Whether it’s for a holiday, birthday, or bonus, you might decide to distribute gift cards to your employees. Giving gift cards to employees is a great way to show your appreciation. But before you start passing them out, brush up on your employer responsibilities. Are gift cards taxable income?
Employee gifts and benefits
There are IRS rules on gift cards to employees. The IRS classifies a gift card as a type of fringe benefit. Fringe benefits are benefits you give to employees in addition to their regular wages.
A fringe benefit can be taxable or nontaxable, depending on what it is. Taxable fringe benefits are subject to federal income, Social Security, Medicare, and FUTA taxes. Nontaxable fringe benefits may be excluded from one, some, or all types of taxes.
Many holiday or other infrequent gifts to employees are considered de minimis fringe benefits. De minimis benefits are items with low values that you give to your employees. Because they are infrequent and low-valued offerings, you don’t need to include them in your employees’ wages or withhold taxes from them. Examples of non-taxable gifts to employees include fruit baskets, holiday hams, or company parties.
However, cash is not considered a de minimis fringe benefit. Cash, like a holiday bonus, is a taxable fringe benefit. Cash is a supplemental wage (e.g., bonus or commission). Supplemental wages are wages paid in addition to an employee’s regular wages. That means you need to include the amount of the cash gifts in each employee’s taxable income.
So, is a gift card taxable income, or is it a de minimis fringe benefit?
Are gift cards taxable income?
According to the IRS, gift cards for employees are considered cash equivalent items. Like cash, gift cards are always included in an employee’s income.
So, are gift cards taxable? Yes—you will need to record the value and pay the appropriate amount of taxes. The taxation of gift cards to employees works the same way as any other supplemental wages.
Supplemental wages are subject to federal income, Social Security, and Medicare taxes. If applicable, they are also subject to the state’s supplemental wages tax rate.
You can withhold federal income taxes on gift cards in one of two ways:
- Percentage method: Withhold a flat rate of 25% for taxes
- Aggregate method: Add value to regular wages and withhold taxes on the combined amount
To simplify the process of withholding taxes on gift cards, many business owners use the percentage method.
IRS gift cards and taxes example
In this example, we will use the percentage method. If you wanted to give an employee a $100 gift card, you would withhold $25 for federal income taxes (100 X .25 = $25). Then, you would need to withhold 7.65% for Social Security and Medicare taxes (100 X .0765 = $7.65). If there are state and/or local taxes for your business locality, withhold those as well.
After federal income, Social Security, and Medicare taxes, your employee would receive a gift card for $67.35. Not the ideal amount, right?
What can you do about taxes and gift cards? Gross up!
You must withhold taxes on gift cards, which can reduce the amount you want to give employees. Giving employees less than they expected can be a let down. To account for the taxes you must withhold, you can gross up the amounts of their gift cards.
Say you want to give your employees each a $100 gift card as a holiday bonus. You can gross up their bonus by determining the supplemental tax rate, Social Security and Medicare taxes, and state and local income taxes.
Let’s say your business is in a state that doesn’t have state or local income taxes. Add together the tax rates of 25% (federal income tax) and 7.65% (Social Security and Medicare taxes). Your total is 32.65%.
25% + 7.65% = 32.65%
Now, turn 32.65% into a decimal: .3265. Subtract this amount from 1. This gives you .6735.
1 – .3265 = .6735
Next, divide the amount you want to give the employee, $100, by .6735.
100 / .6735 = 148.48
To give your employees a gift card with a value of $100, you would need to record it as $148.48 and withhold $48.48 for taxes.
Accounting for gift cards given to employees
When you give gift cards to employees, you must include the value in the employee’s wages on Form W-2. Include the amount in box 1 (Wages, tips, other compensation), box 3 (Social Security wages), and box 5 (Medicare wages and tips).
You can also report the total amount of fringe benefits you give employees in box 14 (Other) on Form W-2.
IRS rules on gift cards to employees exception
Gift cards can be excluded from taxes in specific situations. Gift certificates you give employees for a specific item that is minimal in value, like a gift card that can only be redeemed for a ham, might qualify as a de minimis fringe benefit. However, if your gift card is good for general merchandise, like a gift card to a major retailer, you must withhold taxes on it.
Make sure to check with a tax professional if you have questions about whether you need to withhold taxes on gift cards.
Managing employee taxes can be difficult. Let Patriot Software help. With our online payroll software, withholding taxes and paying employees has never been easier. Get your free trial today!
This is not intended as legal advice; for more information, please click here.