Deck the halls, and take a tax deduction.
By Mark E. Battersby
Tent renters and event planners are experts at throwing parties, but may have less understanding of the tax implications of such expenses when they throw their own holiday parties or give gifts, bonuses or awards. These are often tax deductible, but can also have tax implications for both the business and the recipient.
Small businesses often give gifts to customers, particularly around the holidays. However, only a portion of the cost of certain gifts may be deducted as a business expense. The IRS allows deductions of $25 or less for business gifts given to any one person during the tax year. So, if a client is given a $50 dollar watch, only $25 may be deducted.
Branded items such as key chains or pens are usually exceptions to the $25 limit for business gifts, and their cost is deductible without limitation. Also excepted are items of $4 or less, have the business’s name clearly and permanently imprinted on them and are widely distributed.
Holiday parties, annual picnics, summer outings and even employee meetings may qualify for a unique 100 percent tax deduction. Entertainment expenses must be primarily for the benefit of employees other than those in a so–called “tainted group” (any employee paid more than $110,000 a year, a 10 percent owner or any family member of a 10 percent owner).
It is necessary to satisfy the “ordinary and necessary” business purpose test for this deduction. An “ordinary and necessary” expense simply means an expense is “appropriate and helpful” to the business. Boosting the morale of workers and helping everyone feel appreciated makes an annual party 100 percent deductible. Of course, the expenses must substantiated. Remember to write down the “who, what, when, where and why.”
Employee business gifts
Bonuses to employees are usually considered income and while 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. However, there are 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 percent of employees). Awards in excess of the limits are taxable to the recipient.
Gift certificates and gift cards are for the most part taxable to employees because they can be converted to cash. There has been no official guidance regarding small amounts ($25 or less), so they often qualify as “de minimis” fringe benefits. However, in general, if gift cards or gift certificates are given, taxes must be withheld from the employee’s pay.
If your gift to employees is a charitable contribution in their name, there is no worry about taxes, no matter the amount.
Grossing up bonuses
Because a “gift” is often considered by the IRS to be compensation, it’s important to note the rules so that employees are not responsible for paying taxes on their gifts. Employee gifts are usually small enough that the business does not need to worry about employees wanting to change their withholding allowances. For larger bonuses, however, employees should be given the option of changing their Form W–4 withholding deduction amount for that one paycheck. In many cases, employers will “gross up” a bonus—that is, give the employee more to allow for withholding.
You will ensure that employees won’t face a tax on their holiday gifts if they are small. Whether for customers or employees, gifts under $25 are tax–exempt. Businesses considering a small gift for employees—fruit baskets, hams, turkeys, wine, flowers and occasional entertainment tickets, such as for a show or sporting event, will find they are generally nontaxable de minimis fringes and tax deductible by the business. It is, however, always a good idea to consult a tax advisor.