Giving out cash awards and gift cards is a great way to endear your company to employees and customers. But it is also a great way to land yourself in hot water with the IRS.Cash and cash-equivalent gifts to employees are income. That means that they must be taxed accordingly. Giving such gifts to customers can result in a tax break — but the rules governing this deduction are complex and draconian. Knowing the implications of giving these out can make sure customers, employees, and the Treasury alike stay happy.
When you want to recognize an employee, giving them some kind of gift is the obvious way to do it. But before you do so, it's important to understand how different types of gifts are treated by the tax code.
Cash gifts and de minimis rules
In most cases, anything that employers give to employees is considered income and is taxed accordingly. However, the IRS knows that accounting for numerous small transactions would be (pardon the pun) a taxing endeavor for businesses. So the agency established “de minimis fringe benefits” rules for these kinds of transactions. In brief, any small, infrequent employee benefit – such as inexpensive gifts from employers to employees – are excludable from income for tax purposes.
There’s one big exception to this exception, though: cash gifts never qualify for de minimis treatment. Neither do cash-equivalent gifts, such as gift cards that can be exchanged for “general merchandise” (i.e., an Amazon or even a Starbucks card). However, a gift card that can only be exchanged for a specific item (i.e., a movie theater gift card) can qualify as a de minimis benefit.
Alternatives to cash gifts
Since cash gifts to employees are always taxable, it just makes sense to find an alternative way to show your appreciation for them. There are plenty of other employee gifts that can qualify for de minimis treatment.For small gifts, you can choose event-specific merchandise (such as giving out turkeys during the holiday season) or gift cards for specific, inexpensive items (such as the aforementioned movie theater gift card). Food baskets and the like are another excellent option.
If you want to give something more significant to an employee without triggering a tax bill, consider a gift that doesn't have a set monetary value. For example, the employee of the month might get a dedicated parking space right near the entrance.Note that you can't use de minimis to get around taxation of large gifts such as annual bonuses. According to the IRS, de minimis gifts must have “low fair market value.” The agency has never provided a specific dollar limit, but if you limit yourself to gifts under $100 in value you should be safe. However, tax rules are constantly changing, so check at least once a year to make sure that the de minimis standard is still the same.
Giving gifts to your customers can be a powerful tool for building relationships with them, but the rules governing tax treatment of customer gifts are even more byzantine than employee gift rules.
Deducting customer gifts
Fortunately, customer gifts (including cash-equivalent ones) aren’t taxed as income. They’re considered business expenses and can be deducted as such, as long as the gift is a reasonable one.However, the business gift deduction is limited to $25 per person per year (a limit set in 1954 and never raised since). You can give more valuable gifts to your customers, but you’ll only be able to deduct up to $25 of the cost of each. And gifts to a customer's family are considered gifts to that customer as far as the $25 limit is concerned, unless the family member is also a customer.
Getting around the $25 limit
If you feel that $25 just won’t cut it, but still want to get your full tax break, you have another option. Gifts to a business customer aren't affected by the $25 limit if the gift is for the entire company. Giving a food basket to be shared by everyone in the company would qualify for this exception, while a food basket sent directly to the CEO wouldn't. If you choose to take this gifting approach, include a card or note that spells out the fact that the gift is for everyone to share and keep a copy of that note just in case the IRS chooses to inquire at a later date.Before giving any valuable gift to a customer, ask if they have any company policies forbidding them from accepting such gifts. Many companies limit their employees to gifts of no more than $50 or even $25 to avoid any risk of appearing to accept bribes. For example, US government employees in the executive branch can only accept gifts under $20 in value.
Small gifts (under $4 in value) that have the company name on them and are distributed in large numbers also don't count towards the $25 limit. Pens, notepads, basic calculators, and mugs are all examples of these kinds of gifts. Thus, you can give a customer a calendar with your company name and logo stamped on it as well as a $25 gift card and still deduct the whole amount of each.
Tickets: a special case
If you give a customer tickets to some event, such as a concert or a sporting event, you can treat it as a gift for tax purposes – but only if you don't attend yourself. If you do attend the event along with the client, it’s considered entertainment and is not deductible at all thanks to the new entertainment rules in the Tax Cuts and Jobs Act. Meals during which you discuss business with a customer are 50% deductible, but if you don't talk business, you can't deduct any of the cost.
Maximize your tax results
To avoid tax hassles, it's best to stay away from cash and cash-equivalent employee gifts. There are other ways to show your appreciation that won't embroil your employees with the IRS. Keeping customer gifts under $25 will maximize the related deduction, but you can give something of greater value — you just won't be able to deduct the whole amount.