Other awards, prizes, and gifts
Let’s review other awards, prizes, and gifts, including:
Special rules for sales awards
Cash payments given to salespersons as awards, prizes, or incentives for sales performance are fully taxable as wages. Federal income taxes must be withheld, and FICA and FUTA taxes must be paid on these amounts. An employer may choose to treat such payments as supplemental wages for FIT withholding purposes.
Similarly, suppose a sales award or incentive is offered in the form of merchandise, but the employee elects to receive cash instead. In that case, the same federal tax and withholding obligations apply as if the award had been offered and provided only in cash.
The fair market value of non-cash awards given to sales employees or their spouses is also included in the employee’s income. Non-cash awards include items such as golf clubs, televisions, and other merchandise, as well as employer-paid vacations and trips. Federal income tax withholding, FICA, and FUTA taxes, generally apply to the fair market value of non-cash awards and prizes provided to salespersons or their spouses.
A unique optional withholding rule applies to sales awards or incentives provided to a retail salesperson who is typically paid solely based on cash commissions. Under this optional approach, an employer may elect not to withhold federal income taxes on the value of non-cash awards provided to commissioned sales workers.
This withholding option does not apply to a non-cash award or similar type of remuneration if the retail salesperson is typically paid both a salary and cash commissions or ordinarily is paid other than cash compensation. Additionally, for purposes of this withholding option, insurance agents are not considered retail commission salespersons.
Even if an employer elects not to withhold federal income taxes, it still must report the value of the award on the employee’s Form W-2. The employer also must withhold and pay its share of FICA taxes and pay FUTA taxes on the fair market value of the award or prize.
Gifts to employees
All gifts from employers to employees (other than retirement gifts) are includible as income unless they may be excluded under the de minimis fringes rule.
Retirement gifts to employees are considered length-of-service achievement awards and may be excludable from income under the special employee achievement award provisions if they meet the requirements.
Non-cash holiday gifts of nominal value, such as a holiday turkey or ham, are non-taxable. Any cash gift, including a gift certificate that an employee could convert to cash, is subject to employment taxes.
Suggestion awards given to employees are taxable wages. FIT withholding, FICA, and FUTA apply if the suggestion award results from an employment relationship. The payment of a suggestion award may be treated as supplemental wages.
Bonuses paid by an employer to an employee as compensation for services rendered are generally considered taxable wages.
If the employer pays for an employee’s club dues, it is income to the employee and taxable.
Commissions are subject to federal income tax, FICA, and FUTA.
Commuting expenses are subject to federal income tax, FICA, and FUTA. Travel between an employee’s home and regular workplace is not considered business travel. Reimbursement by the employer for ordinary commuting expenses constitutes taxable wages.
An employee’s personal use of a company car restricted solely for commuting to and from work is valued at $1.50 for each one-way trip. Employer-provided transportation for nonexempt employees due solely to unsafe conditions for walking or taking public transport to and from work is also valued at $1.50 for each one-way trip.
Special rule to commuting expenses
Employer-provided parking at or near the office or at a mass transit, carpool, or vanpool site is non-taxable up to $270 a month for the year 2021. Employers may provide employees $270 in tokens, transit passes, or reimbursements for commuting on public transportation on a tax-free basis. Regarding bicycle commuting, employers no longer may reimburse employees who commute to work by bicycle as a qualified transportation fringe benefit until January 1, 2026. This benefit ended as part of the tax-code overhaul, which took effect on January 1, 2018.
Employees permitted to make personal trips on an employer’s airplane or helicopter receive a taxable benefit (less any amount the employee pays regarding the flight). If the employee uses the company’s aircraft for business reasons and brings along the spouse, the cost of the flight for the spouse is taxable to the employee.
The worth of an employee’s personal use of a company car is includable in the worker’s gross income unless it may be excluded as a de minimis benefit or a qualified nonpersonal use vehicle. Employers may decide whether or not to withhold income tax on the value of an employee’s personal use of a company car. Employers electing not to withhold must notify the affected employee of that decision and include the benefit’s fair market value on the employee’s Form W-2. Employers must withhold Social Security taxes and pay FICA and FUTA taxes on the value of personal use. Those employers electing to withhold income and employment taxes may treat the value of the personal use of a company car as paid on a pay period, quarterly, semiannual, or annual basis. The general withholding methods and deposit rules for taxable fringe benefits apply.
