During the holidays, many employers opt to give gifts to employees and host parties as a gesture of good will, a reward for achievements during the past year, or a morale booster to encourage continued good performance in the year ahead. But did you know that those well-meaning efforts to lift your staff’s spirits could easily end up dampening everyone’s festivities by unintentionally costing them extra in taxable wages?
Under the Internal Revenue Code (IRC), the fair market value of gifts, awards and prizes that employers give to employees is generally subject to federal income tax (FIT) and Social Security and Medicare (FICA) tax withholding and to federal unemployment insurance (FUTA) tax. However, there are certain categories of these perks that you can provide to employees on a tax-free basis so long as you adhere to IRC rules.
Tip #1: Give De Minimis Gifts
Under the IRC, a de minimis fringe benefit is any property or service you provide to employees that has so little value that accounting for it would be unreasonable or administratively impractical. Common examples of gifts that may qualify as de minimis fringe benefits include annual holiday items with a low fair market value, such as:
- A box of chocolates;
- A turkey;
- Theater or sporting event tickets;
- Flowers; and
- Fruit baskets, books or similar items.
An annual holiday party may also qualify as a de minimis fringe benefit.
Employers must err on the side of caution, however, in regard to the value or cost of such gifts and parties because the IRC does not specify any particular amount that qualifies as de minimis.
Lavish or extravagant gifts such as season tickets to sporting or theatrical events, use of the company jet or yacht for weekend getaways, or exclusive golf club or spa memberships do not qualify as de minimis. Similarly, hosting a white glove holiday ball at the Plaza Hotel in New York City is not going to be viewed as de minimis by the IRS.
A good rule of thumb is to set a reasonable maximum value or cost per employee for holiday gifts and parties, e.g., $25 to $50 per person.
But there is more to consider besides value or cost. Holiday gift giving and parties must also be tempered by how often you give de minimis gifts and provide other similar benefits to employees over the course of the entire year. The key is to make your gift giving and parties occasional. Under the IRC, even gifts of minimal value can become taxable to your employees if you provide them too frequently.
For example, it is perfectly acceptable throughout the year to send flowers or a fruit basket to an employee who is recuperating from a difficult surgery or illness or mourning the death of close family member. But if you dole out such gifts too freely or too often, you may run into trouble with the IRS by the time the holidays come around.
Tip #2: Avoid the Cash and Gift Card Danger Zone
Avoid giving gifts to employees in the form of cash and cash equivalents, such as gift cards, charge cards and credit cards. These never qualify as tax-free de minimis fringe benefits no matter how small their value. This is the case even if you only give them on occasion, such as during the holidays.
For example, if you’re thinking it would be easier to give all of your employees a $20 gift certificate or gift card to a specific department store that they can use to buy whatever they like, think again. The IRS will view these as cash equivalent fringe benefits, and their value will be includable in each employees’ taxable income. The restrictions of a set amount and use in a particular store are irrelevant. Likewise, even a gift card for as little as $5 will be viewed by the IRS as taxable cash.
If it is an easy gift you’re looking for, some types of gift certificates or vouchers do qualify as de minimis, but the acceptable circumstances are quite limited. You can safely give employees a voucher or certificate to a local store with no dollar amount if they can only use it to redeem a certain item, such as a ham or a turkey. The difference here is that the store voucher cannot be used freely like cash, and it is the equivalent of giving an actual turkey or ham, which is considered de minimis.
Tip #3: Make Sure Year-End Awards and Prizes Meet IRS Standards
On a similar note, the value of any kind of employee awards and prizes you may want to give at the end of the year are generally subject to FIT and FICA withholding and FUTA taxes unless they qualify as de minimis fringe benefits under the IRC. (There are some very limited exceptions for salesperson awards.) Specifically, you can only give out the following three types of awards and prizes and only under the noted circumstances:
- In-kind awards for length of service or safety achievement given as part of a meaningful presentation and that are not disguised compensation;
- Length-of-service awards given in five-year increments (i.e., for an employee’s 5th, 10th or 15th year of service); and
- Safety achievement awards for employees who are not managerial, administrative or other professionals and only if up to 10% of all employees have received similar awards.
Note that the IRC limits the maximum excludable amount of such awards.
You can also give prizes and awards to employees on a tax-free basis that are primarily to recognize their religious, charitable, scientific, educational, artistic, literary or civic achievement if:
- The recipient employees are not chosen as part of a contest;
- The recipient employees are not required to perform substantial work as a condition of receiving the prize or award; and
- The awarding organization transfers the prize or award to a tax-exempt charitable or government organization of the employee’s choice.
What’s your biggest gift-giving concern during the holiday season? Let us know by leaving a comment below.