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Use tax-free awards to motivate staff, cut your costs

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in Small Business Tax,Small Business Tax Deduction Strategies

As the economy heats up, you'll need to work harder to retain good employees. One good tactic: Set up an employee-achievement-award program. If you handle things the right way, they are tax-free to employees and fully deductible by your company.

Key point: Only certain types of those awards are tax-free. And you can't use the awards program as a way to disguise an employee's taxable compensation. For example, if you hand out employee awards at the same time as annual salary reviews, the IRS may call the award "taxable compensation."

Safety, length of service awards

Here's the whole story: Tax laws define "achievement awards" as tangible personal property granted to an employee for either length of service or promoting safety. (Awards for good job performance are considered bonuses and would be taxable.)

Note that the awards must be tangible items, such as TVs, golf clubs, DVD players, etc. Cash and cash-equivalent gifts (e.g., gift certificates) don't qualify.

Also, the plan must meet a few key requirements to qualify for tax-free status:

• Any employee can receive a length-of-service award, but safety awards can't be given to managers, administrators, clerical workers and other professional employees. Reason: Those positions typically don't face safety issues. Also, the award doesn't qualify for tax-free status if the company grants safety awards to more than 10 percent of staff in the same year.

• The award must be part of a "meaningful presentation." This doesn't mean your company has to throw a party, but the occasion should be noted.

• Employees must work for the company a minimum of five years to receive a length-of-service award.

Award size depends on 'qualified' status

How big of a tangible award can employees receive tax-free? It depends on whether the award is qualified or nonqualified.

Qualified awards: $1,600 per-employee maximum. To be considered "qualified," the award must meet two extra requirements:

1. It must be paid under a written plan that doesn't discriminate in favor of high-paid employees.

2. The average cost of all your employee achievement awards granted during the year can't exceed $400.

Nonqualified awards: $400 per-employee maximum. If your employee achievement awards don't meet those two tests, the annual maximum award for one employee is $400.

Note: Your company can't deduct any amounts over these limits. Plus, such extra amounts are taxable to the employee.

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