Advertise, Entertain, Deduct

Without marketing or advertising, no one will know of the existence of a gift business. Fortunately, a marketing strategy doesn’t have to mean multimillion-dollar TV commercials. There are plenty of ways to market a gift business – and a variety of tax deductions to help make it more affordable. Include entertainment in the operation’s marketing strategy, and tax deductions will also underwrite the fun side of promoting the business.
     Advertising and marketing can mean the continued life of a retailer, manufacturer or supplier affected by the economy, competition or other factors outside its control. Because there are many aspects to both advertising and marketing, it’s not surprising that expenditures related to these activities fall within several sections of tax regulations.

Advertising Expenses
     All-too-often, one of the first expenses reduced or cut by troubled businesses is the most basic of expenditures – advertising costs. This is a doubly shortsighted strategy given the necessity of advertising in bad times and the fact that Uncle Sam, in the form of tax deductions, will often pick up a portion of those expenses.
     Advertising expenses encompass business cards, catalogs, home demonstrations, package design costs, prizes and contests, new line or product launch costs, sponsorships and other promotional activities. Generally, advertising, marketing and other selling expenses are immediately tax deductible as "ordinary and necessary" business expenses – but not always.
     All reasonable advertising expenses are tax deductible, so long as they bear a reasonable relationship to the business. Under our tax rules, deductible expenses may be for the purpose of developing good will as well as gaining immediate sales. The cost of advertising is deductible when paid or incurred, even though the advertising program extends over several years or is expected to result in benefits extending over a period of years.
     Catalogs: The Tax Court and the IRS require that the cost of printing a catalog that is not replaced annually be amortized over the expected life of the catalog. Some courts however, have taken the view that catalog costs are in the nature of advertising expenses and immediately deductible.

Mailing Lists
     Mailing lists are an important part of advertising for many gift businesses. The mailing list is an intangible asset, deductible only if a reasonable life can be determined for it. A tax deduction for the cost of compiling that list is trickier.
     Consider a gift retailer that mails catalogs to its mailing list as well as to lists that it rents. Prospects for the permanent list are from advertising, and added to the company’s list if they make purchases. The business keeps records of its costs in adding to the mailing lists and expenses those costs in the year the catalog to which the expenses relate is distributed.
     The Internal Revenue Service has ruled that the company may deduct as an ordinary business expense its costs related to adding names to the mailing list.
     Keep in mind, however, that this involved a catalog published semi-annually, while in other cases the IRS ruled on a catalog with a useful life of several years.

Research as a Tax Deduction
     Testing the waters before committing to an advertising campaign is always advisable. Unfortunately, only costs of research in the laboratory or for experimental purposes (whether carried on by the business or on its behalf by a third party) are tax-deductible. Market research and normal product testing costs are not research expenditures under the tax rules.

Marketing Counts
     Naturally, paid advertising isn’t the only way to spread the word about your business. Public relations are marketing strategies that span everything from press releases and networking at a Chamber of Commerce meeting to holding a contest or special event. However, no deduction is allowed for dues paid to a club organized for business, pleasure, recreation, or other social purposes – even if membership is used to promote your business. This disallowance does not extend to professional organizations (e.g., bar associations) or public service organizations (e.g., Kiwanis or Rotary clubs).

Entertainment
     A gift business is allowed a deduction for business entertainment, so long as there is a direct relationship between the expense and the development or expansion of the business. However, special limits are imposed on the deduction of business-related entertainment, meals and gift expenses.
     No tax deduction is allowed for the cost of entertaining guests unless the cost is either:
     1 Directly related to the active conduct of a trade or business, or…
     2 For entertainment directly before or after a substantial and bona fide business discussion associated with the conduct of that trade or business.
     The business discussion must be the principal aspect of the combined entertainment and business, and must represent an active effort by the gift retailer, wholesaler or manufacturer to obtain income or another specific business benefit.
     However, if a meal expense directly precedes or follows a substantial and bona fide business discussion (including a business meeting at a convention or trade show), then it is deductible if it is established that the expense was associated with the active conduct of a trade or business. The retailer, wholesaler or manufacturer must, of course, be able to substantiate the expense.
     There are two additional restrictions placed on the deduction of meal expenses:
     1 Meal expenses generally are not deductible if neither the wholesaler or manufacturer nor the wholesaler/ manufacturer’s employee is present at the meal, and…
     2 A deduction will not be allowed for food and beverage to the extent that such expense is lavish or extravagant under the circumstances.

Giving is Often Advertising
     Yet another form of advertising is giving gifts. Deductions for business gifts, whether made directly or indirectly, are limited to $25 per recipient per year. Items clearly of an advertising nature that cost $4 or less and signs, display racks or other promotional materials given for use on business premises are not gifts.
     A business that provides customers or prospective customers with an item that might be considered either a gift or entertainment will usually benefit from the entertainment write-off, ignoring the $25 limit. If the operation gives a customer packaged food or beverages that are to be used later, they are considered gifts.
     Getting the maximum benefits from advertising and marketing expenditures or cost-cutting deductions often requires the help of qualified professionals. But the decision of whether to advertise or market your products or services should be a "no brainer," in good times or bad.

     Mark E. Battersby has more than 25 years experience reporting on tax and financial developments. He can be reached at [email protected].