Tax and Budget Considerations for Year-end Employee Bonuses and Gifts

LAST REVIEWED Sep 18 2019 8 MIN READ

By The Human Interest Team

It’s the end of the year – it’s time to celebrate and reward employees for their contributions. But what does that look like in your company? Maybe it’s an all-company event. Or, it might be an opportunity to contribute volunteer hours to a local charity. Some organizations also make ad-hoc end-of-year bonuses or give employees gifts or rewards in recognition of their work throughout the year. First things first: you need to do something, even if it’s small. Don’t let this opportunity slip by–simple acts of appreciation at the end of the year can positively impact employee engagement. And, you need to make sure whatever you do to celebrate this milestone reflects your company values and culture. According to a 2015 survey by Bank of America, small business owners planned to offer employees the following holiday-related perks:

  • Salary bonuses (52%)

  • Holiday party (45%)

  • Closed office during the holidays (44%)

  • Gifts (40%)

  • Flexible hours or vacation time during the holidays (33%)

These are all viable offerings and represent holiday and end-of-year perks which employees will appreciate. If yours is a company that plans to make a financial reward linked to the end of the year, here are a few important questions you should consider during the planning process:

What fits in the budget? What about next year?

Even if you communicate that this is a one-time event, we’re all human. For employees, it’s hard not to expect that this type of financial reward will happen again next year. So if you’re making a financial reward, be sure that you can afford it this year and that you’ll be able to provide a similar offering for at least the next year, too. If you don’t anticipate being able to afford it, that may be a sign to consider a less expensive way of showing your gratitude.

Who will get the reward? Will everyone get the same amount?

Beware of giving a reward that doesn’t resonate with employees, or which appears to be inequitable. In those cases, your financial investment will be wasted. Some options for how you determine these rewards include:

  • Tenure-based: Divide employees into groups based on the number of years they’ve worked for the company. Give rewards to the individuals in each group the same amount of money based on your budget. For example, for employees with 5 years of service, you might give a $500 reward to each employee who meets that criteria; and for employees with 10 years of service, you might give each of them a $1,000 reward, and so on.

  • Salary-based: Offer employees a reward based on a percentage of their salary. This means higher-paid staff will receive larger rewards.

  • Flat amount: Based on your budget, give the same amount to everyone in your company.

Is this reward considered discretionary or non-discretionary?

For financial rewards, this is an important distinction: “a discretionary bonus is excludable from an employee’s regular rate of pay, while a non-discretionary bonus must be included in the regular rate.” (More on this distinction for tax purposes below.) For example, if an employer makes all decisions about a bonus (including the amount and whether or not it happens), it’s discretionary. But, if the bonus is based on a promise or policy that leads an employee to anticipate payment (e.g., a bonus for sales performance), it’s non-discretionary. A reward that’s non-recurring, such as an ad-hoc end-of-year reward, is typically considered discretionary.

What made this reward possible?

If this year’s reward is the result of outstanding financial results, be sure you let employees know that. Not only does this help them understand and appreciate what made it possible, but it also illustrates for them that you value how their efforts contributed to the organization’s success. Similarly, it helps set realistic expectations if employees understand that the reward isn’t a “given” and that it depends on the company’s performance.

How will the taxes work?

Finally, the all-important question: what about the taxes? It’s an important question because it’s tricky. We’ll highlight the official IRS rules that are relevant here, but we’ll also “translate” them for you below. From the IRS: “The general tax rule under Internal Revenue Code Section 61 is that all forms of compensation are subject to income tax unless specifically excluded by the tax code,” writes Vicki M. Nielsen in an article published by the Society of Human Resource Management. “Section 102(c) provides that the gift exclusion does not apply to any amount transferred by or for an employer to, or for the benefit of, an employee. Thus, when an employer gives an employee a gift, it is taxable under Section 102(c) unless another exception applies.” Information from the IRS also states that “gross income does not include any fringe benefit that qualifies as a de minimis fringe benefit” which is defined in Section 132(e)(1) as “any property or service the value of which is so small as to make accounting for it unreasonably or administratively impracticable.” Gifts are taxable: In plain English, this means that to be on the safe side, the gifts you give to employees at the end of the year should be included in their overall wages (and therefore taxable). Bonuses are also taxable: Bonuses are considered “supplemental wages” and as such are subject to taxes as well Discretionary 401(k) matches are not taxable: The tax implications of your end-of-year reward are important for your employees and for you as an employer. If you’re debating between making a discretionary 401(k) contribution, or choosing to make another type of year-end reward, keep in mind that every dollar a company contributes to employees’ 401(k) plans is tax deductible for the employer and taxes are deferred for the employee. Profit-sharing contributions are also included in this category. More information here: Profit-sharing plan: How is it Different from a 401(k)? Regardless of whether you’re celebrating the holidays or end of the year with company events, community involvement, or ad-hoc financial rewards, be sure that you’re doing it with intention and purpose. Make the most of a meaningful time of year: let your rewards celebrate a successful year while also demonstrating your appreciation for, and commitment to, your employees.

We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.

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