Non-Deductible Expenses:
Permanent vs. Temporary

By Len Pytlak

Recently, while doing some year-end tax planning for one of my attorney clients, I had the task of trying to explain to a non-accountant why his taxable income was greater than the cash he had in the bank and why this gap gets bigger and bigger each year. This is a problem for any business that buys gifts for its customers or suppliers, for those that do any kind of business entertaining or those that make a donation to a charity.

For financial statement purposes, 100 percent of the cost of gifts, meals and entertainment and donations are deductible from income. But for federal income tax purposes, the deduction for these items are limited.

Under current tax law a business can only deduct the first $25 of any gift given to a supplier or customer in the calendar year. This is an annual limit, not a per-gift limit, and has been this amount for as long as I can remember — and I have been doing this for 30 years.

The cost of the gifts that exceed this $25 limit is not deductible for income tax purposes but is a permanent reduction of your cash. This becomes part of the difference between financial statement income and tax return income.

Meals and entertainment, as you probably know, are only a 50 percent deduction for income tax purposes but 100 percent deductible from your checkbook and for financial statement purposes. Again, a permanent difference between taxable income and financial income. In accounting lingo, excess gift costs and the 50 percent portion of meals and entertainment that are not deductible are called permanent differences.

Charitable donations, on the other hand, can either be fully deductible in the year paid or they could fall into one of the differences categories. That’s because the tax deduction for donations made in the current year are only deductible up to 10 percent of the business’s taxable income for the year without taking into account the donations. Using the chart below, you can see that taxable income for year one, without the donation, is $150; 10 percent of this figure would be $15, leaving $10 of the donation not deductible in the current year. This will be a temporary difference for a while.

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