New York State Tax

Tax Implications of Employee Bonuses

When a company is planning or budgeting its expenses for the year, a key component to consider is compensation expense. Employees are what keep a company running smoothly and they must be paid a competitive and fair wage to keep them happy and productive. A large piece of this expense will often be composed of various employee bonuses and incentive programs. Any company offering its employees bonuses should also reflect on the tax consequences of this additional compensation on the company and the employee.

All compensation paid to employees, unless paid directly to certain eligible retirement savings accounts is usually considered. This includes noncash compensation like products, cars and gift cards. However, there are a few exceptions. The IRS allows for a "Christmas Gift Exception" provided the award is not cash and the value is considered nominal, like a ham or turkey. Tax laws also allow employers to award their employees performance with noncash prizes in three specific circumstances: tangible property awarded based on performance that average less than $400 per year, up to $400 per year in awards that do not meet the first circumstance and noncash awards paid to an employee whose salary is normally 100% commission based can be exempted from federal income taxes (all other taxes are still payable).

Because there are so few situations where providing employees with bonuses will be free of taxes, a company should include any applicable taxes when calculating the amounts of the bonuses that it will be able to afford. Many companies also consider the personal tax liabilities placed on the employee when awarding additional incentive-based compensation. It is a fairly common practice to "gross up" the award amount. This means that the employee receives additional monies or the company remits additional payment directly to the taxing authorities to cover the extra tax debt. Grossing up an award is a very important gesture of goodwill that management can make for employees, especially when the award is a noncash taxable item.

Businesses that choose to make awards with or without a tax gross up should take additional time to provide the recipient with the relevant taxation information. For instance, if the company decides to award one-time bonuses to production workers, they should inform the workers if taxes were or were not withheld and if the employees should anticipate an additional related tax bill. Preparing employees with the foreknowledge that they will be taxed on any additional income can help prevent any ill feelings toward management when they later realize that a $1,000 bonus will be less than $700 after taxes (especially if this realization comes after they have spent the $1,000).

Though this article focuses on the federal tax implications of bonuses and incentive payments, employers must also consider state and local taxes as well as FICA and unemployment. Each of these taxes have different laws and formulas for computing taxable and nontaxable income. An educated payroll specialist or accountant can be an invaluable resource when reviewing these unusual or infrequent types of transactions.

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