Many employers provide length of service awards for their employees, often in the form of a small gift, to reward employees for their continued service. But employers must be careful to not turn an award program into a tax liability for their employees. An employee will be treated as receiving taxable compensation equal to the fair market value of the award if it is not within the parameters of an IRS exception. While receiving a gift is always nice, some employees will see an award that comes with a tax bill as a penalty instead of as the token of appreciation it was intended to be. Employers that provide these awards to their employees should be familiar with the requirements necessary to meet the requirements of the exception, and be aware that last year’s Tax Cuts and Jobs Act provided further guidance on this issue.
An employer can provide service awards to its employees as a tax-free incentive if the reward meets certain requirements. Failure to meet any of these requirements would result in the employee’s gross income for the year increasing by the fair market value of the service award. An employer may only exclude employee achievement awards that cost up to $400 from an employee’s gross income in a year. This amount can be increased to $1,600 per year if the award program is: 1) in writing; 2) does not discriminate in favor of highly compensated employees; and 3) the average cost of all service awards granted in a year does not exceed $400. Length of service awards may only be provided tax-free to an employee if they are not awarded within an employee’s first 5 years of service, and no more often than once every 5 years. Finally, the award may only be provided tax-free if it is in the form of “tangible personal property”.
Through the Tax Cuts and Jobs Act, Congress gave official guidance on the definition of tangible personal property (previously only proposed treasury regulations existed). The definition of tangible personal property specifically excludes all of the following:
- cash and cash equivalents;
- gift cards, gift coupons, and gift certificates (other than arrangements conferring only the right to select and receive tangible personal property from a limited array of such items pre-selected or pre-approved by the employer);
- vacation, meals, or lodging;
- tickets to theater or sporting events;
- stocks, bonds, and other securities; and
- other similar items.
While the list does not contain any shocking exceptions, employers with length of service award programs in place should use this as an opportunity to revisit their plans and make sure their programs are compliant with the Tax Code. If the length of service award does not meet the above requirements, the fair market value of the award must be included in the employee’s taxable compensation for the year.