Every business is competing to grow, and growth requires getting the word out about who you are and what you can deliver. Word of mouth is certainly an effective form of advertising, as well as free. I like to think of this type of advertising as the direct benefit of running a well-managed business and knowing your clients. As Peter Drucker said, “The aim of marketing is to know and understand the customer so well the product or service fits him and sells itself.” Still, many companies will engage in further advertising to expand the scope of their brand awareness and increase sales.
Even the best products and services require some form of advertising. Consider the following slogans: A diamond is forever. Be all that you can be. Breakfast of champions. I’m lovin’ it. Just do it. I’m guessing each one of you reading this has conjured up images of these products or brands in your head: De Beers jewelry, the U.S. Army, the Wheaties box, McDonalds, and of course, Nike. Somehow these phrases are retained in our memory for years, often with a catchy jingle.
What do these advertising slogans have in common from a tax perspective? What exactly constitutes an advertising expense in tax law, and are these expenses always deductible?
The cost of producing each slogan you just read qualifies as a tax-deductible advertising expense.
Advertising expenses are typically 100% tax-deductible when paid or incurred. Incurred simply means the good or service (in this case, advertising) has been provided but not yet paid for. The expense must be reasonable in amount and related to the business. Promoting your name before the public can be for gaining immediate sales or developing public goodwill. Take note that although meals and entertainment expenses are generally subject to a 50% deduction limitation, such expenses offered to the general public as a means of advertising and promoting goodwill in the community are considered 100% tax-deductible advertising expenses.
The following is a list of common advertising expenses addressed in the tax code.
- Business cards, deductible from gross income.
- Catalogs, deductible, typically ratably over the expected life of the catalog if not renewed.
- Home demonstrations, deductible from gross income.
- Package design costs, deductible from gross income.
- Prizes and contests, deductible from gross income.
- Product launch costs, deductible from gross income.
- Promotional activities, deductible from gross income.
- Advertising expenses tied to political connections, whether direct or indirect, are not tax deductible.
- Signage attached to a building or property must typically be capitalized. The cost is recovered over the useful life of the sign through depreciation.
Let’s take a look at some examples of advertising expense and how tax law may affect your advertising strategies.
- Example 1. Suppose Joe opens a golf equipment store in town called Golf World, LLC. To market his business, he hosts a promotional grand opening event. He rents an outdoor tent, serves free hamburgers, chips and soda to all in attendance, and gives away golf balls imprinted with the company name. The festivities include a challenging putting contest, the winner of which receives a $500 gift card as a prize. Of these expenses, which of them can be deducted on the company’s tax return as advertising expense? Actually, all of these expenses are 100% tax-deductible. Promotional activities, as well as prizes and contests, are all deductible advertising expenses.
- Example 2. Consider another set of circumstances in which Joe invites only his college buddies to the gathering and serves filet mignon, lobster tail and Dominari 2002 Chateau Sauvignon. This fact pattern should cause one to question whether the definition and spirit of an advertising expense has been met. The expense in this situation would likely be determined excessive and fails to meet the definition of being offered to the general public. Thus, it is unlikely these costs would be deductible as advertising expense.
- Example 3. Assume a young entrepreneur and inventor has developed a cutting-edge technology device. She’s patented the invention and needs some help marketing the product and developing the brand. She hires a marketing team to craft the product launch strategy. Much is invested in developing a product design, creating a brand logo and writing a compelling launch story. The team also designs a unique package for the product with a slogan, “Connecting People.” Can these costs be deducted from taxable income? Although the launch program, package design and logo will presumably provide significant benefits to the company in future years, all of these related advertising costs are deductible immediately.
- Example 4. Moving ahead several years, assume the product has been successfully launched and is in production. The owner would like to boost sales and decides to run several internet ads and sponsor a television and radio show. These expenses are all considered advertising expense and are fully tax-deductible when paid or incurred. Suppose, however, she attends a dinner where the proceeds directly or indirectly go to a political party. In this instance, the expense is non-deductible. Tax law does not allow deduction of expenses for advertising in connection with political conventions, programs or publications.
Each situation can involve a unique set of circumstances. Consult your CPA to assist you in determining what expenses qualify as deductible advertising expenses. iBi
