Excludable Gifts

This question, in one form or another, comes up often enough that it’s worthwhile to address it here. One of my clients asked:

Is a gift under 13k tax deductible? I was reading the IRS website and I came across that.

Gifts are never tax deductible, unless they are made to a 501(c)(3) charity or similar organization. You can check here to search the IRS’s database for 501(c)(3) organizations:


The Tax Code specifically excludes gifts from the gross income of the recipient. So if you were to give your child $5000 as a graduation gift, your child does not even have to mention that $5000 when he prepares his tax return.

So what’s with the special treatment of gifts under $13,000 my client saw on the IRS website?

Gifts are not taxable to the recipient, but they are sometimes taxable to the donor. The reason for this is that people used to avoid federal estate taxes by giving everything away on their deathbed. Since the estate tax is calculated as a % of asset owned at death, this strategy worked nicely to lower the estate tax to zero.

To prevent people from escaping estate taxes quite so easily, Congress passed a law that said any gifts given within 3 years of death had to be included in the donor’s estate. So people started making gifts earlier in life. For example, a person could set up a trust and make her grandchildren the beneficiaries. She could then contribute an office building to the trust and thus get the office building out of her estate. As long as the person lived at least 3 more years, the value of the person’s assets was reduced, and therefore the estate tax was reduced.

Congress reacted to this by passing a Unified Estate and Gift Tax. Over the course of his entire lifetime, a person can give up to a million dollars in gifts to recipients other than 501(c)(3) organizations. Gifts in excess of $1 million are taxable. To track the lifetime amount of gifts, a person if required to file a gift tax return every year a gift has been given.

But Congress really didn’t mean to require every birthday and wedding and graduation holiday gift to be reported. So the law exempts gifts of $13,000/year or less per donee. As long as you don’t give more than $13,000 to any one person during any one year, you don’t have to file a gift tax return. The $13,000 per donee exemption is per person, so a husband and wife can together give $26,000 per donee.

One of the ways to transfer a family business to the owner’s children is to give each child stock or LLC ownership units worth $13,000 each year.

To get back to my client’s question: no, you cannot take a deduction for gifts under $13,000; but you can exclude them when you calculate taxable gifts made during the year.

Do People Really Get To Know New People at Networking Events?

Many years ago, when I first started my law/CPA practice, one of the ways I marketed my services was to sell literally door-to-door. I’d stop by a business location and ask to talk to the owner. I never get tired of hearing about all the different ways people think of to make money, and I always enjoyed hearing about how each business was created. I found that people loved talking about their businesses, so it all worked out well. I had a great time doing door-to-door selling, and my prospects had enjoyable conversations. I even picked up a few clients, some of whom are still using my services all these years later.

Another sales tactic I tried was attending “networking” events. I went to a few that were structured events, such as lunches where you’d move from place to place for each course and have somewhat in-depth conversations with random people. I got a couple of clients that way but, all in all, I didn’t find it worth while. The unstructured cocktail party type of networking event was even worse.  My experiences usally went like this: I’d wander around having meaningless conversations with people, gain a collection of business cards that were meaningless afterwards, and either leave, or end up with another lawyer or CPA who didn’t need my services.

Turns out that my experiences with networking events may not have been unusual. Last month, Wired’s Frontal Cortex Blog had an article by Jonah Lehrer, Opposites Don’t Attract (And That’s Bad News). Lehrer describes a 2007 Columbia University study by two psychologists, who hosted a networking event (which they called a “mixer”) and tracked each attendee’s encounters via electronic name tags. They found that, while the attendees did meet a few new people at the event, they tended to engage in long conversations only with people they already knew.

Even more interesting is a study first published last year by Angela J. Bahns, Kate M. Pickett and Christian S. Crandal. They tracked friendships among university students, and found that students at a large school, whose student population included students with diverse backgrounds, tended to choose friends whose backgrounds and opinions were very much like their own. Students at smaller universities were more likely to get to know people unlike themselves, presumably because there were fewer potential friends to choose from.

Lehrer did not discuss online social networks, but the results of the Bahn et al study would lead one to expect that there would be even greater similarities within online groups than within the groups of students at a large university. A 2009 study, Homophily, Cultural Drift, and the Co-Evolution of Cultural Groups, bears this out (homophily is the principal that like attracts like — that is to say, the opposite of the principal that opposites attract.).

These studies are not surprising. It seems quite natural for people to want to hang out with others who share many of their opinions, whose childhoods were similar to their own, who make about the same amount of money, who follow the same sports.  On the other hand, you can learn a lot more from people who are different from you. Also, people who are different from you, who are in different lines of work, are more likely to need your products or services than people just like you.

So is it worth going to networking events if you make a real effort to engage in extended conversations with people who are different from you?  Or more accurately, with groups of  people who are similar to each other but different from you, since people at networking events hang out with people like themselves.  I don’t think it would work. For example, if I go to a networking event and try to hang out with a group of long-haul truck drivers, I’m going to have a difficult time breaking into the conversation. It’s probably going to make them feel uncomfortable having someone there who is not one of them.

Networking events must work for some people, or there wouldn’t be as many networking events as there are. My guess is that they work best for the people who organize them. When you work together with a small group of people to organize an event, you have a situation more like the small universities in the Bhan study — you and your fellow organizers have time to really talk and get to know one another. That’s the lesson I’m taking away from all these studies and my own experiences — don’t attend networking events unless you’re one of the organizers.

