20.26 Business Gift Deductions Are Limited

Deductions for gifts to business customers and clients are restricted. Your deduction for gifts is limited to $25 a person. You and your spouse are treated as one person in figuring this limitation even if you do not file a joint return and even if you have separate business connections with the recipient. The $25 limitation also applies to partnerships; thus a gift by the partnership to one person may not exceed $25, regardless of the number of partners.

In figuring the $25 limitation to each business associate, do not include the following items:

If you made a gift to the spouse of a business associate, it is considered as made to the associate. If the spouse has an independent bona fide business connection with you, the gift is not considered as made to the associate unless it is intended for the associate’s eventual use.

If you made a gift to a corporation or other business group intended for the personal use of an employee, stockholder, or other owner of the corporation, the gift generally is considered as made to that individual.

Caution

Employee Bonuses

Employee bonuses should not be labeled as gifts. An IRS agent examining your records may, with this description, limit the deduction to $25 unless you can prove the excess over $25 was compensation. By describing the payment as a gift, you are inviting an IRS disallowance of the excess over $25. This was the experience of an attorney who gave his secretary $200 at Christmas. The IRS disallowed $175 of his deduction. The Tax Court refused to reverse the IRS. The attorney could not prove that the payment was for services.

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Packaged food or drink given to a business associate is a gift if it is to be consumed at a later time. Theater or sporting event tickets given to business associates are entertainment, not gift, expenses if you accompany them. If you do not accompany them, you may elect to treat the tickets either as gifts, which are subject to the $25 limitation, or as entertainment expenses subject to the entertainment expense rules, such as the requirement to show a business conference before or after the entertainment and the 50% cost limitation.

Gifts not coming within the $25 limit are: (1) scholarships that are tax free under the rules in Chapter 33; (2) prizes and awards that are tax free under the rules in 11.1; and (3) awards to employees, discussed below.

Employer deduction for awards to employees.

There is an exception to the $25 gift deduction limitation for achievement awards of tangible personal property given to your employees in recognition of length of service or safety achievement. Special deduction limits apply to such achievement awards provided they are given as part of a presentation under circumstances indicating that they are not a form of disguised compensation. For example, awards will not qualify if given at the time of annual salary adjustments, or as a substitute for a prior program of cash bonuses, or if awards discriminate on behalf of highly compensated employees.

The amount of your deduction depends on whether the achievement award is considered a qualified plan award. You may deduct up to $1,600 for all qualified plan awards (safety and length of service) given to the same employee during the taxable year. If the award is not a qualified plan award, the annual deduction ceiling for each employee is $400. The $1,600 overall limit applies if the same employee receives some qualified plan awards and some non-qualified awards during the same year.

To be a qualified plan award, the award for length of service or safety achievement must be given under an established written plan or program that does not discriminate in favor of highly compensated employees. The average cost of all awards under the plan for the year (to all employees) must not exceed $400. In determining this $400 average cost, awards of nominal value are not to be taken into account. In case of a partnership, the deduction limitation applies to the partnership as well as to each partner.

Safety and length of service.

A length of service award does not qualify as an employee achievement award if it is given during the employee’s first five years. Furthermore, only one length of service award every five years is considered an employee achievement award.

Safety awards granted to managers, administrators, clerical employees, or professional employees are not considered employee achievement awards. Furthermore, if during the year more than 10% of other employees (not counting managers, administrators, clerical employees, or professional employees) previously received safety awards, none of the later awards are subject to the employee achievement award rules.

Employee’s tax.

The employer’s deductible amount for an employee achievement award is tax free to the employee (3.12). For example, you give a qualified plan award costing $1,800 to an employee. You may deduct only $1,600. The employee is not taxed on the award up to $1,600; the $200 balance is taxable.