John Finocchario, The Daily Record Newswire
With the holiday season right around the corner, it is important for both employers and employees to be reminded about the tax consequences of receiving gifts, awards and other prizes. Whether it is a free turkey at Thanksgiving, an award for an outstanding accomplishment or a raffle prize won at the company holiday party, many employees and employers don’t consider the tax consequences of such gifts.
The general rule is that all payments made to an employee as a gift, award or prize are considered taxable to the employee as compensation, and subject to income tax withholding and employment taxes unless a specific exemption applies.
Cash awards or prizes are always taxable to the employee regardless of the reason for the payment or the amount. Cash awards include gift cards and gift certificates. There are three types of awards that may be excluded from income. In order to qualify for the exclusions, the award must be a non-cash award. Those exclusions are employee achievement awards, de minimis awards and certain awards transferred to charities. Certain de minimis gifts are also excluded from income.
Employee achievement awards
An employee achievement award is an item of personal property that is given away based on length of stay or safety. In addition, the award must be awarded as part of a meaningful presentation and cannot be made under facts that could support that the payment represents disguised wages.
A safety achievement award is excluded from income unless the award is given to a manager, administrator or other professional employee. Also, the award will not be excludable from income if, during the taxable year, more than 10 percent of the employees have already received a safety achievement award. For an employee to be eligible they must be full time and have worked a minimum of one year.
A length of service award would not be excludable from income if the employee receives the award within the first 5 years of employment. The award would also not be excludable if the employee receives an additional length of service award in the same year or any of the prior 4 years.
The maximum amount of an excludable award is $400 for awards paid under a nonqualified plan and $1,600 in total for awards made under both qualified and non-qualified plans. An award is not considered made under a qualified plan if the average cost of all employee achievement awards made by the employer during the year exceeds $400. Any awards under $50 are not included when calculating the average award.
De minimis awards and gifts
A non-cash prize or award that is nominal in value and is provided on an infrequent basis is excluded from an employee’s income. It is important to note that even if an award would otherwise be de minimis, if it is provided on a frequent basis, it would not be eligible under the de minimis exclusion. There is no set dollar amount that defines nominal in the law. Nominal means small in value in relationship to the compensation of the employee. Some examples of de minimis gifts could include holiday turkeys, small gifts for birthdays or special occasions, small employee of the month awards and nominal gifts at retirement.
Awards transferred to charities
In general, prizes and awards that are given to recognize charitable, scientific, artistic or educational achievement would not be considered taxable if they are then transferred to a charitable organization. The award must be for achievement, the recipient must be selected without any pre-registration in a contest, no future services are required, and the award is transferred to the charity before the recipient receives any benefit from the award.
If you are an employer who is planning to give away gifts or awards or an employee who will receive a gift or reward, it is important to understand the taxability of those gifts. It is especially important when a non-cash gift or award is given to an employee that does not fall under one of the exclusions above. The gift or award may result in a cash outflow to the employee in the form of income tax withholding and payroll taxes with no incoming cash to cover that outflow.
It is also important to note that if an employer decides to give a “bonus” to cover the tax consequences of any gift or award, that “bonus” should also be included as wages to the employee. Please consult your tax advisor if you are unsure of the tax implications surrounding gifts or awards.
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John Finocchario, CPA, is a manager in the tax department at Mengel, Metzger, Barr & Co. LLP. He may be reached at Jfinocchrio@mmb-co.com.
