As an appreciative small business owner, you may want to reward your employees with a gift at holiday time or on other special occasions. Before you do, however, you’ll do yourself and your business a favor if you acquaint yourself with the tax rules that apply to such gifts.
Here is what you need to know to comply with the law.
- Employee gifts may or not be taxable, depending on the type of gift and its value.
- Gifts of cash or cash equivalents, such as gift cards, are taxable to the employee, regardless of the amount.
- Non-cash gifts may not be taxable if they are under a certain value and given only infrequently.
- Employers can deduct the costs of gifts, but typically only up to $25 per gift.
What Is Considered a Gift?
A gift can be anything you would like to provide to your employees, business partners, or clients free of charge. For example, it might be something tangible, like a box of candy, a flower arrangement, or a pair of movie tickets. Or it might come in the form of cash or a cash equivalent, such as a gift certificate or gift card. A gift might also represent a service of some sort, such as a voucher for a day spa.
Gifts vs. Compensation
Cash or cash-equivalent gifts of any amount, including gift cards, are considered taxable compensation. Other gifts fall into that category only if they exceed a certain value, as explained below.
The potential tax on employer gifts shouldn’t be confused with the federal gift tax. The latter is a tax on relatively large transfers of money or property from one individual to another. For 2023, the gift tax kicks in on annual amounts over $17,000. The gift maximum increases to $18,000 for 2024. Also, unlike taxes on employer gifts, gift taxes are paid by the giver rather than the recipient.
Gifts That Are Subject to Taxes and Gifts That Aren’t
As noted above, cash gifts are considered compensation for tax purposes, just like other money you might pay an employee, such as a regular salary, bonus, or other form of cash award. And that’s true regardless of the amount. Cash isn’t just money but anything that acts like money, such as a gift card.
Cash gifts must be reported as income to the employee, making them subject to taxes on that person’s tax return.
Non-cash gifts are taxable only if their value exceeds what the Internal Revenue Service (IRS) considers a de minimis, or minimal, benefit. As the IRS explains, “A de minimis benefit is any property or service you provide to an employee that has so little value (taking into account how frequently you provide similar benefits to your employees) that accounting for it would be unreasonable or administratively impracticable.”
In other words, both the value of the gift and the frequency with which you bestow it on your employees can come into consideration here. If you give your employees a turkey at holiday time, that will likely qualify as a de minimis benefit. But if you give them a turkey every week of the year, that is another matter. What the IRS is trying to do is prevent employers from attempting to disguise otherwise taxable compensation as gifts that aren’t subject to tax.
IRS rules on de minimis benefits apply not only to gifts, but also to other modest perks, such as the use of an employer-provided cellphone or photocopier, certain meal and transportation expenses, and occasional company parties or picnics.
The IRS is vague on the dollar threshold for de minimis benefits, saying that, “Whether an item or service is de minimis depends on all the facts and circumstances.” But it notes that the agency “has ruled previously in a particular case that items with a value exceeding $100 could not be considered de minimis, even under unusual circumstances.” So employers have some latitude, but only up to a certain point.
Note that if a gift is too expensive to be considered de minimis, its entire value becomes taxable to the employee, not just the amount over the limit.
Deducting the Cost of Employee Gifts
You can deduct the cost of gifts to employees, customers, or others with whom you have a business relationship, but only up to a value of $25 per person per tax year. The IRS adds that, “Incidental costs, such as engraving on jewelry, or packaging, insuring, and mailing, are generally not included in determining the cost of a gift for purposes of the $25 limit.”
Tax Filing and Record-keeping Requirements
Gifts that qualify as de minimis do not need to be reported to the IRS.
In the case of taxable gifts, their value should be included as part of the employee’s wages on their Form W-2, and they are subject to income tax withholding. “If the employees are covered for Social Security and Medicare, the value of the benefits are also subject to withholding for these taxes,” the IRS notes.
If you are the sole proprietor of your business, you can deduct the cost of your gifts (up to the allowable limit) on Schedule C of your federal Form 1040 tax return. If your business is structured as a partnership, a corporation, an S corporation, or a limited liability company (LLC), you can claim them on the appropriate tax return.
As with any other deductions that you plan to claim, hang on to the receipts showing what you paid for your gifts in case the IRS ever questions them.?
Other, Non-Tax Considerations ?
Aside from the tax considerations, there are a number of other things to think about in gift giving. For example, are you planning to give gifts to all of your employees or only to certain ones, such as your assistant or closest associates? In the latter case, it’s best to give the gifts discreetly. While gifts can be a morale builder, the last thing you want to do is demoralize anyone who isn’t on the receiving end of your generosity.
Advice on gift-giving etiquette is widely available online, but in general, it’s best to avoid anything that’s too personal in nature (lingerie is obviously out, but some etiquette experts say that even jewelry crosses the line). Gifts like a fruit basket or sausage and cheese sampler are safer than a bottle of wine or other alcohol. And, while something like a pen and pencil set can be a perfectly fine gift, it’s worth considering whether the person might already have enough pens and pencils to last a
How Can Small Businesses Maximize the Tax ??Benefits of Providing Employee Gifts While Staying Compliant with the Tax ??Rules?
Generally speaking, the best practice for business owners is to choose gifts that don’t exceed $25 in value, so that they can claim the full tax deduction for them. Also, bear in mind that cash or cash-equivalent gifts are treated as taxable income, which can create added hassles and costs for both employer and employee.
What Are Some Examples of Good Gifts for Small ??Business Employees?
While cash or a gift card that can be used for any purpose might be most appreciated by employees, they are also taxable, unlike other kinds of gifts below a certain value. Consumable gifts—such as fruit, nuts, candy, a tea or coffee assortment, or a holiday turkey—are likely to be more appreciated than a mug emblazoned with your company logo. There are countless catalogs online that provide suggestions, including many items for $25 or less.
Are Holiday Parties Tax-Deductible?
Yes, while expenses “related to activities generally considered entertainment, amusement, or recreation” are no longer tax-deductible for employers, expenses for a holiday party or summer picnic for their employees are an exception.
The Bottom Line
The occasional gift for employees can be a nice gesture on the part of small business owners. But to keep things simple, it pays to know and heed the tax rules.