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Need to motivate employees? Award tax-free prizes

by on
in Small Business Tax,Small Business Tax Deduction Strategies

Are your employees in a rut? It’s easy for them to fall into the trap of going through the motions. Here’s a way you can lift their spirits without giving away the farm.

Strategy: Establish a program of achievement awards. If you handle things properly, the awards are tax-free to the employees and fully deductible for your company.

Caution: You can’t use the awards program to disguise taxable compensation. For example, employee awards handed out at the same time as annual salary reviews may be suspect. Similarly, you can’t substitute this program for a cash bonus plan that already exists.

The whole story: Under tax law, an “achievement”award is an item of tangible personal property granted to an employee for either length of service or for promoting safety. Examples: watches, necklaces, televisions, camcorders, DVD players, golf clubs, etc. Cash and equivalent gifts (e.g., gift certificates) don’t qualify as tangible personal property.

In addition, the plan must meet a few other key requirements to qualify for favorable tax treatment:
  • Any employee may receive a length-of service award, but you can’t make safety awards to managers, administrators, clerical workers or other professional employees. Reason: Those positions generally don’t involve safety issues. Furthermore, the award doesn’t qualify if the company grants safety awards to more than 10 percent of eligible employees during the same year.
  • The award must be part of a “meaningful presentation.” That doesn’t mean your company has to throw a lavish affair, but you should mark the occasion with an appropriate ceremony.
  • An employee must have worked for the company for at least five years to receive a length of service award. Note: An employee isn’t eligible for this type of award if he or she received a length-of-service award during the current year or the previous four years.
  • How much can an employee receive tax-free? It depends on whether the award is nonqualified or qualified. With a nonqualified award, the annual maximum is $400. With a qualified award, the maximum is $1,600 (including any nonqualified awards).
  • Any amounts over those limits are not deductible to the company and are taxable to the employee.

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