Let's say your company wants to commemorate the long career of a retiring employee instrumental in its success. It hosts an evening celebration that culminates with the presentation of a plaque and an expensive gift. What are the tax implications?
Generally, such "employee recognition awards," also called "achievement awards," are tax-deductible for employers and tax-free for employees — if certain requirements are met. However, meeting those requirements can be tricky.
Typically, amounts paid directly or indirectly by employers to employees for services rendered are taxable. Year-end bonuses or commissions and similar payments received this year are subject to tax this year. They're also deductible this year if payments are made by a calendar-year business entity. If a year-end bonus is delayed to January 2025, it becomes taxable to the employee in 2025 and a calendar-year business can't deduct it until 2025. (Other rules may apply to accrual-basis companies.)
Tax rules for employee recognition awards are slightly more complicated. For example, an employee recognition award is considered an item of "tangible personal property" given to a worker for either length of service or promoting safety. This includes gifts, such as watches, jewelry, electronic devices and golf clubs. But until the Tax Cuts and Jobs Act (TCJA) of 2017 codified the definition of tangible personal property, some uncertainty remained about what the definition does and doesn't include.
Under the TCJA, tangible personal property doesn't include cash, cash equivalents, gift cards, gift coupons, gift certificates (unless the employer has previously approved a limited selection), vacations, meals, lodging, season theater or sports tickets, stocks, bonds and similar securities, and any other nontangible personal property.
Other tax rules apply to awards made through your company's qualified plans. If you want an award to be tax-free for its recipients, be sure to observe the following rules:
Also, there's a dollar limit on this tax-free fringe benefit. The maximum value an employee can receive from a qualified plan without paying tax is $1,600 per year. On the other hand, if awards are received through a nonqualified plan, the maximum tax-free award is only $400. Any amount above either limit is taxable to the employee and it isn't deductible for your company.
Awards must be paid under a written plan that doesn't discriminate in favor of highly compensated employees. Also, the average cost of all employee achievement awards granted during the year can't exceed $400.
What about holiday gifts of turkeys or flowers for employee birthdays? Such gifts may be excluded from taxable income under a special "de minimis benefit" rule. A de minimis benefit is so small that accounting for it would be unreasonable or impractical. Typically, small holiday and special event gifts are covered by this exception.
In determining whether the de minimis rule applies, consider the frequency and the value of gifts. De minimis benefits are occasional or unusual. Also, they shouldn't be a form of disguised compensation.
If a gift is too large to be considered a de minimis benefit, its entire value — not just the excess over a designated de minimis amount — is taxable to the employee. In the past, the IRS has ruled that items with a value exceeding $100 couldn't be considered de minimis benefits, even under unusual circumstances. Gifts under $50 are usually acceptable.
As you plan to make awards and gifts to employees this year, keep in mind all potential tax consequences. Gifts that recognize achievements or simply show your company's appreciation can help boost worker morale and retention. But if you aren't careful, they also can come at a tax cost to both you and your employees.
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