Your best client is getting married and you spend a couple hundred dollars on a nice gift. Or your insurance agent’s mother dies and you send flowers. We give gifts to business associates for all types of reasons throughout the year. Everybody enjoys receiving a gift and they make an impression.
Many business owners are not aware that only a small portion of the cost of a business gift is deductible as as a business expense. The IRS limit is $25 per person per year. The remaining cost of the gift counts as a member withdrawal / shareholder distribution. So anything over $25 per person per year counts as money you take out of the business, and you are taxed on it.
Let’s look at the math:
$100 flower bouquet
-$25 deductible gift expense
= $75 member draw
You have reduced your business profit by $25. If you are in the 35% tax bracket, that amounts to a reduction of your tax bill of $8.75. However, your personal tax bill has increased because of the $75 draw. Your personal tax bill in the 35% bracket would go up $26.25. Your total cost of the $100 gift becomes:
$100 to buy the gift
-$8.75 reduction in business tax
+ $26.25 increase in personal tax
= Total cost of $117.50
This is a big difference from what most people expect. Most people expect that the $100 gift is 100% deductible reducing their business tax by $35. They expect the total cost of the gift to be $100 – $35 = $65.
This really hits home when I have to explain to the business owner that they took money out of the business they didn’t think they were taking out. So keep in mind that anything over $25 per person per year is money you will be taxed on.