The holidays are just around the corner, and now is the time for employers to start thinking about treating their employees with holidays parties or gifts. Such gestures are always a nice idea. Plus in a tight labor market, they can be a smart way to show appreciation and boost retention. But you need to know the tax rules so your well-intentioned efforts don't backfire on you and your employees.
The good news is that holiday parties for employees generally are fully deductible for employers, with no tax implications for employees. Remember, though, that tax-deductible employee social events must primarily be for the benefit of non-highly compensated employees, meaning employees who:
Note, too, that the party must be exclusively for employees (with exceptions for employees' family members and other guests who aren't customers). If you also invite clients or customers, your expenses probably will be only partially deductible due to limits on the deductibility of business meals and entertainment. (See "Tax Rules for Client Gifts and Parties," below).
The taxability of gifts to employees is less clear-cut. It largely turns on whether the gift is one the IRS would recognize as a de minimis benefit. If so, the gift isn't includable in the employee's gross income for tax purposes, though it's still deductible for the employer. If a gift is included in an employee's gross income, it's subject to both income taxes and payroll taxes.
The IRS defines a de minimis benefit as one — given its value and the frequency with which it's provided — that's so small that accounting for it is unreasonable or administratively impractical. An essential element is that a de minimis gift is occasional or unusual in frequency — and it can't be a form of disguised compensation.
The IRS has provided a list of such items that includes holiday gifts. But the agency has ruled that items with a value exceeding $100 can't be considered de minimis, even under unusual circumstances.
In addition, the IRS has indicated that gift certificates that are redeemable for general merchandise or have a cash equivalent aren't de minimis benefits. As such, they're taxable to employee recipients.
On the other hand, an exception may apply to a certificate that permits an employee to receive a specific item of personal property that's minimal in value, provided infrequently and administratively impractical to account for. So, if you give coupons to your employees for, say, a holiday ham or turkey, neither of which has a redeemable cash value, the gifts probably won't be taxable to the employees.
The IRS has identified several other de minimis benefits that can give you nontaxable gift ideas at the holidays. For example, tickets to a one-time theater or sporting event should be nontaxable (but season tickets would be taxable). Flowers, fruit and books "provided under special circumstances" also may pass muster with the IRS.
What about a "holiday" cash bonus paid at year end? The IRS considers that to be taxable supplemental wages, even if it's not specifically based on work performance or achievements (for example, sales quotas). Further, if you pay the employee's share of taxes on a bonus, the taxes paid are considered additional wages to the employee and subject to payroll taxes.
Small gestures can go a long way with your employees, but even seemingly small gifts can lead to unexpected tax consequences. Check with your CPA to help ensure your holiday appreciation doesn't end up giving your workers the "gift" of a higher tax bill down the road.
Your clients or customers may also expect some holiday recognition. The tax rules are different for such shows of appreciation.
You generally can deduct no more than $25 of the cost of business gifts you give directly or indirectly to each person during your tax year. But incidental costs — such as engraving, packing or shipping — aren't included in the $25 limit if they don't add substantial value to the gift. And gifts that cost $4 or less upon which your business name is permanently engraved and that you distribute on a regular basis, like pens or plastic bags, don't count toward the limit.
Depending on the format (for example, a dinner at a restaurant or a party with a band), a celebration for clients would at best be subject to the 50% deduction limit on business meals that aren't lavish or extravagant, assuming you can establish that the event has a business purpose. (While in 2021 and 2022 you could deduct 100% of your meal expenses if the meals were provided by a restaurant, that tax break is no longer available). At worst, your party expenses would constitute nondeductible entertainment expenses. Consult with your tax advisor to determine the proper tax treatment.
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