It’s common for managers to give employees small gifts as incentives and rewards for a job well done – or as part of an employee appreciation or holiday celebration. But these gifts count as taxable fringe benefits in many cases. And your Payroll team needs to know about them ASAP so they can withhold tax appropriately.
Here’s a rundown of how you should treat gifts to employees from a tax standpoint to stay in compliance with IRS regs, as presented in “Taxable and Nontaxable Fringe Benefits, Part 1” by Fred Basehore, CPP, at the 2022 American Payroll Association Congress.
Guidelines for de minimis, taxable fringe benefits
In general, gifts to employees should always be included in their income, and tax should be withheld from the value of the gift appropriately – unless they qualify under the de minimis fringe benefit exclusion.
Typically, de minimis fringe benefits have a fair market value that’s too small to account for easily. Per IRS, this includes such gifts as:
- Occasional money for cab fare/food
- Discounted meals at a company-operated cafeteria
- Occasional company parties, and
- Holiday gifts of turkeys or hams.
However, you’ll have to be careful when you’re giving out those holiday gifts – they don’t count as de minimis fringe benefits if certain criteria aren’t met.
What to watch for with holiday gifts
IRS issued a technical advice memorandum regarding holiday gifts with some tricky areas you should watch for, according to Basehore.
The memorandum discusses an employer that once provided employees with a turkey, ham or gift basket as a holiday gift each year. One year, the employer decided to change the program a bit due to various factors, such as workers’ dietary restrictions and the inconvenience of delivering the gifts.
Instead of food items, the employer started giving employees a gift coupon that had a face value of $35. The coupon was approximately equal to the value of the previous gift, and it still could be exchanged for a turkey, ham or gift basket, but it could also be used toward other items.
The coupons resembled bank checks with the employer’s name and the value of the coupon printed on them. When the employer first started giving out the coupons, they listed four food stores where they were redeemable (several with multiple locations). The following year, the coupons listed 23 different stores where employees could redeem them.
There were restrictions on the coupons. They couldn’t be used toward the purchase of alcohol, tobacco or pharmacy goods. They could only be used once, and they were only redeemable between the time period of November 15 and January 31.
Because of how the program was restructured, IRS said the value of these coupons should count as taxable income to employees. The coupons worked essentially the same way as a cash fringe benefit such as a gift certificate. And it was easy to account for the value of the coupon because it had a clear face value of $35. So, IRS said, it was essentially the same as giving workers cash.
The employer argued that since the coupons weren’t directly redeemable for cash, they shouldn’t be considered as taxable fringe benefits. However, there’s nothing in tax law saying that a cash-equivalent benefit had to be easily converted to cash – just that it operates the same as cash.
In addition, the employer said that the coupons had a low value, so they should’ve been considered de minimis fringe benefits. It argued the Service often used a $75 threshold when determining if other awards, such as length of service and achievement awards, were taxable, so that should apply here.
IRS replied that there’s no such threshold in place for de minimis fringe benefits. The only requirement is that the value should be small and difficult to account for – and that’s not the case with a coupon that has a clear cash value printed on it.
So be wary: If you’re giving employees gifts that function in a similar manner to cash, with few restrictions, they’re likely taxable fringe benefits.
There are exceptions besides the de minimis rule here. Any gifts given to employees who are retiring would count as length of service awards, and they’d be excludable from income as long as the following rules apply:
- If the award is made from a nonqualified plan, the value of the award to one person can’t exceed $400.
- When awards are made from a qualified plan, the cumulative monetary value of any awards given to a person can’t exceed $1,600 in a year. The average value of each award can’t exceed $400. To calculate the average cost, divide the total cost of the awards for the employee by the number of awards the person’s received.
Handling gifts at your company
Bottom line: Gifts to employees are typically taxable fringe benefits – especially if there’s a cash value attached that’s relatively easy to track. Along with actual cash, this includes gift certificates, gift cards, vacation vouchers, vouchers for dinners and any similar awards.
Make sure your managers and your A/P team are aware of these guidelines, as well as your Payroll pros. A/P may receive reimbursement requests from supervisors for gifts they’ve given to employees – and if Payroll doesn’t receive that info, the gifts can’t be taxed appropriately, leaving room for the Service or other organizations to come calling.