December brings many things to look forward to each year, and for many employees, excitement in December bubbles around highly anticipated holiday bonuses. To employers, it is a way to show employees how much their work is appreciated and how they are valued by the company. To employees, it is a way to wrap the year up on a positive note, with a little extra “green” lining their pockets to either spend on themselves or on loved ones. But how are these bonuses viewed in the eyes of the IRS? Both employers and employees need to make sure they are clear on if and how these bonuses can be taxed so they know how this gesture of generosity will have an affect on their workforce and bottom line.
Bonuses that come in the form of cash, gift cards or other monetary forms are taxable. However, the exception to this rule includes gifts that fall under Section 132(a)(4): de minimis fringe benefits. These types of benefits are excluded from being taxed and may come in the form of concert or sporting event tickets, a company dinner party, or physical gift such as flowers or a gift basket. With de minimis, the key to ensuring that the gift is not taxable is that the value must be relatively low and items that occur on a regular basis such as season tickets to a sporting event or theatre production, cannot be gifted.
If an employer chooses to give holiday bonuses in the more traditional form of a monetary gift, employers do have control over how the gift is classified on employee’s W2 tax forms. If the employer chooses to classify the bonuses as “supplemental income” then each employee’s bonus will be taxed at the flat rate of 25% and will display as a separate line item amount on his or her W2. However, if the employer simply rolls the bonus into the employees’ wages, then the employees will be taxed at their own individual tax rates based on the tax brackets they fall into, many times resulting in a higher amount of taxes than the supplemental rate of 25%.1
However, for bonuses paid to high level executives and employees that exceed $1 million, then those bonuses, “...are singled out for higher taxes. If you receive a bonus of more than $1 million, your employer must withhold 39.6% of the amount above $1 million, as well as the standard 25% of the amount below $1 million.”2 Ouch.
Bonuses certainly do boost employee morale, but both employees and employers need to understand the tax laws around how the bonuses should best be paid out so they can give or receive the largest benefit possible or be prepared for the additional tax burdens that could come along with them. Familiarizing yourself with the tax laws can help ensure that a bonus leaves the impression it was originally designed to leave: one of thanksgiving and gratitude!
1 - Christenson, Phillip. “Congrats on holiday bonus -- here's how to minimize your income tax hit.” CBS News, CBS Interactive, 27 Nov. 2017, www.cbsnews.com/news/holiday-bonus-heres-how-to-minimize-irs-income-tax-hit/
2 - Joshritchie, /, et al. “Bonus Time: How Bonuses Are Taxed and Treated by the IRS.” The TurboTax Blog, 17 Nov. 2017, blog.turbotax.intuit.com/income-and-investments/bonus-time-how-bonuses-are-taxed-and-treated-by-the-irs-8003/.