A Quick Guide to Tax Rules for Employee Incentives & Rewards

Employee incentives and rewards are a type of benefit employers can offer to boost employee morale, reward good work, and recognize employees for their service. It’s a large category including things like cash bonuses, gift cards, discounts, service awards, charitable donations, swag, and other benefits. However, the topic of tax requirements—both for employers and employees—is fraught and confusing. For many, the complexity means that leaders abandon the idea of employee rewards programs entirely.

This is understandable– the topic is very complicated, and it can be difficult to find clear-cut information about employer tax liability regarding this issue. Professionals disagree on some of the answers to common questions, and depending on where your business is based, you will be subject to different local laws and regulations. In this article, we’ve gathered some of the most common questions about taxes and employee rewards and answers to guide you on your way.

A quick disclaimer: this article is not intended to serve as professional tax or legal advice. If you have specific questions about your business’ tax, financial, or legal responsibilities, we suggest you consult with your accounting and legal team.

Common Tax Questions About Employee Rewards

Are incentives and rewards taxable?

Generally speaking, employees should plan to pay taxes on any incentives or rewards they receive from their employer. This includes cash bonuses, gift cards, merchandise, travel perks, and so on. The IRS sets out an exception to this rule for certain length-of-service and safety awards. For more details on the requirements for these awards to be tax-exempt, check out IRS publication 535. For specialized and detailed information on employees’ pay and the employment tax treatment of employees’ pay, see IRS publications 15, 15-A, and 15-B.

Should employers withhold taxes for employees on the incentives and rewards they receive?

Yes. When the person receiving an incentive or reward is an employee, employers should withhold taxes on the value of the gift. The IRS gives employers the option of withholding taxes at the same income tax rate as employees normally pay, or withholding taxes at a flat rate for supplemental wages.

If an employer provides incentives or rewards to a contractor rather than an employee, the employer does not withhold taxes. (Independent contractors withhold and pay their own taxes quarterly.) However, an employer may need to report the value of the incentives or rewards on the contractor’s 1099-NEC form.

Can employers deduct the cost of employee incentives and rewards?

This is an issue with a great deal of nuance. Employers can usually deduct the cost of employee incentives and rewards. IRS publication 535 says “You can generally deduct the amount you pay your employees for services they perform. The pay may be in cash, property, or services. It may include wages, salaries, bonuses, commissions, or other non cash allowances such as vacation allowances and fringe benefits.”

Some employers make in-kind donations to charities on their employees’ behalf as part of their employee rewards programs. Employees don’t have to pay taxes on these, and employers may be able to deduct the charitable contribution from their taxes.

How should employers approach length-of-service and safety awards?

There are very specific requirements that service awards and safety awards must meet in order to qualify as non-taxable. Below are the details, according to the IRS, as of the 2022 tax year:

• For service awards that are part of a qualified awards plan, the value of up to $1,600 can be exempt from taxes. A qualified awards plan is an awards program that has official written guidelines, including a list of possible awards and a set of qualifications for each, and does not favor highly compensated employees (defined as employees who are 5% owners of the company either in the current year or prior, or received more than $130,000 in the preceding year).
• For all other service awards (those not part of a qualified awards plan), the amount that is exempt from taxes is up to $400.
• Service awards can only be given every five years of service, at least five years after each previous length-of-service award, and if the employee didn’t receive another service award (other than one of very little value) during the same year or any of the previous 4 years. Additionally, the award must be tangible property (for example, a set of golf clubs, a tablet, or a watch). Gifts such as cash, gift cards, paid time off, meals, or event tickets do not qualify.
• Safety awards cannot be given to more than 10% of eligible employees (excluding managers, administrators, clerical employees, or other professional employees) in the same year.

Are there any employee rewards that don’t count as taxable income, or that are tax exempt?

Yes, certain length-of-service and safety awards as described above. Another exception to the general rule of taxing incentives and rewards is de minimis benefits. These benefits are so low in value and frequency that having to account for them would be unreasonable or impractical. For example, office snacks, use of the company copy machine, holiday gifts, or occasional meal money for working overtime.

Should I withhold tax on my employees’ rewards upon recognition or redemption?

Like all rules regarding the taxation of employee rewards, the exact expectations will vary based on your location. The IRS offers a great deal of flexibility to employers about when they can choose to withhold employee taxes on rewards and incentives. Employers can choose to do so by pay period, monthly, quarterly, or some other frequency– as long as it’s at least annually.

Some countries have stricter regulations, like those that require employers to withhold tax on issuance of a reward. As we’ve said, the best way to know for certain is to speak with your accountant and/or attorney about local laws and regulations.

IceHrm’s employee rewards and recognition platform helps HR managers appropriately manage funds across the company and keep track of the incentives and rewards that are distributed throughout the year. We are always happy to provide any kind of reporting that your payroll team might need for tax purposes.