At this time of year, many employers join the holiday spirit and show their appreciation for their employees by giving year-end gifts, either in the form of cash or other tangible goods. These gifts are excellent ways to express gratitude, but they oftentimes come with tax stipulations of which the giver should be aware.
Everybody, even if they were not fans of her show or viewers of it, remembers the time Oprah gave all the people in the audience a car. The bad news, it later came to light, was that the recipients had to pay tax on those cars. Employers giving gifts to employees do not want to inadvertently saddle them with a tax liability, so here are some rules of thumb to keep in mind during this giving season.
Taxability of Cash
Any cash award or gift that is given is subject to all of the income taxes (federal, state, local, Social Security, Medicare, etc.) as normal wages. So, a $50 intended gross gift may end up being only a $30 net to the employee. All cash gifts should be run through payroll, which makes the withholdings easier to calculate and apply, but physical cash (i.e. a $100 bill) is taxable to the exact same extent as a $100 gross check. Gift cards are considered cash and are taxed in the same manner.
Taxability of Gifts
Any gift, other than a de minimis benefit, is taxable compensation to an employee and, like the cash noted above, subject to all of the same employee and employer taxes. The IRS has generally held that anything over $100 cannot be considered de minimis. It is worth noting, however, that a gift by an employer is only deductible to the extent of $25. So, a $200 holiday gift to an employee is taxable to the employee, and only $25 is a deductible expense to the employer.
Certain items given to employees receive special treatment – those that are considered awards as opposed to gifts. Awards for length of service are not taxable, with some stipulations. The award cannot be given in the first five years of service to the employee or more frequently than every five years. Safety awards are permissible to be given free of taxes if they go to less than 10 percent of the workforce. The total amounts of these awards that an employer can deduct is up to $1,600 per recipient as long as there is a written plan indicating that the awards program does not favor highly-compensated individuals. A final requirement is that awards cannot be disguised wages in order to be nontaxable.
How to Alleviate the Burden on Employees
If an employer does not want to subject its employees to unforeseen tax burdens, the company has a couple options. Some businesses like to give round numbers as holiday bonuses. For instance, if the business wants an employee to receive a $500 net bonus, the gross bonus may be closer to $700 so that the tax withholdings bring the check amount to $500. Sometimes you may hear about employers “covering the tax” on a bonus. That is essentially what is happening here. The employee technically is getting $700 and is subject to withholding, but the employer views it as a $500 gift and the assumption of related taxes.
Employers have the choice to do the same thing on gift cards or non-monetary gifts. If the value of these is, say, $250. The employer could add $350 to the W-2 and cover the $100 of federal, state, local, and other withholdings as well as the employer portion of payroll taxes.
By Dan Massey, CPA, Manager