‘Tis the season – for additional employee taxes.
Business owners planning to give employees bonuses of any kind should be prepared to give Uncle Sam a little extra gift as well – in the way of employee taxes. Gift certificates, cash and event tickets all come with an extra bonus for the Internal Revenue Service.
“The bare essence of the law is that if you give money or any gift that costs more than $25, it’s considered taxable income to the employee,” said Brian Flynn, president of Flynn Accounting in Colorado Springs. “Anything under $25, they don’t have to report.”
Flynn said employers should be cautious this time of year, as efforts to be generous to employees can lead to audits by the IRS.
“Sometimes employers will try to use the tax exemption for contract employees,” he said. “There’s a rule that says if you pay a contract employee less than $600, you don’t have to issue a 1099. Employers will sometime use that when paying the Christmas bonuses. It’s dangerous. If you get audited, it will be trouble.”
The IRS rules leave very little room for interpretation, he said. No matter what form the gift takes, employers must take out the necessary taxes. And employees are responsible for claiming the gift on their tax returns.
“I have a client who owns nine restaurants in town,” he said. “Every week, he gives the employee with the highest sales $50, but the employee who makes the highest sales for the year gets a trip to Hawaii. And while it’s nice to go to Hawaii, that employee has an additional $3,000 on his W-2.”
The rules don’t change because the gift is not cash, Flynn said. However, he works with clients to make sure employees receive the full benefit of holiday bonuses. All an employer needs to do is make sure the check is for the bonus, plus any taxes.
“If you want to make sure that your employee receives a $500 bonus, for example,” Flynn said, “just work with your payroll specialist to write the check for $540, that will cover any taxes that need to be paid.”
Flynn said he stays busy during the holiday season, fielding questions about holiday gifts and bonuses, as well as cutting extra checks for employers.
Employers must be careful to claim every perk that employees receive. For example, business travel does not require taking out employee taxes or claiming it on a W-2. However, if an employee leaves for a trip early, and the boss pays for an extra night or two in the hotel – that perk is taxable.
“It’s best to be careful and check with your accountant,” Flynn said. “That’s what we’re here for. I think 80 percent of my clients will say I’m here to keep them out of trouble.”
Trouble with the IRS can mean hefty fines, along with interest, Flynn said. Often it can take two years to get audited. If employers have not paid appropriate taxes, they will be liable for taxes, fines and interest from the time the taxes were supposed to be paid.
“It can get expensive,” Flynn said. “Just remember, the basic rules don’t change just because it’s not cash. If it’s a gift of value above $25, you must take out employee tax, and the gift must appear in monetary form on the employee’s W-2.”
A free report about Christmas gifts and bonuses – and whether they are taxable – is available from the American Institute of Professional Bookkeepers. To obtain "Bonuses, Gifts, Prizes and Awards – What’s Taxable, What’s Not," send an e-mail to email@example.com.