How Imitating Santa Can Help You Save Taxes This Year –

Twas the night before Christmas when all through the house, not a creature was stirring, not even a mouse. As Christmas Eve draws near, my family is busy preparing for guests. Mostly, we’re waiting on cousins, aunts, and uncles; but my little cousins are also waiting for a certain man with glasses and a white beard. You guessed it – St. Nick!

With several cousins under the age of ten, there have been more than just a few discussions in my household about how Santa manages, in one night, to get all of his work done. It does not take endless reruns of a “Miracle on Thirty-Fourth Street” to know that Santa has help. And that help has financial and tax consequences. This sparked a conversation in my household recently about Santa’s money and his tax bill. And here’s what we – a tax attorney and two kids – decided:

First, residency. My cousins got letters from Santa this year and they were postmarked North Pole, Alaska. That tells me one very important thing: that Santa maintains his primary residence – and place of business – in the U.S. What we can’t be too sure of, however, is Santa’s citizenship.

Second, revenue. How Santa makes his money is a mystery. My youngest cousin has a theory. He has decided that Santa doesn’t need money because the elves make all of the toys. However, that was hotly disputed by his brother, who believes that Santa must have some additional form of revenue because he obviously spends a lot. To that end, he thinks that Santa might be making money on the side as a distributor of toys for one or more of the big toy chain retail stores such as “Toys R Us” and “FAO Schwartz.” Now, whether Santa is reporting the income from the sales of those toys is a story better left for another day.

Assuming Santa doesn’t have another job, how does he manage to stay afloat, especially in these hard economic times? On that point, my cousins agree – Santa might just be independently wealthy like Bruce Wayne (i.e., Batman) is.

Now for some statistics to show how busy of a man this Kris Kringle is on one night of the year. Based on figures reported in 2011, there are 526,000,000 children – worldwide – under the age of 14 who celebrate Christmas. That works out to a delivery rate of almost 22 million kids an hour, every hour, on Christmas Eve (phew!).

In the United States (which, granted, is a bit more commercial than other countries), gifts per child average $ 271 at Christmas. Assuming 526,000,000 children, that works out to $ 142,546,000,000 in gifts – that’s $ 142 Billion with a “B”. Of course, there is no way of knowing what percentage of those children were “naughty” as opposed to “nice,” but we’ll save that for another day.

Since Santa doesn’t sell the toys – he gifts them – he’s poised to take advantage of a very special exemption in tax law called the annual gift tax exemption. That exemption immunizes Santa from gift tax – just like the flu shot immunizes us mortals from the flu – for gifts of up to $ 14,000 per child per year. That means that Santa can give away millions and millions of dollars worth of toys without federal gift tax consequences – so long as they’re to different children.

With such a generous exemption, it might appear as if the only thing that Santa has to worry about is a winter storm on Christmas Eve. But that might well be the least of Santa’s problems. To the extent that Santa gives any child more than $ 14,000 in gifts (using the fair market value, since the IRS has not yet approved of “elf-made value”), he would be subject to the federal gift tax and would need to file a Form 709, federal gift tax return.

What about Santa’s expenses? With so much overhead and no source of income, it’s a miracle that he hasn’t had to file for Chapter 11 bankruptcy. My youngest cousin was able to shed some light on how Santa is able to keep his overhead low. He’s convinced that Santa doesn’t pay the elves a wage for their work. Instead, he provides them with room and board and other perks. Why the U.S. Department of Labor has not opened up an investigation into alleged violations of the Fair Labor Standards Act at the North Pole is a story better left for another day.

Even though Santa doesn’t pay his elves a wage, they still receive income. How you may ask? The expenses that Santa pays for their room, board, and meals are considered compensation. As such, it’s taxable to the elves. Fortunately, it’s also deductible for Santa. To say that the elves are getting the short end of the stick would be an understatement.

After hearing enough of my rants about Santa and violations of the Fair Labor Standards Act, my cousin changed his mind and decided that there is no way that someone as generous as “Ol Saint Nick” would be stingy enough to withhold a decent wage from his elves – after all, they are indispensable to his operation. Especially since the cost of living in Alaska is slightly more than the national average – about 34% more. The state median income for one person is $ 54,272, according to the Department of Justice. While that might seem a bit high for an elf, the fact remains that the work they do is important. So Santa clearly wouldn’t skimp. Assuming 500 elves (a “conservative” estimate according to my cousin), that works out to $ 27,136,000 in compensation.

Compensation is taxed to the elves as income. However, Santa pays taxes on their behalf, starting with payroll taxes. Payroll taxes for the elves – at the employer contribution rate of 7.65% — work out to $ 2,075,904. Remember that for 2012, the elves got a 2% break on their share of payroll taxes.

While Santa doesn’t pay income taxes on compensation paid to the elves, he must still manage their withholding according to any forms W-4 provided to him. That issue turns on how the elves are classified – as “employees” or “independent contractors.” Since the primary, if not exclusive, industry in the North Pole is toy making, it’s hard to imagine what, if any, other job would be available for an elf outside of toy making. Certainly, they wouldn’t be moonlighting as taxi drivers after hours or serving Big Macs at the drive-thru of McDonalds. Selling hot chocolate or lattes to participants of the Iditarod, “The Last Great Race on Earth,” is a different story. But that only happens once a year. Therefore, my vote is that the elves are employees, and not independent contractors. Thankfully, my cousins agree.

