Are Employee Gifts Tax Deductible for Your Business?
Understand the tax implications of employee gifts, including deductibility rules, reporting requirements, and how to distinguish gifts from taxable compensation.
Giving gifts to employees can be a thoughtful way to show appreciation, but business owners must consider the tax implications. The IRS has specific rules on when these expenses are deductible and how they should be reported, which can affect a company’s tax liability.
Deduction Requirements
To deduct the cost of employee gifts, the expense must meet the IRS definition of an “ordinary and necessary” business expense under Section 162 of the Internal Revenue Code. This means the gift should be customary in the industry and contribute to business operations. The expense must also be directly related to the business and not considered excessive.
The IRS limits the deductible amount for business gifts to $25 per recipient annually under Section 274(b). This cap applies to gifts given to individuals, including employees, but excludes incidental costs such as engraving, packaging, or shipping. If a gift exceeds this limit, only the first $25 is deductible. However, promotional items featuring the company’s name, such as pens or calendars, may be fully deductible if they qualify as advertising rather than gifts.
Gifts vs. Taxable Compensation
Whether an employee gift is taxable depends on its form and value. The IRS treats cash and cash-equivalents, such as gift cards, as taxable income regardless of the amount. These must be included in the employee’s wages and are subject to payroll taxes.
Non-cash gifts may be excluded from taxable income if they qualify as de minimis fringe benefits—items of minimal value that are infrequent and impractical to track, such as holiday turkeys, occasional flowers, or small company-branded merchandise. The IRS does not set a strict dollar limit for de minimis benefits, but businesses should ensure the gift remains nominal.
Larger non-cash gifts, such as electronics or vacations, do not qualify as de minimis benefits and must be reported as taxable income. The fair market value of these items must be included on the employee’s Form W-2 and is subject to payroll taxes. Misclassifying high-value gifts can lead to penalties for underreporting wages.
Reporting Obligations
Businesses must properly document and report employee gifts to remain compliant. If a gift is taxable, the employer must withhold applicable payroll taxes and report the amount on the employee’s Form W-2 in Box 1 (Wages, Tips, Other Compensation) and, if subject to Social Security and Medicare taxes, in Boxes 3 and 5. Employers must also include these amounts when filing Form 941 for quarterly payroll tax returns.
If a gift is given to an independent contractor and its value exceeds $600 for the year, the business must issue Form 1099-NEC.
Failing to report taxable gifts correctly can result in penalties. The IRS may impose fines for incorrect W-2 filings, ranging from $60 to $630 per form in 2024, depending on how late the correction is made. Misclassifying taxable gifts as non-taxable benefits can also trigger audits and additional tax liabilities.
Documentation
Maintaining records is necessary to substantiate deductions and comply with IRS regulations. Businesses should keep invoices or receipts specifying the nature of the gift, its cost, and the date of purchase. If multiple gifts are given throughout the year, tracking each one separately helps determine whether deduction limits apply.
Beyond receipts, businesses should document the purpose of the gift and its connection to the company. This may include memos, emails, or meeting notes explaining why the gift was given. If the gift is part of an employee recognition program or holiday tradition, maintaining records of the program’s guidelines and eligibility criteria can support its classification as a business expense. For gifts given to groups of employees, keeping a distribution list can help demonstrate that the expense was reasonable and aligned with company policy.
Reasons for Disallowance
Some employee gifts may still be disallowed as deductions. The IRS enforces strict criteria for what qualifies as a business expense, and failing to meet these requirements can result in the expense being classified as personal or non-deductible.
One common reason for disallowance is exceeding the $25 per-employee deduction limit. Any amount beyond this threshold cannot be written off. Additionally, if a gift is deemed primarily personal rather than business-related, the IRS may disqualify the expense. For example, an expensive watch given to an employee without a documented business purpose could be considered a personal expense rather than a deductible business cost.
The IRS may also reclassify certain gifts as entertainment expenses, which are subject to different tax rules. Tickets to concerts or sporting events may not be deductible unless they meet specific requirements under Section 274(a). If a business provides an experience-based gift, such as a luxury box at a sporting event, the IRS may categorize it as entertainment rather than a deductible gift, potentially limiting or eliminating the tax benefit.