Gift deductions can be tricky

By Joyce M. Rosenberg
Associated Press

NEW YORK — Taking clients or customers out for dinner or giving them gifts are ways for a small-business owner to cement good relationships. Dealing with such expenses on your income tax return isn't always a straightforward process.

For meals and entertainment, the general rule is that you can deduct 50 percent of what you spend on restaurant dinners or taking clients to shows or sporting events — as long as the expense can be considered an ordinary and necessary part of doing business.

For gifts, you can deduct $25 per recipient per year. That means if you give one client two gifts for $25 each, or a total of $50, you can deduct only $25.

As is often the case with the tax code, there are a few loopholes as well as pitfalls to look out for.

With entertainment, for example, if you're traveling or attending a trade show and take a client to dinner, you are permitted to deduct 50 percent of the check, said Bill Egan, a CPA with Egan & Associates in Pittsburgh. But travel expenses are fully deductible.

Among the pitfalls: You can't deduct just any activity as entertainment. "It has to be in an environment that's conducive to doing business," said Dennis Kroner, a CPA and financial planner with Pitt Ryan & Linnear in Chicago.

So dinner at a restaurant is deductible, and a round of golf probably is, too. But Egan noted that events like plays might not be.

The problem comes up if you're audited. The Internal Revenue Code isn't always clear and it's up to the IRS examiner to determine whether it was appropriate for you to take a client to a play for business reasons.

You might find in such a situation that the examiner allows you to deduct half the amount of dinner before the show, but not the tickets. Of course, you can always appeal the examiner's finding.

Another gray area is when you give tickets to a client to attend an event like a baseball game or a play. Should such tickets be listed as a gift or entertainment?

Egan said it might take a reading of some tax court rulings to figure that out. "I've read things going both ways," he said.

As in many other cases, your best course of action is probably to consult a tax professional.

Perhaps the most critical part of deducting meals, entertainment and gifts is documentation. Egan noted that you technically don't need receipts for meals or entertainment costing less than $75, but to be on the safe side, keep your receipts for everything. If you don't get one, create a log — something you need to do anyway for all your business expenses — and record it.

Egan strongly advises business owners to immediately write on the back of the dinner check or ticket receipt the name of the client and to give specifics of what was discussed — for example, a particular project or order.

"If you don't document it property, and make sure you have the (client's business) affiliation and what you talked about, if you were ever examined, they could say that wasn't in a business environment," Kroner said.

The 50 percent limit on entertainment deductions goes back to the 1986 tax reform act.

But Kroner noted that the $25 limit on gifts has been part of the tax code for decades. Congress has never chosen to raise the limit, even if $25 was a considerable amount in 1960 but a nominal sum today.

"The rules are rather arcane," he said.

Still, there are some ways to increase your deduction. Kroner noted, for example, that if you give employee or customer incentive awards, you can deduct up to $400 per year — that's a total of $400 for your entire business.

Let's say you have a restaurant, and you give a free dessert to regular customers for each 10 meals they have. You can deduct up to $400 of the costs of those desserts. The same applies to $20 gift certificates you might give to your highest-producing salespeople.

Another idea: Instead of sending one big gift to a client's firm, send smaller ones. You can deduct only $25 for a $200 food basket, but if you send four $50 baskets, you can give yourself a $100 deduction.

Correction: A previous version of this story erroneously reported that meals during business travel or during a trade show are fully deductible. While travel expenses are fully deductible, meals during a trip or trade show are only 50 percent deductible.