The most popular article on my site, for some reason, has always been my original post on advertising expenses. Here’s an updated version.
Almost any type of business-related advertising is a tax deductible expense in the year the money is spent, so long as it’s ordinary, necessary, and reasonable.
Generally, for a business expense to be ordinary and necessary, the taxpayer must show a bona fide business purpose for it — meaning: there must be a clear connection between it and the company’s ability to reach customers, manage its brand, or provide information about products and services. It must be “appropriate and helpful” to the taxpayer’s business.
But even if an expense is ordinary and necessary, it is tax deductible only to the extent it’s also reasonable in amount — which is often determined on a case by case basis, based on the particular facts and circumstances.
Some examples of typical marketing expenses:
- Advertising on radio or TV, in trade publications or newspapers, or on the internet
- Fees paid for the services of creative agencies, such as website developers or designers, copywriters, or branding strategists
- Website hosting and maintenance fees
- Billboards, brochures, and other types of displays, with this important exception: Certain “permanent” signs are to be capitalized as fixed assets and depreciated over their useful lives. (For example: You purchase a sign for placement above the entryway of your business. It costs $2,000, and its useful life for tax purposes is five years, which means $400 is deducted in each of those five years, rather than $2,000 all at once.)
- Giveaways and prizes
It’s that last one that can be a little tricky, as exemplified in a recent tax court opinion (Evans, TC Memo 2014-237 ).
Is sponsorship of son’s motocross racing a tax-deductible advertising expense?
A general contractor (DEC) is licensed to operate his business in Boise, Idaho. Motocross racing is a very popular activity in Boise, and is especially popular within the construction industry. All five of the contractor’s children race motorcycles, one of whom (Ben) went on to become a well-known professional racer with numerous sponsors. The contractor’s CPA advised him that supporting Ben’s motocross racing would be a valid promotional activity. Because many of the contractor’s jobs came through word of mouth, his sponsorship of Ben played an important role in boosting his company’s exposure within the community.
For the two tax years in question, the company had gross revenues of more than $16.2 million and $16.7 million, and motocross-related expenses of $86,619 and $74,579, respectively. The expenses consisted mostly of motorcycle purchases, replacement parts, racing fees, fuel, and food.
Here’s what the Tax Court determined about DEC’s motocross expenses:
THE EXPENSES WERE NOT PERSONAL
In many previous cases, the court found “proximate relationships to exist between various car racing activities undertaken for promotional purposes and businesses engaged in construction.” The contractor’s attorney relied upon these findings, but the IRS argued that the motocross expenses were actually personal expenses. The court disagreed, stating:
“[The taxpayers] supported all of their children in their motorcycle racing pursuits but deducted expenses only for Ben’s activity because he was the only one of their children to attain a level of fame in motocross racing that held promotional value to DEC.”
THEY WERE ORDINARY AND NECESSARY
The IRS argued that the promotional value of motocross racing was virtually nonexistent because most of Ben’s races took place outside of the Boise area, but DEC performs work only in Idaho. The court disagreed, stating:
“Ben’s increasing national stature — fueled by his participation in races on the national circuit — served to improve his fame and name recognition locally. Many of DEC’s customers and business partners were fans of motocross racing, and [the taxpayers] have established that their association with a rising star in motocross racing helped DEC generally to gain new business connections and to strengthen existing ones.”
AND THEY WERE REASONABLE
The taxpayers argued that because the motocross racing expenses constituted less than 1% of DEC’s gross receipts in each year, they were reasonable. But the IRS argued that, as a general rule, expenses should not be considered reasonable simply because they equal a small percentage of a company’s gross receipts. The court agreed with the IRS on this point, but nevertheless found:
“In light of the significant tangible and intangible benefits DEC obtained from the motocross racing activity, we estimate that the amounts DEC spent on the motocross racing activity during the years in issue were reasonable.”
There’s a lot more to this case than just my summary, but the taxpayers prevailed on all the above issues and the deductions were allowed.
The entire case is an interesting read because it shows the level of scrutiny to which a taxpayer may be subjected during an IRS audit. It also shows how long it sometimes takes for a matter to be decided: The opinion is dated November 2014, but the tax years in question were 2006 – 2007. And finally, the case demonstrates the importance of relying upon the advice of a competent tax preparer — which the taxpayers did, and which the court viewed favorably.