As we approach the holiday season, many employers consider giving employees a gift as a token of appreciation. What employers may not consider is whether those gifts create taxable income to employees.
Although gifts are generally not taxable to the recipient, this general rule does not apply to gifts given by an employer to an employee (see, Section 102(c)(1) of the Internal Revenue Code of 1986 as amended (the “Code”)). Many gifts, however, qualify as a “de minimis fringe benefit” and are excludable from employee income. The following is a summary of the de minimis fringe benefit rules and the types of gifts that may qualify.
What is a de minimis fringe benefit?
A de minimis fringe benefit under Code Section 132(e) is a property or service that:
- Is provided on an infrequent basis; and
- Has a small value such that accounting for it would be unreasonable or administratively impracticable.
All of these conditions must be met in order for a gift to be treated as a de minimis fringe benefit that is excludable from employee income.
When is a gift considered not to have a small value?
The IRS has not provided a bright line test, but it did rule in one case that a non-monetary gift with a value of $100 would not be considered de minimis. If a benefit is too large to be considered de minimis, the entire value of the gift is taxable income to the employee, not just the excess over a designated de minimis amount.
What are examples of employer-provided benefits that may qualify as de minimis fringe benefits?
IRS regulations outline the following examples of benefits that may qualify as a de minimis fringe benefit:
- Holiday gifts of property (not cash) with a low fair market value (e.g., holiday ham or turkey)
- Occasional holiday party, group meal or picnic
- Coffee, doughnuts, and soft drinks
- Occasional sporting or theater tickets
What are examples of employer-provided benefits that do not qualify as de minimis fringe benefits?
IRS regulations also provide examples of benefits that do not qualify as de minimis fringe benefits, and must be included in an employee’s taxable income:
- Season tickets to sporting or theatrical events
- Use of an employer-provided facility (apartment, hunting lodge, or boat, for example) for a weekend
Do gift cards or gift certificates qualify as de minimis fringe benefits?
No. IRS regulations are clear that a cash fringe benefit or a “cash equivalent” fringe benefit (gift certificate or gift card) is not excluded from income as a de minimis fringe benefit. This is the case even if the same property (if provided in kind) would be excludable from income.
The IRS’ logic is that the value of cash is not unreasonable or administratively impracticable to account for, because the value provided is readily apparent and certain. Thus, even though a one-time $25 gift card meets the “infrequent” and “small value” tests, it does not meet the accounting test.
A gift card that allows an employee to receive a specific item of property (holiday ham or turkey) that is minimal in value, provided infrequently, and is administratively impractical to account for may be treated as a de minimis fringe benefit, depending on the facts and circumstances. However, an employer should proceed with caution in providing such gift certificates. In Technical Advice Memorandum 200437030, an employer gave its employees $35 gift coupons that could be used to purchase items at four local grocery stores. The gift coupons were given in lieu of holiday food baskets that the employer previously provided. The IRS ruled in this Technical Advice Memorandum that the gift coupons were essentially cash equivalents, and were not excludable from employee income as a de minimis fringe benefit.
How do the reporting and withholding rules apply?
If the employer reasonably believes that a gift qualifies as a de minimis fringe benefit, it is not subject to federal income tax withholding and is not “wages” for purposes of employment tax withholding.
If, however, an employer has determined that a gift does not qualify as a de minimis fringe benefit, and no other exemption applies, the employer must report the value of the gift in Box 1 of Form W-2 and withhold federal income tax and withholding taxes (FICA and FUTA), whether the gift is provided in the form of cash or non-cash.
Are gifts considered “compensation” for purposes of 401(k)/403(b) deferrals or matching contributions?
An employer should review its plan document to answer this question. Many defined contribution plans exclude “fringe benefits” from the definition of plan compensation, so any qualifying de minimis fringe benefit should not be plan compensation pursuant to this exclusion. It is less clear that the value of gift cards or gift certificates is excludable as a “fringe benefit.” If the employer provides employees with gift cards or gift certificates, it may be prudent to specifically amend the plan to exclude these items from the definition of plan compensation.
Conclusion
Employees appreciate holiday gifts and most will prefer a non-taxable gift. In any event, an employer should understand the tax implications and, if a gift increases an employee’s taxable income, be prepared to answer questions.
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About the Author:
Cynthia A. Moore is a member of Dickinson Wright’s Troy office, where she assists clients in all areas of employee benefits law, including qualified retirement plans, welfare plans, and nonqualified compensation programs. Cyndi can be reached at 248-433-7295 or cmoore@dickinsonwright.com, and you can visit her bio here.