As the year draws to a close and holiday spirits abound, employers can anticipate reviewing year-end figures to determine who goes on the naughty or nice list. For those who receive bonuses, here a few points on bonuses and gifts that employers should keep in mind.
1. Employees must report bonuses as taxable income. No wiggle room on this one. Bonuses are considered taxable income by the IRS and to be included on an employee's Form W-2, Federal, state, and local income taxes and FICA taxes must be withheld. Employers should also be mindful whether they agreed, in the first instance to a gross-up arrangement with the employee as the employer will have to pay the entire bonus amount and the tax as well.
2. Employers may deduct bonuses under certain circumstances. The IRS permits bonuses to be deducted by the employer if the bonus is an ordinary and necessary business expense. If a deduction is made, keep in mind that any bonus must be reasonable. An “ordinary” expense is one that is common or accepted in your company's particular industry. A “necessary” expense is one that is helpful and appropriate for your trade or business. Also, employers can deduct the costs of a holiday party for employees as a business entertainment cost.
3. Gift cards are taxable as income unless de minimis. Most gift cards and gift certificates to employees that are redeemable for general merchandise or have a cash equivalent are taxable as income. Other smaller gifts such as movie passes may not be taxable, but giving the employee cash for the ticket to the movie would be considered taxable.
4. Bonuses may be earned pro-rata. If the terms of a bonus plan are definite, a promise to pay a bonus as an incentive for continued service may constitute an enforceable contract, rather than a mere gratuity. But, where an employer has full discretion whether to issue a bonus and the amount of the bonus or the terms of the bonus plan are indefinite, a bonus will likely be construed as a gratuity. If a promise to pay a bonus is enforceable, employees in most jurisdictions are entitled to a pro-rata share of the bonus if terminated without cause before the distribution of the bonus. Ordinarily, an employee who voluntarily terminates employment is not entitled to any portion of a bonus. Depending on the jurisdiction, an employer may avoid liability and pay a bonus when an employee is discharged before a bonus is due if a bonus plan states an employee forfeits his or her bonus if terminated with or without cause prior to the end of the fiscal year and
5. Identify fair bonus practices. Like all compensation, bonuses are subject to equal pay and anti-discrimination laws. To maintain fairness and guard against discrimination, bonuses should be based on objective, identified factors. In addition to maintaining an appearance of fairness, an employer must disclose these factors well in advance of year's end. At the same time, such disclosure will work to motivate employees to achieve benchmarks the employer considers valuable.
Please feel free to contact me at [email protected] for any further information or questions as it relates to this article. Have a great holiday season.