskets were purchased.
That way if your tax preparer—or the IRS—question the deductibility of your gift, you have written documentation to support it.
Everyone knows it’s better to give than to receive—even more so if that giving can benefit your tax bill.
At the end of the day, it’s a win-win: A small gift of appreciation can leave a lasting impression and serve as a valuable deduction. (Just make sure you keep thorough records so your giving spirit doesn’t come back to bite you at tax time!)