Tax Considerations for Recognition and Rewards Programs

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1 White Paper Tax Considerations for Recognition and Rewards Programs Implementing recognition and incentive programs requires an awareness of the taxation associated with the awards. While ever-changing federal and state regulations make it difficult to determine the exact requirements that would apply to every recognition initiative, understanding general income tax guidelines will increase the potential for a successful program and, more importantly, avoid unpleasant surprises for both the corporate sponsor and the program participants. This paper outlines the key concepts, based on current practices. 1 Tax Considerations for Recognition and Rewards Programs

2 What You Should Know Before You Plan a Program Tax and Legal Advice Disclaimer Next Level Performance and its affiliates do not provide tax, legal, or accounting advice. The material in this document has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. Sponsors, owners, and those responsible for creating and managing recognition and incentive programs should consult their own appropriate advisors. The General Principle As you might expect, since awards are given to an employee or associate for work related to their employment or relationship to the company, they are typically taxable as gross income. This applies whether the award is cash-based or in the form of merchandise, gift cards, or travel. According to George B. Delta, Esq., Executive Director and Counsel at the Incentive Federation: Prizes and awards are also subject to FICA (social security) and unemployment taxes. If the prize or award is merchandise or travel instead of cash, the Fair Market Value of the item must be included in income. What constitutes Fair Market Value depends on the item and whether it is merchandise or travel. 1 Regulatory Compliance The Federal Government and most state governments keep a close eye on all earned income, including recognition and anniversary awards. Because most awards are considered compensation, they are taxable. Organizations must carefully monitor these items to avoid tax trouble. While merchandise given as an anniversary or Years of Service award may, within specific parameters, be tax exempt, other awards must be included and reported as taxable income on employee paychecks or 1099-MISC annual forms. Unfortunately, many organizations have non-compliant recognition and incentive programs. It could be a manager with a stack of gift cards in a desk drawer, who doesn t report the income to HR for each recipient. Or a supervisor who takes employees out to a milestone dinner, and simply notes it on an expense report. These informal recognition programs do not hold up well to an audit, and can cause problems for the organization. 2 Tax Considerations for Recognition and Rewards Programs

3 Global Recognition Programs With participants in various locations around the globe, corporate sponsors are faced with the ever-changing tax laws and specific interpretations of local laws in each country. Development of an effective global program that meets the various tax implications definitely requires involvement of legal, tax, and accounting experts, along with an incentive solution provider with global capabilities. In addition, local Human Resource departments should be consulted to take advantage of their expertise in local laws, tax reporting forms and timing, governmental procedures, and cultural parameters. The primary resource document for US Federal guidelines is published annually by the Internal Revenue Service: Employer s Supplemental Tax Guide, Publication 15-A. 2 The key section is titled Employee Achievement Awards and specifically details what type of awards are included and excluded, as well as specific limits where applicable. The current publication describes what may be excluded from tax withholding: To be excludable from your employee s gross income, the award must be tangible personal property given to an employee for length of service or safety achievement, awarded as part of a meaningful presentation, and awarded under circumstances that do not indicate that the payment is disguised compensation. To be exempt, Tangible personal property awards cannot be in the form of cash, check, credit/debit cards, gift certificates, meals, lodging, event tickets, and stock certificates or other securities. Length of Service and Safety Awards As mentioned previously, years of service awards and safety initiative awards receive special consideration. In general, for length of service awards, currently an employee is allowed receive up to a $400 service award for every five years of service without taxation liability for the recipient. Only one length of service award every five years is considered to be an employee achievement award. 3 Tax Considerations for Recognition and Rewards Programs

4 A special note regarding company branded items: Awards bearing a company logo that are under $4 in value are tax free. Anything with a value of $4 or more is considered a taxable reward, whether or not it contains Up to $400 every five years may be exempt for service anniversaries. a logo. 3 When it comes to safety achievement awards, as many as ten percent of a company s employees can be given up to $400 annually as a reward for increasing job site safety. It is important to note, however, that safety awards granted to managers, administrators, clerical employees, or professional employees may not be considered as employee achievement awards in every case, and therefore, might be taxable. Sales and Use Taxes Whenever a tangible product ( award ) is purchased, a sales/use tax is generally also applicable. The majority of states, plus many counties and cities, have specific, and differing, regulations concerning taxation on sales, including reporting thresholds and limits, and methods and frequency of reporting. The task is even more daunting because the tax remittance is typically to the geographic location where the award was delivered (as opposed to a single shipping location or corporate headquarters.) Most state regulations do not specify who is responsible for or who remits the taxes on the transaction (buyer, fulfillment partner, program sponsor, or recipient); the only requirement is that the sales/use tax is paid. Typically, the responsibility for paying applicable sales/use taxes has been assigned to the employer/sponsor of the program. A top-notch recognition solutions provider can ease this burden of reporting to each state and city through taxinclusive pricing of awards and reporting/remitting on behalf of the sponsor. Reporting and Documentation The reporting of awards and taxable income is dependent on the type of recipient. For direct employees, the Fair Market Value of awards in a given tax year should be reported on their Form W2, and will typically be subject to federal and state payroll tax withholding, within the limits and exceptions outlined above. 4 Tax Considerations for Recognition and Rewards Programs

5 For non-employees (independent contractors, distributors, dealers, etc.) the Fair Market Value of the award(s) will be reported on Form MISC, assuming the total of all such compensation exceeds $600 in the tax year. The payer is not required to issue a Form 1099 if the award is made to a corporation. The program provider should be able to provide clear Fair Market Value reporting to the sponsor of the program. A Programmatic Approach to Incentives Fair Market Value reporting is critical for an effective program A formal, documented recognition program offers the sponsoring organization a way to ensure that awards are consistently and fairly given and recorded according to tax regulations. Recognition and incentive solutions providers can not only assist in designing and implementing recognition programs but can also administer them for the sponsor. The incentive program provider will typically offer reporting for the sponsoring organization with a summary of awards given and awards redeemed, and will invoice for the cost of such rewards. More importantly, a world-class recognition platform provider will be able to include extensive detailed reward data, including Fair Market Value, for the corporate sponsor s payroll and other HR systems, allowing that data to be tracked and captured along with all other compensation data. This extensive reporting also helps the sponsor determine which awards are and are not taxable and report/ withhold accordingly. What About Grossing-up? Grossing-up means that an employer has agreed to pay income taxes due on an award, instead of passing the financial burden to the recipient. In most cases, a company that chooses to recognize an employee with a $500 reward intends them to receive the full value, rather than the net value after taxes. Grossing up the value of the award allows that to happen. For example, an award with a Fair Market Value of $500 would normally be reported as $500 gross income on the employees Form W2. This would become part of their taxable income, and they would be liable for the income tax on that amount. 5 Tax Considerations for Recognition and Rewards Programs

6 Alternatively, the employer can gross up the payment by contributing additional money (to be determined by the sponsor), in the form of payroll tax withholding, which is reported on Form W2, and offsets the income tax liability. This then reduces or, ideally, eliminates, any additional tax payable by the employee. A recognition solutions provider will be able to offer specific data on awards issued and redeemed, along with appropriate Fair Market Value data, to assist the corporate sponsor in developing a suitable gross up policy and process. For more information, visit or Tax Considerations for Incentive Programs, Author: George B. Delta, Esq., Published by: National Association for Employee Recognition 2. Employer s Supplemental Tax Guide, Publication 15-A, for use in 2015, Internal Revenue Service, Department of the Treasury U.S. Code Disallowance of certain entertainment, etc., expenses 6 Tax Considerations for Recognition and Rewards Programs