Giving prizes, awards, and gifts may be an ordinary and necessary part of doing business as a direct seller. In each of the situations illustrated next, you can deduct the cost as a business expense.

Situation 1. You do your direct selling on the sales party plan. As an incentive for people to host your parties, you offer them a variety of gifts. The choice of gift depends on the success of the party-the higher the volume of sales, the more valuable the gift.

In this situation, your gift to the host or hostess is actually payment for hosting the party, and the host or hostess must report the fair market value of the gift as income.

You can deduct the cost of the gift. If you give hosts and hostesses items from your inventory or items you purchase from the company at the same time you purchase goods you sell, their cost will be included in the cost of goods sold. You cannot deduct their cost again as a business expense. However, if you purchase the gifts separately from the goods you sell, deduct their cost as an ordinary and necessary business expense.

Situation 2. You have several direct sellers working under you. Because your income depends in part on their sales, you regularly meet with them, encourage them, and provide them with incentives and support. As an incentive to make sales, you sometimes offer a prize, such as an evening on the town or tickets to a sporting event, to the person who sells the most during the month.

In this situation, the prizes you give are actually payments for the winners' selling efforts. You can deduct the cost of the prizes as ordinary and necessary business expenses. The direct sellers who receive your incentive prizes must report them as income at their fair market value. For more information, see Other Income, earlier.

Situation 3. You sell cosmetics door-to-door. To spur sales, you often give away small samples.

In this situation, you can deduct the cost of the samples. If you purchase samples separately from the products you sell, you can deduct their costs as an ordinary and necessary business expense.

Do not deduct the cost of the same item twice. If the item was included in inventory, you cannot later deduct it as a business expense. The item will already be part of the cost of goods sold.

Gift limit. You cannot deduct more than $25 for business gifts you give directly or indirectly to any one person during the year (see the exceptions discussed later). Personal gifts are not deductible.

Figuring the limit. A gift to the spouse (or family member) of a customer is generally considered an indirect gift to the customer. However, if you have bona fide independent business connections with the spouse (or family member) and the gift is not intended for the customer's eventual use, this rule does not apply.

If you and your spouse both give gifts, you are treated as one taxpayer for the $25 limit. It does not matter whether you have separate businesses or independent connections with the recipient.

Incidental cost. Costs that do not add substantial value to a gift, such as engraving on jewelry, packaging, insuring, and mailing, are generally not included in determining the cost of a gift for purposes of the $25 limit. For example, the cost of gift wrapping is considered an incidental cost. However, the purchase of an ornamental basket for packaging fruit is not considered an incidental cost if the basket's value is substantial in relation to the value of the fruit.

Exceptions. The following items are not included in the $25 limit for business gifts.

• Items that cost $4 or less, on which your business name is clearly and permanently imprinted and which are part of a number of identical items you widely distribute. This includes such items as pens, desk sets, and plastic bags and cases.
• Signs, display racks, or other promotional material to be used on the business premises of the recipient.

Gift or entertainment. Any item that might be considered either a gift or entertainment will generally be considered entertainment and not subject to the $25 limit. However, if you give a customer packaged food or beverages to be used later, they are gifts.

If you provide business associates with tickets to a theater performance or a sporting event and you do not accompany them, you may treat the tickets as either a gift or entertainment, whichever is to your advantage. However, if you go to the event with them, you must treat the cost of the tickets as an entertainment expense.

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