Recognizing your employees’ performance and loyalty with rewards is nothing short of stellar. Your employees are happy and more engaged, whereas your organization’s productivity shoots up.
However, if your rewards are taxable and your payroll team skips the process, it can result in minor compliance issues, such as penalty fees, or severe legal consequences. Your employees might also be flagged for underreported income during personal audits.
In this article, we’ll break down which rewards are taxable and share best practices to ensure your payroll team stays compliant and your employees stay informed.
What Qualifies as a Reward?
Employee rewards are primarily monetary or non-monetary extras that you give to recognize and encourage your employees’ roles within the organization. This can be anything from cash bonuses, gift cards, or even premium gym access.
For better understanding, you can classify rewards into cash equivalents and non-cash perks. Cash-equivalents rewards include:
- Cash bonuses
- Gift cards or vouchers (regardless of the amount)
- Stock options or shares
- Company-paid vacations (if not a business necessity)
- Reimbursement for personal expenses
Non-cash perks include:
- Free snacks or meals at work
- Use of the company gym or recreational facilities
- Employee recognition plaques or small gifts (if infrequent and low value)
- Parking space at work
- Cell phone or laptop (used mainly for work purposes)
Not everything given to your employees can be considered a reward. Examples are:
- Reimbursement of travel fees for official events
- Tools and equipment for work, like a laptop
- Statutory leave payments and retirement contributions
Knowing what counts as a reward or not will help prevent misclassification of benefits and ensure proper tax processing.
IRS Guidelines on Taxable vs. Nontaxable Rewards
According to Publication 525, unless a specific IRS code section provides an exemption, any reward or fringe benefit is considered taxable income. Only clearly defined categories, like de minimis perks, business reimbursements, or qualified benefits, may be excluded.
Per IRS guidelines, the following are taxable:
- Cash gifts and bonuses
- Gift cards and gift certificates, regardless of amount or occasion
- Non-statutory stock options, unless specifically excluded
- Employer-paid vacations (if not for business purposes)
- Prizes and awards (unless qualifying for a narrow exclusion)
- Regular personal use of company assets (like vehicles or lodging)
Non-taxable rewards, on the other hand, include:
- De minimis benefits
- Employer-paid health insurance premiums
- Work-related training or education assistance (within limits)
- Use of on-site athletic facilities
- Cell phones used primarily for business
- Reimbursements under accountable plans
De minimis perks are rewards that are too low-value, given infrequently, and hard to track, or the cost of reporting them outweighs the original value. They’re generally exempted by the IRS from being taxed. Examples include:
- Coffee, tea, snacks, or soft drinks in the office
- Occasional meal money or taxi fare when working overtime
- Holiday gifts (not cash) with low value, like a fruit basket or a company mug
- Flowers or a small gift for special occasions, such as birthdays and weddings
- Occasional personal use of the office copier
- Company-branded T-shirts for every occasion, pens, or other small branded items
Usually, the cost of de minimis perks is capped at $100. Anything beyond that needs to be taxed. Any cash gift, regardless of the value, even if $1, is taxable, according to the IRS.
If you’re operating outside the US, you need to find the local tax laws that apply to your operations there. For instance, in the UK, HMRC considers most employee rewards, including bonuses and vouchers, as taxable benefits-in-kind, unless they fall under exemptions like trivial benefits such as gifts under £50 or not given as a reward for work.
Are Training and Certification Rewards Taxable?
Training and certification rewards are benefits or compensation given to your employees for initiating or completing a course or training. This can include:
- Reimbursement for training costs
- Paid access to training or courses
- Cash bonuses or non-cash gifts for training completion
Note that any cash bonus or cash reward, regardless of the value or purpose, is taxable.
Also, if the course or training helps your employees perform in their current role, it’s taken as a working condition fringe and not taxable. On the other hand, if the training is not job-related or it’s intended for your employee’s benefit, it’s taxable.
Education or training provided to any employee of your company who is either a veteran or in a family of one is also non-taxable.
Implications of Payroll and Best Practices
Your payroll teams are responsible for processing and withholding taxes. Failure to do that results in legal penalties like accrued interests that increase for as long as you do not sort the tax, according to the IRS.
Employees might also end up facing unexpected tax liabilities due to underreported income, affecting their loan approvals or tax filings.
Here’s how to avoid that and ensure proper filing.
- Track and Document All Employee Rewards
“Record keeping is at the heart of tax filing. Keep an eye on every reward, noting its value, tax percentage, purpose, whether it’s cash or non-cash, and the date. This should be kept in the rewards log with evidence of disbursement, such as invoices and receipts”, Jarrod Epps, CEO at CPR Certification Labs, says.
- Classify Rewards Accurately for Tax Purposes
Clearly define what type of reward you’re giving out, if monetary or non-cash perks, de minimis or tangible benefits, whether taxable or not. This will help apply correct withholding and avoid payroll errors or IRS penalties.
- Ensure Coordination Between HR and Payroll Teams
HR often initiates employee rewards, while payroll handles tax reporting. Misalignment between both teams results in improperly documented rewards and issues with tax withholding. So, ensure your HR and payroll teams work in tandem on all rewards-related matters, no matter how insignificant.
- Leverage Payroll Software for Automation
Manual record keeping and tax tracking can be quite bogus. It’s also easy to miss out on one or two key details, thus derailing your tax process. To solve this, you can use a payroll software like Gusto. Services like Salaryslip can help generate a comprehensive payslip containing deductibles, bonuses, and tax percentage for easy tracking and records.
- Train Managers on Taxable and Nontaxable Rewards
At the core of it all, keep your team updated on what’s taxable and what’s not. Consider local tax laws pertaining to your region of operation and service when training your managers. In addition, encourage strict compliance through regular formal reviews and audits.
Communicate with Your Employees About Taxable Benefits
Almost every tax is deducted from your employees’ total income. So, it’s essential to keep them informed about which benefits are taxable and allow them to make a choice instead of handing one out of the blue.
Conclusion
Employee rewards are vital to boosting team engagement and improving productivity. However, not all rewards are created equal. Some trigger tax responsibilities.
So, it’s a must to know and classify which rewards are taxable and those that are not. Inform your employees about these taxes, sync your HR and payroll team, and utilize payroll software for automation.
File each tax return at the appropriate time and keep your records clean.