01/04/2023 in Accountant

The Correct Tax Treatment of Employee Bonuses

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A common question from business owners is: How can we reward our employees with a bonus that does not run through payroll? Unfortunately, the IRS does not give us a good way to do that. The IRS’s view is that, generally, if an employee receives a payment from an employer, it is taxable compensation.

However, there is a category of employee expenses known as “de minimis fringes” that are deductible to the business but not included in the recipient’s income. These are benefits that are so small and frequent that attempting to account for them via payroll would be an unfair administrative burden on the business. Here are examples:

  • occasional cocktail parties, group meals or picnics for employees and their guests;
  • traditional holiday gifts of property (not cash) with a low fair market value;
  • occasional theater or sporting event tickets;
  • coffee and doughnuts;
  • occasional personal use of the employer’s copy machine, if significant restrictions are placed on employee use, so that at least 85% of machine use is for business purposes;
  • soft drinks;
  • flowers, fruits, books or similar property provided to employees under special circumstances (for example, illness, family crisis, or outstanding performance);
  • the value of snacks the employer furnished to its employees because quantifying the value consumed by each employee of snacks that came in small, sometimes difficult to quantify portions, and were stored in open-access areas, was administratively impractical given the low value of each snack portion, even if the employer offered the snacks on a continual basis.
  • personal use of a cell phone provided to the employee primarily for noncompensatory business use purposes.

Cash and cash equivalents (charge cards, credit cards, debit cards, gift cards) are specifically excluded from the de minimis fringe exclusion rules. Therefore, in most cases, employee bonuses will be taxable to the recipient.

One workaround is to have the business pay the tax on behalf of the employee. Here is how that works: The business can pay the employee by whatever means it chooses – cash, check, gift card, etc. The business then “grosses up” that payment for the normal taxes that would be due on that payment. If you use a payroll service, they are accustomed to making those calculations for businesses. The business then remits the tax, resulting in an after-tax benefit to the employee. This does cost the business more money and, thus, should be factored into the bonus calculation.

If you have any questions about the do’s and don’t’s of paying your workers, please contact our office before taking action.