Holiday gifts made to customers are
generally deductible as ordinary and necessary business expenses as long
as the taxpayer can demonstrate that such gifts maintain or improve
customer goodwill. Such gifts must bear a direct relationship to the
taxpayer's business and must be made with a reasonable expectation of a
financial return commensurate with the amount of the gift. However, the
$25 annual limitation per recipient on deductibility is applicable to
holiday gifts, unless a statutory exceptions applies.
Holiday turkeys and other holiday distributions of nominal value made by an employer to employees to promote goodwill are treated as tax-free gifts to those employees instead of taxable compensation. If the employer gives cash, gift certificates or similar items of readily convertible cash value, however, the value of those gifts is considered additional compensation regardless of the amount. But if holiday gift certificates given by an employer to its employees are redeemable only for merchandise and were not convertible to cash, they may be considered tax-free gifts.
Employers can give items worth a "nominal amount" without fear that the IRS will tax the employee. Gifts of items worth more, or a gift of any amount of cash, risks the IRS taking the view that the gift belongs in the employee's gross income. What constitutes a nominal amount is not crystal clear, but keeping a gift under $25 is erring on the safe side. It also assures a situation in which the employer can deduct the expense of the gift while not having it taxable to the employee.