It is important for to keep your company’s name consistently in front of the public, particularly in a competitive business environment.
It can be helpful to be innovative in your marketing and promotional techniques, but where do you draw the line? In a recent case, the Tax Court upheld more than $160,000 in deductions over two tax years that the owner of a construction firm claimed for sponsoring his son’s motocross racing activities. (Evans, TC Memo 2014-237)
Background
Half a century ago it may have been enough to do quality work and rely solely on word of mouth to be successful. But in an era of strong competition you must pursue various advertising and promotional activities for your business to thrive.
These can range from basics techniques such as handing out business cards, to more aggressive methods such as television and radio ads and taking advantage of the quickly growing opportunities on social media websites.
And that costs money. Businesses may deduct these costs and the IRS treats them as a regular part of doing business. The tax deductions help defray the overall cost of ads and promotions that can lead to future growth.
Generally, the deducted expenses must be ordinary and necessary. In other words, they must have a clear connection to the business and its ability to reach customers, manage its brand or provide information about products or services.
Typically, deductible expenses may include the costs of:
- Signs and other outdoor advertising;
- Fees for radio, TV and online marketing;
- Services of advertising agencies or marketing firms;
- Copyrighting ads, logos and marketing slogans;
- Printed materials such as business cards with company logos, brochures and reports;
- Special events for customers; and
- Sponsorships of athletic teams and other activities that result in public recognition.
No Horsing Around with Deductions
The Tax Court often toes the line on deductions for business promotions.
Robin Trupp, an attorney who had been a talented equestrian as a youth, was a frequent spectator at riding events for his son, Austin. Trupp became president of an equestrian organization and began representing clients in the equine industry.
Over time, Trupp became well known as the attorney-father of Austin, but he never formerly advertised at events.
In the tax year in question, Robin claimed a deduction of $71,836 as business promotion expenses. The claim included costs for horse shoes, boarding, feeding, grooming, transportation, supplements, lessons and insurance. The law firm didn’t reimburse him.
Ruling: The Tax Court ruled that the connection between the promotional expenses and Austin’s horse riding was not sufficient to justify the deductions. (Robin Trupp, TC Memo 2012-108)[/vc_column_inner][/vc_row_inner]It is the last type of expense that is often problematic. The IRS may say that they are not related to the active conduct of the business or they do not help generate revenue or goodwill – or both.
As a result, claims for these costs often wind up in the courts, with mixed results (see right-hand box). And the IRS doesn’t always win.
Facts of the Motocross Case
Dave Evans owns Dave Evans Construction, based in Boise, Idaho. The construction firm develops land and constructs residential homes and commercial buildings in the Boise area.
The Boise region is a major center for motocross racing and other off-road racing sports. These activities are especially popular with members of the local construction industry. Many, including Dale Evans, ride, or have children who compete, in local races.
One of Dale’s children, Ben, quickly demonstrated a special talent. While his siblings competed only in local races, at the age of seven Ben competed in a nationally televised race at the Seattle Kingdome.
Evans personally paid for the motorcycles his children rode, as well as parts, travel and race entry fees. In 2005, Ben’s racing career started to take off and in 2007 he won the Loretta Lynn title. He was featured in various motocross magazines, and sponsors – including American Honda, Carl’s Cycle Sales, Western Power Sports and Step One Graphics – started supporting him.
At this point Mr. Evans realized that his son’s talent and star power might help to boost his company’s business. His accountant advised him that supporting Ben’s motocross racing would be a valid promotional activity for the company and the business became one of Ben’s sponsors. It stopped paying for expenses once Ben turned pro.
The company had gross revenues of more than $16.2 million in 2006 and $16.7 million in 2007. During those years the firm incurred motocross-related expenses (excluding depreciation and section 179 expenses) totaling at least $86,619 and $74,579, respectively. The expenses consisted mostly of purchases of motorcycles and payments for parts, equipment, racing fees, membership fees, fuel and food. The Boise construction industry was particularly competitive during the years at issue and sponsoring Ben helped give Evans Construction an advantage over its competitors.
Finish Line: The Tax Court ruled in favor of the company, finding a clear connection between the motocross activities and the business. The court noted that Ben’s fame improved the company’s community relations, brought in more clients, attracted investors and helped secure financing for the company.
Furthermore, the Tax Court dismissed the IRS objections that the amount of the expenses was unreasonable. Based on the significant benefits DEC derived, the amounts DEC spent on sponsoring Ben, which were comparatively small compared to the firm’s revenue, were reasonable under the circumstances. Thus, DEC was allowed to deduct virtually all the costs relating to the motocross racing activity.
Lesson to be learned:
Think outside the box, but remain firmly within the tax law boundaries. A company can deduct all the reasonable expenses of advertising and promotional efforts as long as the costs have a clear connection to the business.
If you have questions about tax deductions for your business, please contact Gray, Gray & Gray’s Tax Department.
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