Promotional budgets are typically one of the first costs businesses look to slash when times get tough. But understanding available tax deductions can help offset advertising expenses.
By Mark E. Battersby, Contributing Editor.
Without effective marketing and advertising, customers may recognize the existence of your convenience store business, but they won’t know anything about it. Fortunately, a marketing strategy doesn’t have to mean multimillion-dollar TV commercials. There are plenty of ways to market a convenience store—from promoting the foodservice program to the fuel offering—and a variety of tax deductions to help make that marketing and advertising more affordable.
Including entertainment in the convenience store operation’s marketing strategy and tax deductions will also underwrite the fun side of promoting your convenience store business.
Advertising, as well as marketing, can mean the continued life of a convenience store affected by the economy, competition or other factors outside the control of the operation’s manager, executives or operators. Because there are many aspects to both advertising and marketing, it is not surprising that the expenditures related to these activities fall within several sections of the tax regulations.
All too often, one of the first expenses reduced or cut by many troubled businesses is the most basic of expenditures—advertising costs. This is a doubly short-sighted strategy given the necessity of advertising in bad times and the fact that Uncle Sam, in the form of tax deductions, will often pick-up a portion of those advertising expenses.
Advertising expenses encompass everything from expenditures for basic advertising to flyers, catalogs, sponsorships, prizes and contests, new product or service launch costs and other promotional activities.
In fact, a well-planned promotion will include a wide range of components, ranging from sponsorships and contests to traditional standbys, such as coupons and sampling. Generally, advertising, marketing and other selling expenses are immediately tax deductible as “ordinary and necessary” business expenses, but not always.
All reasonable advertising expenses are tax deductible as long as they bear a reasonable relationship to the convenience store business. Under U.S. tax rules, deductible expenses may be for the purpose of developing good will as well as gaining immediate sales. Even better, the cost of advertising is deductible when paid or incurred, even though the advertising program extends over several years or is expected to result in benefits extending over a period of years.
When it comes to promoting the interests of the convenience store business, lobbying expenses directed towards influencing federal or state legislation are generally not deductible. However, this prohibition does not generally apply to in-house expenses that do not exceed $2,000 for a tax year. Lobbying expenses pertaining to local legislation are, of course, deductible.
The cost of public service or other impartial advertising, such as advertising designed to encourage the public to register to vote, are also deductible. But no deduction may be claimed for the expense of advertising in political programs or for admission to political fundraising or inaugural functions and similar events. This includes admission to a dinner or program if any part of the proceeds of the event directly or indirectly inures to or for the use of a political party or a political candidate.
Website Development Costs
The Web is the only advertising medium experiencing double-digit growth and is proving itself as an ideal forum for promoting products to consumers. Some experts predict that the digital extensions of traditional media will soon replace newspapers as the largest advertising medium.
Although the Internal Revenue Service (IRS) has not issued formal guidance on the treatment of Website development costs, informal internal IRS guidance suggests that one appropriate approach is to treat these costs like an item of software and depreciate them over three years.
It is equally clear that taxpayers who pay large amounts to develop sophisticated sites have been allocating their costs to items such as software development, which is deductible like research and development costs and currently deductible advertising expenses, without a challenge from the IRS.
Testing the waters before committing to an advertising campaign is always advisable. Unfortunately, only costs of research in the laboratory or for experimental purposes, whether carried on by the business or on behalf of the taxpayer by a third party, are tax-deductible. Market research and normal product testing costs are not research expenditures under the tax rules. This applies to convenience store chains that invest in things like new product research and foodservice development.
Marketing as Advertising
Mailing lists are an important part of the advertising campaigns of many convenience stores. On one hand, the mailing list is an intangible asset, deductible only if a reasonable life can be determined for it. A tax deduction for the cost of compiling that list is a little trickier.
Consider the situation of a convenience store business that routinely mails to people and businesses on its mailing list, as well as to others on lists that it rents. Prospects for the permanent list are from advertising and added to the company’s mailing list if they make purchases. The business keeps records of its costs in adding to the mailing lists and expenses those costs in the year that the mail campaign— to which the expenses relate—is distributed.