An employer may determine the value of a worker’s personal use of a company car by using one of several valuation rules established by the IRS. For example, under the general valuation rule, the personal use-value of a vehicle is the fair market value of its availability, such as the amount a worker would pay to lease the car. Several optional valuation rules also are outlined in IRS regulations. These include:
- Annual lease valuation rule: an automobile made available to employees for an entire year may be valued according to IRS’s annual lease value table, which provides lease values based on a car’s fair market value. Employers may use several methods to determine a car’s value.
- Cents-per-mile rule: under this second optional valuation method, the employees’ personal use of the vehicle may be valued by multiplying the total of personal miles driven by the standard mileage rate.
Deductions from paychecks
- Federal income tax withholding, FICA, and FUTA if paid by the employer.
- The amount of withholding for income tax, FICA, and FUTA must be based on the gross amount of the employee’s pay.
- Any deductions made from the employee’s pay must be added back to determine the amount of withholding, FICA, and FUTA.
Deferred compensation (nonqualified arrangements)
Contributions made to a funded, nonqualified plan under which an employee has nonforfeitable rights to the contributions are included in the employees’ gross income when the contributions are made and are subject to federal income tax withholding, FICA, and FUTA. Employer contributions to plans under which the employee’s rights are forfeitable are not subject to employment taxes when these contributions are made. Benefit payments made to a former employee from an unfunded nonqualified deferred compensation plan ordinarily are subject to income tax withholding. However, withholding is elective if payments are in the form of an annuity after retirement.
Exception: If the compensation paid currently to an employee is exempt from federal income tax withholding, then deferred compensation payments to such an individual also are exempt from withholding. Death benefits paid to the employee’s beneficiary or estate under such a plan are not subject to employment taxes. FICA and FUTA taxes are not imposed on supplemental plans that are limited to providing cost-of-living increases.
The income exclusion of up to $5,250 annually in employer-provided educational assistance from an employee’s taxable wages applies to undergraduate and graduate studies. However, employer reimbursements for job-related educational expenses, even in excess of $5,250, are treated as a non-taxable working condition fringe benefit. "Job-related education" is that which maintains or improves skills needed in the employee’s present job or is required by law (e.g., required for license or certification) or by the employer to retain employment, status, or rate of pay. If educational assistance is not job-related, then the value of the assistance above $5,250 or outside of the time restrictions stated above is taxable wages for the employee. Minimum educational requirements necessary to qualify for employment, or education that will qualify an employee for a new trade, is not job-related. A graduate-level course, for purposes of the $5,250 exclusion, is one taken by an employee who has a bachelor’s degree or is receiving credit toward a more advanced degree, and which may be taken for credit in a program that leads to a law, business, medical, or other advanced academic and professional degree.
Group legal services plans
Employer contributions to and benefits from a non-discriminatory, pre-paid group legal services plan are not excludable from an employee’s income or exempt from employment taxes.
Leave paid by employer
Employers that pay their employees for periods of leave away from work (e.g., short-term sick leave, funeral leave, childbirth leave, "personal" leave, vacation, etc.) must include such amounts in the employee’s taxable wages.
Loans to employees
A compensation-related loan is any loan bearing a below-market interest rate made in connection with the performance of services directly or indirectly between employer and employee. A demand loan is a compensation-related loan that is callable at any time by the lender, or one when the interest rate automatically increases to at least the market rate upon the termination of the working relationship.
All other compensation-related loans are term loans: a loan or combination of loans exceeding $10,000 at less than the relevant federal interest rate results in an employee’s receipt of additional compensation equal to the difference between the applicable federal interest rate and the rate charged by the employer. For demand loans, imputed income from below-market interest rates occurs only on those days that the outstanding balance on all compensation-related loans exceeds $10,000. For term loans, once the outstanding balance of all compensation-related loans exceeds $10,000, the employee incurs income until the loans are paid off. For both demand and term loans, the amount of income is subject to FICA and FUTA. Although exempt from federal income tax withholding, additional compensation must be reported on the employee’s Form W-2. The amount is generally deductible by the employer as a business expense attributable to the payment of wages. Applicable federal rates for both term and demand loans are published monthly in IRS revenue rulings. The $10,000 limit does not apply if the principal purpose of the interest arrangement is avoidance of any federal tax.
