While the tax law around cash bonuses is fairly straightforward, things can get a little murky when it comes to incentive gifts and trips.
What is the actual value of a merchandise item — the store price, or the catalog price? How do the cost of shipping, handling, insurance, administration, and (sales) tax factor into the equation? Should you hire an accountant to figure it out?
The following information will help clarify the tax law for gift cards, merchandise, and incentive travel.
1. The Basic Rule
Incentive prizes given to employees to award them for sales or performance are taxable, whether they are in the form of cash, merchandise, or travel. Gift cards or certificates that are redeemable for general merchandise are taxable in the same way as if the winner was receiving the physical gift.
According to the Internal Revenue Service Publication 525: “Awards you receive for outstanding work are included in your income and should be shown on your W-2 Form.” Prizes and awards are also subject to FICA (social security) and unemployment tax.
Some companies choose to “gross up” the incentive award by paying the additional money required for payroll tax withholdings to cover their employees’ tax liability.
2. Employee Achievement Awards
Internal Revenue Service Publication 525 includes a special tax exemption for qualified “employee achievement awards,” stating: “If you receive tangible personal property (other than cash, a gift certificate, or an equivalent item) as an award for length of service or safety achievement, you may generally exclude its value from your income. However, the amount you can exclude can’t be more than $1,600 for all such awards you receive during the year.”
3. The “DeMinimis” Principle
Some gifts (up to $100) are considered too small to make accounting for them unreasonable or impractical, which is known as de minimis. This category of gifts includes items such as tickets for entertainment events, holiday gifts, or things like flowers or food baskets.
The keys to determining whether a gift is de minimis are frequency and value: It must be occasional in frequency and not a form of disguised compensation.
4. “Fair Market Value”
Recipients must pay tax on the fair market value (FMV) of an incentive award. This is where things start to get confusing because the Internal Revenue Service does not provide a clear value or formula. Instead, it vaguely says: “FMV is based on all the facts and circumstances.”
One study compared store prices to the catalog point-list prices, concluding that “a reasonable, fair market value would be 70% of the sales (point-list) price.” So if the point value of an HDTV used as an award in an incentive program is $1,000, its fair market value would be $700.
The 30% discount encompasses what is referred to in the business as “SHIAT”: shipping, handling, insurance, administration, and (sales) taxes. It includes: (1) the incentive design professional services to create the incentive program, (2) ongoing program management of the incentive program, (3) tracking and evaluating results for the incentive program, (4) merchandising services, (5) the fulfillment service for each order and its processing through a distribution center, and (6) web site and technology software.
5. $25 Threshold
According to IRS Publication 526, the limit for companies to deduct business gifts given to any one person during the tax year is $25 per recipient. Incidental costs, such as engraving on jewelry, or packaging, insuring, and mailing, are generally not included in the $25 limit.
According to the guideline, “A cost is incidental only if it doesn’t add substantial value to the gift. For example, the cost of gift wrapping is an incidental cost. However, the purchase of an ornamental basket for packaging fruit isn’t an incidental cost if the value of the basket is substantial compared to the value of the fruit.”
6. Business Travel Deductions
Companies can deduct business travel costs — if the primary purpose of the trip is business-related.
Incentive travel is a gray area, and many companies choose to include meetings as part of their incentive programs and then claim them as business meetings.
There are three conditions for a business trip to be tax-deductible, according to IRS-Publication 463: 1. It must be ordinary and necessary for your business; 2. It must be directly related to the active conduct of your trade or business; 3. It must not be extravagant under the circumstances.
Incentive experts suggest hiring an accountant to assist you with these decisions.