How Government Regulation Stifles Creation of Jobs

This is a blog entry posted by a Hungarian entrepreneur: http://www.arcticstartup.com/2012/01/09/this-is-why-i-dont-give-you-a-job

He explains that he would not hire a woman, because the cost of required maternity leave is prohibitively expensive; nor would he hire someone over 50, because he would not be able to fire the person if the person did not perform the work adequately.

This is an extreme example of the harmful effect of government interference with the right of employers and employees to enter into agreements.

When laws raise barriers against small businesses rather than creating a system that fosters the freedom of business owners to contract freely with people who wish to work for compensation, the end result, when the barriers get too high, is a situation in which the only thing keeping the economy going at all is the black market.

Employee Fraud

The U.S. Marshall’s online auction of clothing seized from Sujata “Sue” Sachdeva continues at Gaston & Sheehan. I didn’t bid on anything, but I stopped by the website, curious to see what sort of things Ms. Sachdeva bought with the $34 million she embezzled from Koss Corporation (link to a Reuters summary of the fraud case; Ms. Sachdeva was convicted and sentenced to 11 years in prison last year). I was surprised to see how many items still had the tags attached, indicating they had never been worn. It would take a while to go through millions of dollars worth of apparel, even if you bought very expensive designer clothes and wore two or three different outfits each day. It must have taken many hours of shopping each week to accumulate so much stuff. In fact, Ms. Sachdeva’s attorney presented her in court as the pathetic victim of a compulsive shopping disorder.

I’m not sure what to think of classifying an urge to acquire stuff as a disabling mental illness. In SHAM – How the Self-Help Movement Made America Hopeless, Steve Salerno argues against excusing crimes based on the criminals’ reasons for committing them. Consideration of mitigating circumstances at the sentencing phase of a trial seems only fair in some cases (for example, a man stealing food to keep his starving children alive), but to lighten the sentence on someone who almost put her employer out of business by embezzling money to buy clothes and limousine rides … I don’t know … it seems that once someone accepts this view, it’s only a short step from holding the employer responsible for harming Ms. Sachdeva by enabling her compulsion.

At least two other Koss employees knew about the thefts, which took place over a period of five years. Both employees reported directly to Ms. Sachdeva. No charges were ever filed against the other employees, so their reasons for keeping quiet are not public information. Were they afraid of losing their jobs? Did Ms. Sachdeva somehow convince them that she was doing nothing wrong?

Can small business owners learn something from this? Having an upper management open door policy comes to mind, so that employees could feel somewhat less uncomfortable about going over their supervisors’ heads. Personal review by the CEO or CFO of all expenditures over a certain amount I another. Koss actually had a review policy for expenditures over $5000. It’s not clear how Sachdeval circumvented this, or why the CPA’s who audited the company didn’t notice it.

The Internal Controls section of Koss’s 2010 annual report states that “approximately 98.1% of the of the unauthorized transactions from fiscal years 2005 through December 2009 was misappropriated by circumventing the Company’s internal controls and other operating procedures for the payment of Company expenditures by using wire transfers or cashier’s checks from the Company’s bank accounts to pay for personal expenditures.”  The remaining 2% of the money apparently was stolen via the petty cash funds.

All purchases of more than $5000 were supposed to be approved by the CEO, Michael Koss, and the auditors should have chosen representative samples of wire transfers and cashier’s checks and matched them to signed CEO approvals. Since this somehow didn’t happen, it made sense for Koss to change whatever it had been doing. The annual report says that Koss remedied the situation in the following way: “This has been remediated by: (1) disallowing the use of any cashier’s checks; (2) enforcing that all wire transfers are initiated within the financial function and electronically approved by the CEO; and (3) performing an enhanced review, reconciliation and reporting of cash activities.”

The fraud was first discovered by Michael Koss when American Express notified Koss of large wire transfers being used to pay personal expenses.

Lawsuits were filed by Koss v Grant Thornton (their auditor);shareholders v Koss Corp, Michael Koss, and Grant Thornton; Koss v American Express. A quick online search indicates that the shareholders’ class action lawsuit against Grant Thornton was dismissed, and the shareholders’ case against Michael Koss and the corporation was settled. I believe the Koss v Grant Thornton is still pending.

One point about this case that especially caught my attention was that the Koss family was said to have been not entirely careful about their own transfers of cash and other assets into and out of the company. Michael Koss held several corporate offices, including CEO and CFO, an arrangement which tends to encourage financially loose behavior.

Commingling business and personal assets is one of the most common mistakes I see in my own clients’ businesses. When I set up a business entity for a client, I tell them that if they can remember only one bullet point from their organizational meeting with me, it should be NEVER COMMINGLE.

The attitude of business owners, especially of a closely held business is, “It’s my money, I can do whatever I like with it.” This is true where there are no other owners, but it has to be done correctly in order to prevent tears in the “corporate veil.”

Where there are other owners, such as partners or investors, the owners have to be far more careful about taking assets out of the entity, or using entity equipment for personal purposes. Most business owners are aware of this, even if they do not always act accordingly. It’s less common to consider the effect it has on employees when they see the owners freely helping themselves to money and other assets belonging to the business entity. Not only does a general attitude of financial carelessness on the part of management encourage employees to have the same outlook, it can also make it more difficult to notice when fraud is taking place. For example, constantly transferring cash between various entity and personal accounts provides a great springboard for dishonest employees to add a few discreet transfers of their own.

I do not know the details of the Sachdeva case, but if the Grant Thornton auditors overlooked $34 million of bogus payments, I’d be willing to bet that the Koss accounting practices were not shiny-clean.