UPDATE: Please see the 2015 version of this post here.
This is the fourth in a series of posts on tax deductions for small business owners. (The first post is here, which contains some important definitions.)
Marketing is intended to portray your business in a positive, customer-inducing light. Most small business owners are intuitively aware of what constitutes tax deductible marketing expenses, which include (but are not necessarily limited to) the costs of the following:
- Any sort of traditional advertising, such as newspaper ads, radio spots, brochures, and the like;
- Your website, including hosting, design, creation, and maintenance;
- Sponsorships, such as having your logo emblazoned on the local cycling team’s jersey;
- Holiday cards;
- Your business cards;
- Seminars, webinars, and workshops provided by you; and
- Gifts to clients, but only up to $25 in value.
It’s not a particularly tricky tax deduction. As long as your marketing expenses can be reasonably related to the promotion of your business, you should be deducting those expenses from your business income.
Usually for this series on tax deductions, I concoct a scenario likely to be encountered by a small business owner. For this post, I’ve gone straight to the database of the US Tax Court for some excerpted examples.
The Nutritional Consultant
This taxpayer claimed deductions for advertising on her 1998 and 1999 tax returns in the amounts of $4,964 and $5,160, respectively. According to a Tax Court (TC) Summary Opinion from May 24, 2004 (which by the way can’t be used as precedent because it’s only a “summary opinion,” but I’m using it here anyway as an example):
Approximately $1,000 of her claimed advertising expense for 1998 and $1,500 for 1999 was for [nutritional] samples which she gave away. The remaining $3,964 for 1998 and $3,660 for 1999 of her advertising expenses was for products which she used personally. She did not maintain any records of the products that she gave away or for the products she used herself. The amounts she deducted as advertising expenses were based upon the retail value of the items, not on the amount which she had actually paid for the products, which was $3,276 in 1998, and $3,406 in 1999.
The problem is that the taxpayer also claimed these deductions as her “cost of goods sold” (the calculation of which is an entirely separate topic). The Tax Court rightfully said she couldn’t count the costs of those samples twice as tax deductions, so it disallowed the amounts she claimed as cost of good sold.
The Certified Financial Planner
This taxpayer testified to the Tax Court that he “spent money on ‘leads’–mass mailings undertaken by advertising companies, as part of his insurance and investment business, but he did not submit documentation regarding these expenses.”
End result: No documentation = Deductions for advertising expenses denied. (TC Memo 2006-265 from December 14, 2006.)
The Loan Consultant
This example shows how nit-picky the IRS can really be. On his 2004 tax return, this small business owner lists advertising expenses of $2,335. During his testimony for the Tax Court (TC Memo 2010-191 from August 30, 2010):
“…[the taxpayer] concedes on brief he is claiming advertising expenses of only $2,085. [The IRS] concedes on brief that the taxpayer is entitled to advertising expenses of $1,978. The discrepancy of $107 is mainly attributable to a floral arrangement that the taxpayer sent to a woman who worked at his business when her brother passed away and another floral item that the taxpayer sent to a client after closing the client’s loan file.”
Because the taxpayer could not prove that the floral items were purchased to actually promote his loan consultation business, the deduction for advertising expenses beyond the $1,978 that the IRS conceded was denied. Nice gesture, not deductible.
And by the way, when the Tax Court agrees with the IRS and denies deductions (ANY kind of deductions, not just those for marketing and advertising), the taxpayer has to pony up not only the extra taxes due, but usually also interest and penalties — some of which can be quite steep.
What’s the most important takeaway from this post?
This statement is found so routinely in TC opinions that I’m sure it’s copied and pasted between documents:
As a general rule, the [Internal Revenue] Commissioner’s determinations are presumed correct, and the taxpayer bears the burden of proving that these determinations are erroneous.
And this one is also very common:
A taxpayer must substantiate amounts claimed as deductions by maintaining the records necessary to establish he or she is entitled to the deductions.
The bottom line: Keep your receipts, or any other type of documentation that verifies your marketing expenses.Yes, your bank, credit card, or PayPal statements are adequate. But an actual dated receipt from the vendor is always best.
Please note that this post serves as just a broad overview of deductible marketing expenses and shouldn’t be relied upon as tax advice. For more information, take a look at IRS Publication 535, or ask your tax adviser.