Most incentive prizes are taxable as ordinary income to the recipient regardless of whether the award is in the form of cash, gift certificates, merchandise, or travel. Such awards are also subject to FICA (social security) and unemployment taxes. If the award is merchandise or travel instead of cash, the fair market value of the item must be included as income and reported on the employee's W-2 form.
How do you measure fair market value? As a rule of thumb for merchandise, reasonable fair market value is 70 percent of the sale price. If the prize is travel, individual trips have a higher fair market value than group trips because the individual receives more of the direct benefit. The fair market value of group travel is discounted 25 percent due to costs borne by the group (e.g., a tour director). The fair market value of land travel is also considered to be 75 percent of its retail cost, while fair market value of air travel is its actual retail cost. Group travel awards are also deductible by the company as a business expense — currently 50 percent of the costs incurred.
Companies are also allowed up to $25 per person per year to spend on spot awards tax-free (known as “di minimis fringe”). Awards of tangible personal property given to employees in recognition of length of service or safety achievement are excluded from employee income. Deduction limits apply to such achievement awards provided they are given as part of a presentation under circumstances indicating they are not a disguised form of compensation. For example, awards will not qualify if given at the time of annual salary adjustments, as a substitute for a prior program of cash bonuses, or if they discriminate on behalf of highly compensated employees.
Companies may deduct up to $1,600 per employee per year for all such awards. The average cost of the individual awards must not exceed $400. For additional details on the deductibility of length of service and safety achievement awards, visit the MeetingsNet Web site: http://meetingsnet.com/corporatemeetingsincentives/awards_taxes_0812.
By being a little creative, you can get the most from your recognition and incentive programs while still working within the tax guidelines. The best advice is to consult with your incentive firm or tax attorney as you design the program, so your company and your award recipients are not hit with any unexpected taxes.
Bob Nelson, PhD, is president of Nelson Motivation Inc.; a frequent presenter to management teams and conferences; and a best-selling author of several books, including 1001 Ways to Reward Employees and The Management Bible. www.nelson-motivation.com
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Tip: When using monetary rewards or gift certificates, you can add the tax associated with the award directly to the award amount. This avoids any “take away” impact on the employee, which can be demotivating. For example, if an employee is receiving a $250 performance award, the company may actually pay him or her $330 so the net amount the employee receives after taxes is $250 (based on an employee tax rate of 32 percent).