Employee Incentive Awards are Taxable Fringes
If you, as an employer, provide incentives as a way to award top-performing employees for extraordinary accomplishments, you need to keep in mind that they are considered taxable fringe benefits. Thus, awards such as merchandise or a vacation trip are non-cash fringe benefits that are taxable to the employee and deductible by you, the employer, as compensation. The fair market value of the award should be shown as wages on the employee's W-2.
Since these awards are a type of supplemental wages, employers must, under the general rules, withhold income, social security, and Medicare taxes and deposit the withheld taxes along with employer matching amounts in the same deposit period they were treated as paid. Note: If you, as the employer, pay the withholding taxes on the incentive award for the employee, then those amounts are also considered compensation.
Under the optional flat-rate procedure, for federal purposes, employers withhold on supplemental wages at the third lowest tax rate for single filers, which is currently 25%. However, if a supplemental wage payment when added to all other supplemental wage payments previously made by the employer to the employee during the calendar year exceeds $1 million, the excess is subject to mandatory withholding at the highest income tax rate in effect for that year. The highest rate is currently 39.6%. Withholding of state income taxes generally will also be required.
Employers may treat taxable non-cash fringe benefits as paid by the pay period, by the quarter, or on any other basis as long as they are treated as paid at least once a year. However, this rule does not apply to:
(1) The transfer of tangible or intangible personal property of a kind normally held for investment; or
(2) The transfer of real property.
In these situations, the actual property transfer date is used in determining when the benefit was “paid.”
Non-Cash De Minimis Fringes - The incentive award rules don't apply to non-cash employee achievement awards of tangible personal property made for length of service or safety. Such awards are deductible by the employer, and excludible by the employee, within certain limits. Additionally, non-cash de minimis fringes, such as traditional birthday or holiday gifts of property with a low fair market value, or occasionally gifts of theater or sporting event tickets, are deductible by the employer and tax-free to the employee.
If you have any questions about employee incentive awards or non-cash de minimis fringes, please call our office.
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