Fortunately for Santa, there is no withholding requirement for state taxes in Alaska. There is, however, an employer contribution to unemployment insurance (SUI). Considering the overwhelming number of toys that have to be made each year, it’s hard to imagine that there are a lot of unemployed elves. So I’m guessing that Santa’s contribution rate to SUI is fairly low. But just to be on the safe side, I’m going to calculate these costs using the average rate of 4.11%. Applying that rate to the wage base for all of the elves results in $ 735,690 of employer contributions for SUI.

For 2013, Santa must report health care insurance costs paid by him for the elves on their Form W-2. Fortunately for both Santa and the elves, there is no tax payable on those benefits. Other perks, however, may be taxable if they are more than insignificant. For example, cell phones for the elves would not attract any tax so long as there’s a business purpose. But tickets to the “Reindeer Games,” the North Pole’s version of Quidditch – the premier sporting event in the wizarding realm of the Harry Potter universe – would not be considered a small perk, especially if Santa splurged by buying box seats for all of the elves along with several rounds of butter beer.

While withholding tickets for the Reindeer Games is not likely to be popular amongst the elves – one can already hear the chorus of disapproval beating like a drum off in the distance – Santa can always steal a page out of Ebenezer Scrooge’s playbook and say, “Bah, humbug!”

My cousins are pretty sure that Santa doesn’t operate as a for profit business. But he likely doesn’t meet the criteria to be tax exempt under section 501(c)(3) of the internal revenue code either. By default, that would make his venture for profit in the eyes of the IRS. Therefore, it is taxable.

Even if Santa’s toy factory was classified as not-for-profit, there may be other unrelated trade or business income. While the source of his income remains a mystery, my very astute cousin questioned the value of all of the cookies and milk left out for him noting, “that’s a lot of cookies!” Not to be outdone by his younger brother, my other cousin was quick to point out all of the Santa merchandise in stores. It stands to reason that Santa must get some licensing revenue for his own image, not to mention that of Rudolph, in the same way that Pixar does for Buzz Lightyear. That income would be taxable to the extent that it’s not offset with expenses.

What, if anything, is deductible? For an expense related to business to be deductible, it must be both “ordinary” and “necessary.” No matter what the industry, toymaker or bricklayer, that is the standard used by the IRS. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. You don’t have to prove that you couldn’t be in business without the expense – it just needs to make good business sense.

What does that mean for Santa? First, compensation and related costs (as discussed above) are deductible. Santa can also deduct the cost of goods and the cost of materials used to make the toys. Further, he can deduct the costs associated with keeping the toy factory up and running – including heat and electricity. My cousins have decided that the heating costs alone would be astronomical.

What about clothing/uniform costs? Anyone who has ever seen a Santa film knows that Santa dresses in a red suit. As for the elves, they dress in special elves clothes, complete with a hat (with a fluffy round ball at the end) and long, spiraling, pointy shoes. These clothes are deductible only if they must be worn as a condition of employment and are not suitable for everyday wear. The rule doesn’t turn on whether someone would actually wear the clothes outside of work; but merely whether they could.

After a chat with my cousins, we’ve decided that Santa wears those red suits regularly. In fact, that might be all that he wears, except at night when he goes to bed. Therefore, the red suit is not deductible.

The elves are another story. My cousins are convinced that the elves only wear their special uniforms when they are in the toy factory or delivering gifts. At all other times, they wear street clothes. If that’s the case, the elf uniforms are deductible.

What about transportation? With an estimated distance of 75,500,000 miles, that’s not something that can be overlooked. According to Abogo, upkeep for the reindeer costs about $ 2,000 per reindeer per year. For nine reindeer (how could we ever forget Rudolph!), that comes to a total of $ 18,000. Abogo also estimates that Santa spends $ 1,000 on sleigh maintenance per year and annual insurance premiums for the sleigh and reindeer of $ 42,000. The grand total for transportation costs for the year is likely to hit $ 60,000.

Santa can deduct actual expenses. But in his case, he’d be a lot better off if he used the mileage method. The IRS’s standard mileage rate for 2013 is 56.5 cents per mile for business use. At 75,500,000 miles (his estimated trip), Santa would be entitled to a very generous $ 42,657,500 mileage deduction. However, Santa would be begging for an audit if he were to ever claim a deduction this large.

Does Santa have a cell phone? According to my youngest cousin, he must. Otherwise, how would the teachers at his school be able to call him to report on how good (or naughty) their students were? My oldest cousin opines, pointing out that Santa must have a way of staying in touch with the beloved Mrs. Claus, not to mention the elves. One can only imagine the number of minutes, let alone the roaming costs, involved. Luckily for Santa, the cost of his cell phone service would be deductible as an ordinary and necessary expense.

We’ve also decided that Santa doesn’t attend any special classes or pursue any higher education – though he does offer toy making classes for the elves. Assuming he pays for them (and we say he does), they would be deductible.

Santa might need a lawyer – perhaps for tax advice or, at the very least, to deal with any pesky lawsuits related to damaged roofs or harm caused by misfit toys. There’s also that matter of Grandma getting run over by a reindeer (allegedly). To the extent that legal expenses are related to the business, here toy making, they would be deductible.

The takeaway is this: Santa won’t pay any federal income taxes this year (with the exception of payroll, as previously noted). Indeed, Santa’s deductions far outweigh his revenue, at least according to our mostly unscientific surmising. But the more important question is, “Will you?” There is an old saying that, “imitation is the sincerest form of flattery.” So go ahead, be like Santa.

In accordance with Circular 230 Disclosure