The IRS has ruled that the company may deduct—as an ordinary business expense—its costs related to adding names to the mailing list. Keep in mind, however, that this situation involved a mailing that was conducted semiannually, while in other cases the IRS ruled on catalogs with a useful life of several years.
Paid advertising isn’t the only way to spread the word about a convenience store business. Public relations are marketing strategies that span everything from press releases and networking at a Chamber of Commerce meeting to sponsoring a contest to holding special events.
However, no deduction is allowed for dues paid to any club organized for business, pleasure, recreation or other social purposes, even if membership is used to promote the convenience store business. Fortunately, this disallowance does not extend to trade and professional organizations or public service organizations such as Kiwanis and Rotary clubs.
Everyone is aware that salespeople, distributors and service providers routinely entertain to enhance their businesses. They, and many c-store operators, managers and executives, are allowed a deduction for business entertainment as long as there is a direct relationship between the expense and the development or expansion of the business.
Remember, however, special limits are imposed on the deduction of business-related entertainment, meals and gift expenses. First and foremost, no tax deduction is allowed for the cost of entertaining guests at nightclubs, sporting events, theaters, etc., unless that cost is either:
• Directly related to the active conduct of a trade or business.
• For entertainment directly before or after a substantial and bona fide business discussion associated with the conduct of that trade or business.
The business discussion must be the principal aspect of the combined entertainment and business and must represent an active effort by the convenience store operator, manager or executive to obtain income or other specific business benefit.
However, if a meal expense directly precedes or follows a substantial and bona fide business discussion, including a business meeting at an industry convention or trade show, then it is deductible if it is established that the expense was associated with the active conduct of a trade or business. The convenience store operator, executive or manager must, of course, be able to substantiate the expense.
There are two additional restrictions placed on the deduction of meal expenses:
1. Meal expenses generally are not deductible if neither the operator nor the convenience store operation’s employee is present at the meal.
2. A deduction will not be allowed for food and beverage to the extent that such expense is lavish or extravagant under the circumstances.
The amount allowable as a deduction for meal and entertainment expenses is generally limited to 50% of such expenses. The 50% rule is applied only after determining the amount of the otherwise allowable deductions. For instance, the portion of a meal that is lavish or extravagant must first be subtracted from the meal cost before the 50% reduction is applied.
Giving is Often Advertising
Yet another form of advertising is the giving of gifts by a convenience store business. Deductions for business gifts, whether made directly or indirectly, are limited to $25 per recipient per year. Items clearly of an advertising nature that cost $4 or less and signs, display racks or other promotional materials given for use on business premises are not gifts.
A convenience store business that provides customers or prospective customers with an item that might be considered either a gift or entertainment will generally benefit from the entertainment write-off, ignoring the $25 limit. If the operation gives a customer packaged food or beverages that are to be used later, they are considered gifts.
To spur sales, many convenience store operators frequently give away small samples. Under the tax rules, the cost of the samples can be deducted immediately. If the samples are provided by a manufacturer or distributor, they are entitled to the tax deduction. If the samples are purchased separately from the products being sold, their cost is an ordinary and necessary business expense. If the item was included in inventory, it cannot be deducted twice. It will already be part of the cost of goods sold.
Convenience stores serve the entire purchasing population within a geographical area, but generally focus on customers who need to purchase items outside of normal working hours.
In order to capture attention and sales, many stores employ prominent signs at the store location, billboards, media bites on local news and radio advertisements to capture customers.
Complex, simple or in-between, in-store promotions are a great way to drive store traffic, showcase a particular product and help increase sales. They also may be time-consuming and costly, if not executed properly. Tax deductions, of course, can reduce those costs.
The tax rules clearly label the majority of advertising and marketing costs as immediately tax deductible, albeit with some restrictions or limits. Obviously, getting the maximum benefits from advertising and marketing expenditures or reaping the cost-cutting deductions, often requires the help of qualified professionals.
Whether help includes advertising or marketing professionals or is limited to a qualified tax professional, the decision of whether to advertise or market the convenience store operation’s goods, products and services should be a standard operating procedure in good times or bad.