You may want to provide your employees or others with special acknowledgment at certain times of year such as holidays, birthdays and anniversaries. The IRS assumes that if you provide additional benefits to someone specifically because you have a business relationship, that the benefit will be taxable. Though in some cases the IRS makes a benefit not taxable. The IRS may also limit the deduction you can take.
This blog will cover the taxability and deductibility of bonuses, gifts and fringe benefits. Taxability refers to whether the person who receives the bonus, gift or fringe benefit has to pay income tax on the amount. Deductibility refers to whether your business can take the expense as a tax deduction.
In some cases a business expense is only partially deductible on your taxes. If so, you still record the full cost in your accounting records. When you or your tax professional prepares your tax return, you will take a deduction for the allowable portion of the expense. Tip: For a partially deductible item, record it in a separate expense account to make it easier to identify and adjust when preparing your year-end tax forms.
The following IRS Publications address the deductibility and taxability of bonuses, gifts and fringe benefits:
Bonuses paid to employees are considered wages and are added to their W2. If you give a bonus to an independent contractor it is included on their 1099-Misc form. While there are special rules for bonus withholding, the income tax is the same as regular wages.
Deductible achievement awards need to meet several rules based on whether you are recognizing length of service or a safety achievement. Awards need to be given as part of a meaningful presentation and the circumstances do not indicate it is pay disguised as an award. If you plan to give achievement awards consult a tax preparer as the type and manner of the award can make it taxable to the employee.
Gifts to employees
Gifts are generally considered taxable to an employee as wages. The tax treatment presumes you are giving the gift for business reasons and thus it is treated the same as regular pay. If taxable as wages, the gift is classified as salary or wage expense, not gift expense.
There is an exception if the gift counts as de minimis. A de minimis gift can be deducted as a business expense and not taxable to the employee. De minimis means the gift has minimal cost, is not cash, is given infrequently and/or is difficult to track. See more about de minimis fringe benefits below.
If it bothers you that your employee will pay tax on their gift, you can give them the money to pay the tax. This is called grossing up. It means you give the employee the gift plus an additional amount so after paying the tax they walk away with the value you originally intended to give them.
Cash and gift cards
Cash, checks or gift cards are always taxable to the employee no matter how small. They are also fully deductible as a salary or wage expense. If you give a gift card to an employee you can let your payroll processor know about the gift so it can be added to wages and also ask them about how to gross up the amount to cover the tax.
Gifts to contractors
It is likely that if you give a gift to someone you pay as a contractor that you need to include the cost of the gift on their form 1099-Misc as additional compensation for work performed. You are not giving them a gift due to your personal relationship, but rather because they work for your business. However, you may exclude the cost of the gift if it is de minimis. See fringe benefit discussion below and speak to your tax advisor about gifts you give to contractors.
Gifts to customers, vendors and others
The rules for deducting gifts to those who are not employees and do not work for you are covered in IRS Publication 463. Gifts to others includes referral sources, delivery persons, building security you do not employ yourself, etc. Because there is no mechanism to tax the recipient of these gifts, as no income is reported on a W2 or 1099-Misc, the business deduction is limited to $25 per person. Therefore, if you give a holiday gift basket that cost $125 you can only deduct $25.
Direct and indirect gifts
The limit of $25 includes direct and indirect gifts. A direct gift is for the person you know, an indirect gift is given to someone they know but that you aren't personally or professionally connected to. For example, say you gift a gift to your building security person and include a gift for their spouse. It is treated as though both gifts were given to the security person and you can only deduct $25, not $50.
Incidental costs not part of the gift
Incidental costs such as wrapping, packaging or mailing a gift are considered separate and not part of the $25 gift limit. You can deduct the incidental costs separately.
Exceptions to the $25 gift rule
If you give gifts such as pens and stress balls that individually cost $4 or less, where your name is engraved on the item and you widely and frequently distribute such items, you can deduct it as a marketing expense even if in total the cost is over $25. You cannot slap your logo on an expensive item, give it to your favorite software vendor and get an exception to the gift rule.
Signs or display racks are not considered gifts if you intend to use them to promote our business on someone else's premises.
The IRS defines fringe benefits in IRS Publication 15-B as "a form of pay for the performance of services." The IRS also states the value of fringe benefits are generally deductible as a business expenses.
The IRS considers any fringe benefit to be taxable to the employee unless the law specifically excludes it. Check with your tax preparer if you are uncertain. If taxable, you must include the value as reportable income on an employee's W2, on Form 1099-Misc for an independent contractor, or a K-1 for a partner. There are many different types of fringe benefits including dependent care assistance, health care and life insurance benefit, meals and gifts.
Fringe benefits can be provided to employees or independent contractors, but be careful about treating independent contractors as you would an employee as you could be found to have misclassified workers.
De minimis fringe benefits
Fringe benefits are not taxable to the employee or contractor if they qualify as de minimis. De minimis, or small, infrequent, non-cash benefits do not have to be added to an employees wages and taxed. Whether a gift is de minimis is based on the facts and circumstances. The IRS does not draw a hard line on what counts as de minimus but provides this definition:
A de minimis benefit is any property or service you provide to an employee that has so little value (taking into account how frequently you provide similar benefits to your employees) that accounting for it would be unreasonable or administratively impracticable.
If a gift to an employee is over $100 will not be considered de minimis by the IRS. However, a gift below $100 may still be taxable, such as gift cards, regular gifts or gifts that are easily tracked.
Some examples of de minimis gifts are holiday cards or birthday gifts with a low value. For example, if you buy a birthday cake you are not expected to track who ate how much of the cake and add it to their W2, that would be absurd. Nor is a birthday card expensive enough to make tracking it worthwhile. However, if you buy a $30 book for a birthday gift for the employee, that is easy to track because it's one item given to a specific person and may be considered taxable.
Knowing the rules for bonuses, gifts and fringe benefits can help you decide to reward those who work for you while keeping in mind the tax implications. Create a plan for how you want to use bonuses, gifts and fringe benefits and sit down with your tax preparer to discuss how these will affect your tax reporting and tax deductions.
Questions: email [email protected]
Jennie Schottmiller, LMFT, CPA is a licensed marriage and family therapist who practiced as a CPA prior to becoming a therapist. She has an active solo therapy practice and runs a facebook group for clinicians and offers courses to help small business owners with accounting, tax and financial analysis matters.
Disclaimer: This blog is for education only. Please consult with a qualified professional when you have any questions about your personal accounting, tax or legal situation. Information contained in this post is for informational purposes only and not intended to replace professional advice.