ARDMORE, Pa. — The season for gift-giving and holiday parties will soon be upon us. Although many drycleaning and laundry business owners and managers clearly know how to celebrate and show their appreciation to both customers and employees, few are aware that Uncle Sam, in the form of our tax laws, is more than happy to pick up part of the cost.
While parties, business gifts and employee awards often qualify as tax-deductible, giving gifts, bonuses or awards to employees, clients or customers can have significant tax implications for both the business operation and the recipients. Bottom line, however, everyone will be excited to know that their annual employee holiday party may be 100% tax-deductible.
Small businesses, including dry cleaners, often give gifts to clients and customers, particularly around the holidays. What is often overlooked is that only a portion of the cost of certain gifts may be deducted as a business expense.
Basically, the Internal Revenue Service (IRS) will let a business deduct only $25 or less for business gifts given to any one person during the tax year. This means that any number of employees, co-owners, or business partners may give a client business gifts although the deduction will be limited to $25 per recipient. Any amount of expense in excess of $25 is disallowed as a deduction. So, if a client is given a $50 watch as a gift, only $25 may be deducted.
The $25 limit for business gifts doesn’t include incidental costs—packaging, insurance, and mailing costs, 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.
If key chains or pens with the business name on them are given to customers and clients, they are usually “exceptions” to the $25 limits for business gifts, and their cost is deductible without limitation. Also excepted are items that cost $4 or less, have the business name clearly and permanently imprinted on them, and are one of a number of identical items widely distributed. Signs, display racks, or other promotional material to be used on the business premises of the recipient are also ignored for purposes of the $25 limit.
It is not a secret that tax rules allow businesses to claim a deduction for only 50% of business meal entertainment expenses. In fact, in order to reach that level, those expenses need to be “ordinary and necessary” as well as closely related to the business. And, unfortunately, even if the expenses are considered related to the business, the sky is not the limit. No business can deduct meal and entertainment expenses that are lavish or extravagant. The expenses must be reasonable considering the facts and circumstances.
But about those parties. Holiday parties, annual picnics, or summer outings may qualify for a unique 100% tax deduction. Even employee meetings can be turned into a party for a tax deduction.
Under U.S. tax rules, entertainment expenses must be “primarily” for the benefit of employees other than those in a so-called “tainted group.” This group consists of any employee paid more than $110,000 a year, a 10% owner, or any family member of a 10% owner.
While the owner of a closely held drycleaning or laundry business belongs in the tainted group, it is often not a big deal so long as the partying with the employees is primarily (more than 50%) for the benefit of the employees. Going one step further, the cost of entertaining employees’ spouses is also 100% deductible.
Of course, it is still necessary to satisfy the “ordinary and necessary” business purpose test. Such an expense simply means it is “appropriate and helpful” to the business. Boosting the morale of workers and helping everyone feel appreciated makes that Christmas party 100% deductible.
Of course, just as any entertainment must be documented, the 100% deductible employee entertainment expenses must substantiated. Also, remember to write down the “who, what, when, where and why.” Like all tax deductions, the write-off can’t be nailed down without writing it down.
EMPLOYEE BUSINESS GIFTS
Bonuses to employees are usually considered income and while obviously tax-deductible by the business, they are taxable to the employee. Income taxes and FICA taxes on employee bonuses (unless the employee is over the Social Security maximum for the year) must be withheld.
It’s a slightly different story when it comes to employee awards. In general, up to $400 of the cost for employee awards of tangible personal property (such as a watch) for each employee each year can be deducted. This includes service awards and safety awards. There are, unfortunately, limits on employee awards given by partnerships.
Service and safety awards are not taxable to employees if they are limited. There are limits on service awards (not during the first five years, and not more often than every five years) and safety awards (not to more than 10% of employees). Awards in excess of the limits are taxable to the recipient.
Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult a tax attorney for advice regarding your particluar situation.
Check back Thursday for the conclusion!