If your New Year’s resolution was to recognize and reward your employees with a bit more gusto in these trying times, remember that different types of incentive programs come with different tax liabilities.
A business can deduct up to $25 for business gifts each year per recipient, whether given directly or indirectly. The $25 limit excludes incidental costs for engraving, wrapping, packaging, insuring and mailing. The IRS treats a gift that is intended for the personal use or benefit of an individual or group of people as indirect gift to him or them. Similarly, a gift to the spouse of a client or business customer is treated as an indirect gift to that client or customer, unless the donor has a separate connection to that spouse. This rule also applies to other family members. If a gift is specifically earmarked for a business, there is no limit on the amount of the deduction.
There are some exceptions the $25 law that are of limited usefulness. For example, if an item costs no more than $4, has the donor’s name clearly and permanently imprinted on the gift, and is one of a number of identical items that a company distributes widely, it is not subject to the $25 limit. Examples of such items include pens, desk-sets, and tote bags. Signs, display racks, and other promotional material also qualify as long as they are to be used on the recipient’s business premises.
Employee achievement awards are treated differently from business gifts and have separate legal requirements. An employee achievement award is defined as an item of “tangible personal property” that an employer gives to an employee for length of service or safety achievement. The award must be given as part of a meaningful presentation and under such conditions that it does not amount to disguised compensation. If certain other statutory conditions are met, an employer may deduct the cost of employee achievement awards given to the same employee up to $400 in any year.
If the employee achievement awards are given under an employer’s qualified plan, the $400 deduction limitation is increased to $1,600 per employee, as long as the average cost per employee of all employee achievement awards does not exceed $400. If an award has normal value, it is excluded from the calculation of the total amount of incentive awards given under established written plans in any year. This amount excludes awards of nominal value. Although the employer may deduct the cost of employee achievement awards, they are not taxable to the employee.
A length-of-service award can be excluded from an employee’s income only if it is received by the employee after his first five years of service with the employer making the award, and then only if the employee has not received another length-of-service award from his employer for at least five years. An award for safety achievement can be excluded from an employee’s income only if that employee is a full-time employee, and then only if during the taxable year all other employee awards for safety achievement have previously been made to 10 percent of less of the eligible full-time employees of the employer.
An employee achievement award cannot qualify for preferential tax treatment if it is in the form of cash or a gift certificate. Any certificate that may be converted to cash is not tangible personal property and cannot qualify for preferential tax treatment. Other items that are not tangible personal property include travel, vacations, meals, lodging, tickets to theater or sporting events, and stocks, bonds or other securities.