Holiday Gifts to Employees May Be Followed by Tax Man

The holidays come early for law firms. As much as it pains my husband to think about Christmas before Thanksgiving arrives, there is much to do: holiday cards to be ordered, parties to plan and decorations to be installed. Even more importantly, there are gifts to buy.

There's no rule that says that you have to buy year-end or holiday gifts for employees, but they certainly are appreciated. A quick survey on Twitter revealed that employees are generally enthusiastic about receiving gifts that show some personal thought. Popular gifts include small electronics such as computer speakers, tricked-out cell phones and MP3 players (our firm handed out personalized iPods one year). Also high on the "wish list" were gift cards to popular restaurants and department stores; one employee suggested a membership plus gift card to a warehouse store like Sam's Club.

And then there's cash. Everyone loves cash, right? You'd be surprised. Cash gifts and bonuses are received with mixed feelings: Some employees are put off by the perceived lack of thought that goes into a cash gift, others are disappointed by the amount. Employees who received their cash gift or bonus in the form of a contribution to ordinary payroll were most disappointed. Those who seemed happiest with cash as a gift received significant gifts or bonuses that were clearly distinct, delivered as separate checks or gift cards (such as Visa check cards).

Surprisingly, my admittedly unscientific survey revealed that many employers do not issue end-of-the-year or holiday gifts and bonuses or make other plans to show appreciation for their employees. This is surprising: Holiday gifts or other acknowledgments can make employees feel valued and keep them motivated. In a tight economy, a small investment in the form of a thank-you at the holidays could translate into increased productivity and loyalty.

But be careful. Just like the ugly, red sweater that you get from your Aunt Erma, there can be consequences to your employees as a result of your company's generosity. Chief among them are tax consequences.

For starters, no matter what you call it -- a gift or a bonus -- cash or checks given to employees are considered compensation as far as the Internal Revenue Service is concerned. That means that the gross amount of the gift or bonus must be included in the employee's income for tax purposes and employers must withhold the proper amounts for income tax, Social Security and Medicare. Depending on the amount of the gift, this can be quite a surprise for the employee. A $100 check can quickly become a $70 check, with an additional cost to the employer for matching FICA contributions.

But what about those gift cards, turkeys and electronics? The rules for non-cash gifts vary depending upon the type and value of the gift.

The IRS has made it clear that it considers gift cards and gift certificates taxable. This is because gift cards and gift certificates are considered cash equivalents. In other words, they act the same as cash and are therefore taxed just like a few bills slipped into a card or a check at payroll.

Turkeys, hams, small electronics and the ubiquitous fruit basket may actually escape taxation. Small gifts that are considered de minimis from the IRS are not considered taxable. The idea is that accounting for these kinds of gifts is administratively impractical, so the IRS gives you and your employees a "pass." However, if you make non-cash gifts which are clearly not de minimis, such as a trip, expensive jewelry or major appliance, you must report the value of the gift as taxable income to the employee.

Whether you distribute cash, checks or taxable gifts, make sure that your employees understand the tax consequences of the "gift." If the employee does not understand that the gift is taxable, you may be stuck with an unhappy employee once you make year-end adjustments to payroll. All of that holiday cheer may go right out of the window when an employee is stuck with an unexpected tax bill.

To avoid these kinds of issues, you might consider nontaxable holiday and end-of-the-year perks. For example, the IRS allows you to throw a firm holiday party with no tax consequences to the employees. Instead of giving gift certificates to a local restaurant (taxable), why not take your employees out for dinner (not taxable)? Or consider hosting an all-day buffet at the office. Reasonable holiday parties are not considered taxable to the employee and, unlike other business lunches and dinners, you don't have to "talk business" at any time in order to make it deductible to the employer.

Another alternative is to give employees an extra day off for the holidays. Assuming that there are no human resources issues (check your employee handbook), this could be a great way to give employees an extra holiday perk without breaking the bank. Hourly employees who are not compensated for days off may appreciate an extra day or two of rest, and there are no tax consequences to the employer or employee. If you choose to compensate the employee for the time off (or are required to do so by law or the terms of employment), the tax consequence to the employer and the employee is the same as if the employee had put in a normal workday. For salaried employees, there may be no change to compensation and no tax consequences to the employer or employee as a result; again, you would need to confirm the specifics of your individual employees' arrangements first.

From small gifts to holiday parties, there are a number of ways to make your employees happy this holiday season. Don't limit yourself to gift cards or employee checks: Think outside of the box to maximize the "wow" factor and limit the tax consequences. Thinking ahead at the holiday season ensures that your employees feel appreciated and that the joy at being remembered as part of your team isn't overshadowed by the "surprise" that could follow at tax time. [via law]

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