What expense category is Branded Merchandise?

Giving away branded merchandise, such as pens, t-shirts, or bags, is a popular and effective way for businesses to build brand awareness and foster goodwill. However, when it comes to taxes, it's crucial for accountants and small business owners to know how to classify and deduct these expenses correctly. Are they an advertising expense or a business gift? The answer determines how much you can deduct.

This guide will walk you through the IRS rules for categorizing promotional merchandise, explain the tax implications, and show you how an automated system can streamline the entire process.

How To Classify Branded Merchandise: Advertising vs. Business Gifts

According to the IRS, businesses can generally deduct reasonable advertising expenses that are directly related to their business activities. While this sounds straightforward, Branded Merchandise can sometimes blur the line between an advertising expense and a business gift. The IRS has specific rules to help you distinguish between the two, which directly impact their deductibility.

The Widespread Distribution Rule

The key difference often comes down to intent and distribution.

• Advertising expenses are intended to keep your business name in front of the public and are generally distributed widely.
• Business Gifts are typically given to a specific person or a limited group of people.

If you give items to the general public to promote your business, it's an advertising expense. If you give an item to a specific client or business associate, it is more likely to be considered a business gift, which has different deduction limits.

The $4 Rule for Advertising Items

The IRS has a specific exception for certain low-cost items that prevents them from being treated as business gifts. An item is considered an advertising expense, and not a gift, if it meets all the following criteria:

• It costs you $4 or less.
• It is one of a number of identical items you widely distribute.
• It has your business name permanently and clearly imprinted on it.

Items that meet these requirements are fully deductible as advertising expenses and are not subject to the limit for business gifts.

The $25 Limit for Business Gifts

If a promotional item does not meet the criteria for the $4 advertising rule, it is likely to fall under the rules for business gifts. For business gifts, you can deduct no more than $25 for gifts given directly or indirectly to any one person during your tax year.

A single $30 branded jacket given to a specific client, for instance, would be subject to this $25 limit.

What about incidental costs, such as shipping and engraving?

When determining the cost of an item for the $25 gift limit, you do not need to include incidental costs such as packaging, insurance, mailing, or engraving, provided they do not add substantial value to the gift. This same logic can be applied when determining if an item meets the $4 advertising rule.

Examples of Merchandise Advertising Expenses

Here are some practical examples to help you classify your promotional spending:

Items Fully Deductible as Advertising

• Branded pens, desk sets, and plastic bags that cost you $4 or less each and are distributed widely at a tradeshow.
• Branded t-shirts or hats costing $4 or less each that you give away to the general public at a community event.

Items Limited by the Business Gift Rule ($25 per person)

• A high-quality, branded polo shirt worth $35 that you give to a top client. Your deduction would be limited to $25.
• A gourmet gift basket worth $80 was sent to a specific company's executive team for their personal use. This is considered an indirect gift to the individual executives, and you can only deduct up to $25 for each person who receives one.

Other Promotional Materials

Signs, display racks, and other promotional materials that you provide for use on the business premises of the recipient are not considered gifts and are fully deductible advertising expenses.

Tax and Recordkeeping Requirements for Branded Merchandise Expenses

Once you’ve correctly classified your expenses, you need to know how to deduct them and what records to keep.

How to Deduct Advertising Expenses on Your Tax Return

For sole proprietors, advertising expenses are deducted on line 8 of Schedule C (Form 1040). If an item is classified as a business gift, the deductible portion (up to the $25 limit) is also deducted as a business expense. Corporations and partnerships deduct these expenses on their respective returns (Form 1120, Form 1065, etc.).

IRS Recordkeeping Requirements for Promotional Expenses

You must keep thorough records for all your business expenses, including advertising. You cannot deduct expenses that you approximate or estimate. Your records must be supported by documents that prove the amount, date, payee, and business purpose of the expense.

Supporting documents you should keep include:

• Invoices from vendors for the Branded Merchandise.
• Receipts or cash register tapes.
• Canceled checks or other documents showing proof of payment, like credit card statements.

For items treated as business gifts, you must also be able to prove the business purpose of the gift and the business relationship of the person receiving it.

How Fyle Can Automate Tracking for Branded Merchandise Expenses

Keeping track of every promotional purchase and ensuring compliance with IRS rules can be a challenge. Fyle’s expense management platform automates this entire process, ensuring every dollar spent on advertising is accurately documented and ready for tax time.

Fyle's real-time credit card feeds send an instant SMS notification to an employee as soon as they make a purchase of branded merchandise on a company card. The employee can immediately reply via text with a photo of the receipt, capturing necessary "documentary evidence" at the moment of the transaction and eliminating lost receipts. 

Fyle then automatically matches the captured receipt with the transaction data, creating a complete and documented expense record in seconds.

This automation simplifies compliance for accountants. You can create custom expense categories, such as "Promotional Advertising" or "Business Gifts," and build rules into Fyle's policy engine to automatically categorize expenses. For example, a policy can flag any item categorized as a "Business Gift" that exceeds the $25 IRS limit before it's even submitted. 

Once approved, Fyle exports these fully coded expenses directly to your accounting software, including QuickBooks, Sage Intacct, Xero, and NetSuite—saving hours of manual work and ensuring your books are always accurate and audit-ready.