Work Related Holiday Expenses – What’s Deductible?Tax Planning
This is the time of year many employers are thinking about gifts and bonuses for employees during the holidays. It’s also a time to consider the expense of holiday parties and gifts to clients. Before you start handing out gifts and invites, consider the tax implications both for your business and for the employees.
Sure, thinking about taxes during gift giving is no fun, but there are things to think through as a business owner. Here’s a breakdown of what you should consider as you prepare for your holiday festivities at work.
Let’s start with gifts and bonuses to employees.
Two Questions to Ask Yourself First:
1. Are these gifts and/or bonuses taxable to the employees? If they are taxable, you must deduct all applicable federal, state, and local income and FICA taxes.
You must also pay other employment taxes (unemployment tax, for example) on these amounts.
2. Are these gifts and/or bonuses deductible to you as a business expense? To be deductible, often these items have limits. Knowing the limits helps you determine the amount of the gift.
Business Gifts to Employees
Your business can deduct no more than $25 of a gift to any one person each year, including employees.
Gift Cards and Gift Certificates to Employees
Gift certificates and the newer gift cards are for the most part taxable to employees because they can be converted to cash. There has been some discussion about whether small amount gift cards/certificates ($25 or less) are not subject to taxes because they are “de minimis” fringe benefits (a small amount) but the IRS has given no guidance on this, so it's safest to consult your tax advisor and to consider them taxable.
If you give gift cards or certificates, you must withhold taxes from employee pay for these gifts or gross them up (more on that in a minute).
Bonuses to Owners
Bonuses for employers or owners are a legitimate business expense and can be deducted under certain circumstances.
First, let’s look at bonuses for owners or shareholders:
· S-Corporations can deduct bonuses for shareholders and owners, if they own their shares at the time the bonus is paid.
· C-Corporations can only deduct bonuses for shareholders and owners who have a 50 percent or higher ownership at the time the bonus is paid.
· For sole proprietorships, partnerships, and limited liability companies (LLCs), bonuses are not deductible business expenses because the owners/partners are considered by the IRS to be self-employed.
Bonuses to employees
Employee bonuses are considered income and are taxable to the employee. You must withhold income taxes and FICA taxes on employee bonuses unless the employee is over the Social Security maximum for the year.
If you decide to give your employees a bonus, you must give them the opportunity to change their withholding authorization (on Form W-4) for that paycheck, and change it back for subsequent paychecks. Some employees like to change their bonus check withholding so they receive more of the bonus.
How do you do that?
Employee gifts are usually small enough that you don't need to worry about employees wanting to change their withholding allowances. But for larger bonuses, you should give employees the options of changing their W-4 withholding deduction amount for that one paycheck. You must allow employees to change their W-4 forms as often as they wish. Some employees will want to change their withholding to receive more of the bonus. This process requires two W-4 forms - one for the smaller withholding on the one check and another to return to the employee's original withholding amount.
In some cases, you may want to gross up a bonus. That is, you give the employee more to allow for withholding.
For example, if you give an employee a $1,000 bonus, by the time you take out taxes, the bonus check might be only, say, $750. You can calculate a higher amount for the bonus so that the check shows the full $1,000. In this example, you are giving the employee a larger bonus to account for the additional taxes.
Now Let’s Talk About Parties!
Company holiday parties are great fun, but can be costly. So, what’s deductible from these events and what is not? What if you invite clients or prospects? Is there a difference between client parties and employee parties?
Here’s the scoop…
If the party is for employees only, it’s likely the cost is fully deductible.
However, if you invite customers (or prospective customers) to the party, it could be another story. It’s possible to deduct part of the cost attributable to those non-employees, but to do so, the party must be part of a substantial business activity. That means that the primary reason for having the event is for business. In most cases, the amount that can be deducted in this scenario is 50% of the expense.
For example, having a semiannual meeting around the holidays with work related presentations would be considered a substantial business activity, whereas a five minute “we were awesome this year!” speech during the middle of a DJ set would likely not.
Don’t forget to keep all documentation!
In case you find yourself in the unfortunate situation of being audited, make sure you have the paperwork handy to back up why you took certain deductions related to your party. This means keeping good records of the expenses, attendees (whether employees, employees’ guests, or clients), and any business activities during the event.
As with all things tax related, these issues can be complicated and every situation is different, so you should consult your tax advisor before you do anything if you are unsure. Here are a few links with more information on the topics discussed here.
· IRS Guide to Fringe Benefits: https://www.irs.gov/publications/p15b/ar02.html
· IRS Info on Gifts: https://www.irs.gov/publications/p463/ch03.html
· IRS Info on Entertainment Expenses: https://www.irs.gov/uac/about-publication-463