Quirky Question #231, Is it Really Employee Appreciation if the Gift Card is Taxable?

by Dorsey & Whitney LLP
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Question:

Our company awards prizes at holiday parties and, from-time-to-time, at employee appreciation events.  The prizes range from company logo t-shirts to $50 gift cards and cameras worth about $125.  Do we need to report any of these items as compensation on Form W-2 for the employees who win these prizes?

Answer:

Yes – Some prizes should be considered compensation, although other prizes are not compensation.  Under the Internal Revenue Code, generally gross income includes amounts received as prizes and awards.  See 26 U.S.C. § 74(a).

Prizes of property that are of de minimis (very low value) that are not cash or gift cards, especially those given at a holiday party, generally can be given to employees and not included in income.  See 26 C.F.R. § 1.132-6(e)(1).  Thus, the company logo t-shirts (which have a very low value) would not need to be included in compensation.  See Priv. Ltr. Rul. 2010-05-014 (Feb. 5, 2010); see also Priv. Ltr. Rul. 2011-35-022 (May 20, 2011) (revoking Priv. Ltr. Rul. 2010-05-014 based on variations in distribution).

The IRS, however, has indicated that cash and gift cards always need to be treated as compensation paid to an employee.  This is true regardless of the amount of the gift card.  See 26 C.F.R. § 1.132-6(c).  Thus, the IRS views even a $10 gift card as compensation.

If a prize is worth more than a de minimis amount, it also likely needs to be included in compensation.  For example, generally a camera worth $125 would need to be included in compensation.

Note that failing to include the value of prizes in compensation raises a second potential problem – failure to properly deduct and contribute amounts to the company’s 401(k) plan.  If a prize is compensation and there is no exclusion under the 401(k) plan’s definition of compensation for prizes (and usually there is not because most 401(k)plans use a safe harbor definition of compensation), then the company has failed to deduct and contribute amounts to the 401(k) plan.

Thankfully, the value of these types of prizes – things that are not awarded for performance on the job – while considered compensation for purposes of the company’s 401(k) plan are not considered part of the employee’s regular rate of pay under the Fair Labor Standards Act.  See 29 C.F.R. § 778.332.  Thus, the employer need not apportion the value of the prize over some prior work period and pay overtime on the value of the prize.  If the prize were tied to the employee’s performance – like an award for most courteous service employee – then it would need to be included in the recipient’s regular rate of pay and included in the overtime calculation.  (The FLSA provides that “[t]he regular hourly rate of pay of an employee is determined by dividing his total remuneration for employment (except statutory exclusions) in any workweek by the total number of hours actually worked by him in that workweek for which such compensation was paid.”  Id. § 778.109.)

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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