- An employee relocation loan at below-market rates will not result in additional income to the employee if the loan is secured by a mortgage on the new principal residence of the employee or if it is a bridge loan payable in full within 15 days after settlement on the employee’s former residence.
- There is no taxable income for below-market rates when the interest on a loan is reduced to 6% according to the Soldiers’ and Sailors’ Civil Relief Act (when employees are called to active military duty).
- Advances to employees in anticipation of business-related expenses are not considered loans.
Military duty pay
According to the IRS, differential wage payments made to an individual "on active duty in the United States uniformed services for more than 30 days are subject to income tax withholding." Still, they are not subject to FICA or FUTA taxes. These payments must be reported on the employee’s Form W-2.
Moving expense reimbursements
All moving expenses paid for by employers to or on behalf of employees are taxable, starting January 1, 2018.
If compensation for employment services is made in some form other than cash, such as in stocks or bonds, the fair market value of the payment item is considered wages subject to payroll taxes. The employer is responsible for collecting the required income and FICA taxes and paying the employer share of FICA and FUTA.
- Under Social Security and unemployment tax laws, non-cash payments are not taxable wages when paid to agricultural laborers, casual workers, and private household domestics.
- Non-cash tips are not wages for federal income tax withholding or FICA.
- Advances to employees in anticipation of business-related expenses are not considered loans.
- Non-cash payments for services not in the course of the employer’s business are exempt from federal income tax withholding, FICA, and FUTA.
- Non-cash payments to retail salespersons ordinarily paid solely on a cash commission basis are taxable for FICA and FUTA purposes; withholding for federal income taxes is optional by the employer.
Taxes of employee paid by employer
Any employee tax absorbed by the employer is treated as additional wages to the employee. Additional federal income tax withholding, FICA, and FUTA taxes apply to the amount paid by the employer. These additional employment taxes result in a pyramiding situation in which the employer’s payment of employee taxes generates additional taxes for the employee. Formulas are available to calculate the employer’s amount owed if they wish to make a tax-free payment to the employee.
Exception: Payment by the employer for the employee’s contributions under New York disability insurance law has been held by the IRS not to constitute taxable wages.
Tips are subject to federal income tax withholding, FICA, and FUTA. The business tax credit for food and beverage establishments equals the employer’s FICA tax obligation (7.65%) attributable to reported tips in excess of those treated as wages for purposes of satisfying the minimum wage provisions of FLSA.
While all tips, including non-cash items, are taxable income to employees, only cash tips totaling at least $20 in a month and reported to the employer are subject to employment taxes. A tip is a voluntary payment from a customer, the amount of which is determined by the customer. Suppose the employer includes a mandatory service charge or gratuity on the customer’s bill and distributes that amount to employees. In that case, that is considered an ordinary wage payment rather than a tip. However, if customers charge tips to their credit cards or accounts, these payments qualify as cash tips. Tips that total less than $20 in a month and are not reported to the employer are exempt from FICA and FUTA taxes. Tips totaling less than $20 a month are subject to federal income taxes, but the employer has no federal income tax withholding obligation.
Exception: Employment taxes do not apply to allocated tip income under the tip allocation rules for large food and beverage establishments.
Special rule to tips: When federal income tax and FICA withholding apply to tips, the withholding is done from ordinary wage payments rather than tip income. If wages are insufficient to cover the amount of withholding, employees may provide funds to the employer to meet income tax withholding and FICA obligations. If the employee fails to make sufficient funds available, wages should be applied to the employee’s tax obligations in the following order of priority:
- employee FICA due on regular wages
- federal income tax withholding on regular wages
- employee FICA on reported tips
- federal income tax withholding on reported tips
When an individual has been placed by a state agency into vocational training with an employer, and that individual performs employment services for the employer, amounts paid are taxable wages, even if the employer is reimbursed partially or entirely by the state. However, if no actual employment services are performed, such as the individual primarily attending classroom training and demonstrations, and no employer-employee relationship is intended, payments would not constitute taxable wages.