As the holiday season approaches, gift-giving is on the minds of many business owners. But there are reasons why a business owner may want to give gifts to workers and clients throughout the year and not just during the holidays. Whether to recognize a job well done, boost employee morale, or solidify client relationships, monetary and nonmonetary gifts can provide a powerful psychological boost for people.
Gifts also have the added benefit of providing the business with a tax deduction. To help minimize your tax bill while maximizing your goodwill with employees, business associates, and clients, you should become familiar with the Internal Revenue Service’s (IRS’s) tax rules applicable to gift-giving.
The Psychology of Reciprocity (or Why It Really Is the Thought That Counts)
Clichés such as “It’s better to give than receive” and “It’s the thought that counts” abound on the topic of gift-giving. There is solid evidence, however, that human beings are hard-wired to respond positively to gifts.
For example, clients who receive a gift from a business may be more likely to not only return, but also to recommend that business to others.[1] Reciprocity works similarly among workers. Over 80 percent of employees say an employer gift improves their work engagement and happiness, and more than half say they are more likely to be loyal after receiving a gift.[2]
A study in American Economic Review indicated that the reciprocity triggered by nonmonetary gifts can have an even stronger effect on workers’ performance than monetary gifts if the employer puts thought and effort into the presentation of the nonmonetary gift.[3]
The act of giving may be its own reward. But amid high worker turnover, frequent burnout, and competition to land clients, gifts can be a way to make people feel valued and trigger reciprocity.
Gifts do not have to be expensive or flashy to attract and retain talent. A small token of appreciation may be even more meaningful than compensation for employee retention.[4]
Gifting and IRS Rules
Unfortunately, there are limits on how much a company’s generosity will be rewarded on their tax bill. If your business is considering providing gifts to clients or employees, the following information is important for you to know:
The $25 Rule
All or parts of gifts that are given “in the course of your trade or business” are tax-deductible at a limit of $25 per recipient per year.[5] This limit applies only to gifts given to an individual. Gifts given to the company as a whole for business purposes may be fully deductible.
- The $25 limit does not include what the IRS calls incidental costs such as engraving, packing, and shipping that do not add substantial value to the gift.
- Items that cost $4 or less, have a company’s name clearly and permanently imprinted on them, and are distributed regularly (e.g., pens, desk sets, plastic bags and cases, and similar branded company swag) typically are not considered gifts.
- The IRS generally treats any item that could be considered either a gift or entertainment as nondeductible entertainment. This distinction can be tricky. Gifting game tickets to a client and attending the game with them could be considered an entertainment expense, while gifting tickets and not accompanying them to the game could be considered a gift.
- Gift cards, gift certificates, and other cash equivalent gifts are not tax They are instead counted as taxable income for the recipient. The IRS generally only considers tangible personal property (for example,gifts that can be bought in a retail store) to be gifts.
Direct versus Indirect Gifts
The IRS distinguishes direct and indirect business gifts. The main thing to know about this distinction is that even if a gift is not given directly to a person—for example, a gift given to a customer’s family that is considered an indirect gift to the customer—it may still count as a gift to the customer and count toward the $25 per recipient annual deduction limit.
Employee Gifts and Taxes
Gifts and taxes are a consideration not only for employers who give gifts but also for the employees who receive them, with the latter possibly owing taxes for gifts that count as compensation under the tax code.
- Companies may be able to write off up to $25 of what the IRS calls de minimis fringe benefits. Items that are so small and infrequently given that accounting for them would be unreasonable or impractical, such as office snacks and coffee, holiday gifts, and occasional event tickets, meal money, transportation expenses, and fruit, flowers, and books, may count as de minimis benefits.[6] The IRS says to consider all of the facts and circumstances, including the frequency and value of the benefit, when making this determination.
If a gift falls within the de minimis fringe benefit category, then it is excluded from an employee’s taxable income. The business may also be able to deduct no more than $25 of a gift that is considered a de minimis fringe benefit to a single employee. This limit does not include benefits such as donuts and snacks provided to the entire office staff.
- Employee achievement, safety, and service awards of tangible personal property are tax-free for both employers and employees up to $400 for nonqualified plan awards and up to $1,600 for qualified plan awards. Tangible personal property does not include cash, cash equivalents, gift cards, gift coupons, gift certificates, vacations, meals, lodging, theater or sports tickets, stocks, bonds, and similar items and investments.[7]
Gift Like a Pro with Guidance from a Small Business Attorney
The IRS stresses that tax-deductible gifts must be documented in records that prove a gift was for business purposes and provide details about the amount spent. On a tax return, the difference between a legitimate and improper business gift deduction could come down to having an itemized receipt of gifts purchased. Further, a distinction as minor as providing a gift certificate for general merchandise or for a specific item could also determine whether it will be includible in an employee’s taxable income.
Knowing what is—and what is not—tax deductible for a business or taxable income to employees under IRS rules can help business owners get the greatest benefit from their gift-giving. For answers to your tax-related gift questions and advice on how to keep correct records, please contact us.
[1] Marcia Layton Turner, 7 Effective Ways To Boost Valuable Business Referrals, Forbes (Nov. 30, 2016), https://www.forbes.com/sites/marciaturner/2016/11/30/7-effective-ways-to-boost-valuable-business-referrals/?sh=7d68ab8e806b.
[2] Jefferson Hansen, 12 Gift Ideas to Show Employee Appreciation and Why it Matters, Awardco (Nov. 15, 2023), https://www.award.co/blog/employee-appreciation-gifts.
[3] Sebastian Kube et al., The Currency of Reciprocity: Gift Exchange in the Workplace, 102(4) Am. Econ. Rev. 1644 (June 2012),https://www.aeaweb.org/articles?id=10.1257/aer.102.4.1644.
[4] Roger L. Martin, The Real Secret to Retaining Talent, Harvard Bus. Rev. (Mar.–Apr. 2022), https://hbr.org/2022/03/the-real-secret-to-retaining-talent.
[5] Internal Revenue Serv., Frequently Asked Questions, Income & Expenses 8 (June 15, 2023), https://www.irs.gov/faqs/small-business-self-employed-other-business/income-expenses/income-expenses-8.
[6] Internal Revenue Serv., De Minimis Fringe Benefits (Mar. 9, 2023), https://www.irs.gov/government-entities/federal-state-local-governments/de-minimis-fringe-benefits.
[7] Internal Revenue Serv., Tax Cuts and Jobs Act: A comparison for businesses, Businesses with employees: Changes to fringe benefits and new credit (June 8, 2023), https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-a-comparison-for-businesses#:~:text=TCJA%20clarifies%20that%20tangible%20personal,securities%2C%20and%20other%20similar%20items.&text=and%20medical%20leave-,No%20previous%20law%20for,This%20is%20a%20new%20provision.
