Employers: Avoid Tax Surprises When Making Holiday Gifts to Employees

As the year draws to a close, many businesses look for ways to recognize and thank their employees. From gift cards to holiday treats to service awards, the options are plentiful. But not all gifts are treated equally by the IRS. The tax implications depend on factors such as the type and value of the gift. Understanding these distinctions can help avoid costly tax surprises for both your business and your team.

Year-End Bonuses and Similar Payments

Generally, amounts effectively paid for services rendered are taxable, just like other forms of compensation. Therefore, year-end bonuses, commissions and similar payments made in 2025 are subject to tax in 2025. That means employees will owe income and payroll taxes on these amounts in 2025. Employers also must pay their share of payroll taxes, but they can deduct the payments as a business expense for the tax year.

However, if a year-end bonus is delayed until January, it's taxable to the employee in 2026. And a calendar-year business can't deduct it until 2026.

Achievement Awards

The tax rules for achievement awards are slightly more complicated. But if the gifts meet certain criteria, they can qualify for tax-free treatment for the recipients.

For these purposes, an "achievement award" is tangible personal property given to employees for length of service or promoting safety. Examples include watches and jewelry, electronic devices, and sports equipment. The definition of "tangible personal property" specifically excludes the following items:

• Cash and cash equivalents,
• Gift cards, gift coupons and gift certificates (other than those where the employer preselected or preapproved a limited selection),
• Vacations,
• Meals,
• Lodging,
• Tickets for theater or sporting events, and
• Stocks, bonds or similar items.

Being tangible property isn't the only requirement for an achievement award to qualify for tax-free treatment to recipients. For example, the award must be part of a meaningful presentation.

Also, a safety award won't qualify for tax-free treatment if the employer granted safety awards to more than 10% of the eligible employees during the same year. In addition, safety awards can't be made to managers, administrators, clerical workers or other professional employees.

Any type of employee can receive a length-of-service award. However, the employee must have worked for the company for at least five years.

Dollar Limits on Achievement Awards

If an employer uses a "nonqualified plan," an employee may receive up to $400 in achievement awards during the year without owing any tax. This tax-free amount is quadrupled to $1,600 if the employer uses a "qualified plan." Any amount above these limits is taxable to the employee and can't be deducted by the employer.

Two additional requirements must be met for qualified plans:

1. The award must be paid under a written plan that doesn't favor highly compensated employees.
2. The average cost of all employee achievement awards granted during the year can't exceed $400.

A qualified plan requires a little work to set up, but the benefits can be well worth it.

Small Tangible Gifts

How about giving employees small tangible gifts, such as turkeys or hams? Such gifts may be excluded from taxable income under a special "de minimis rule." A de minimis benefit is one that's so small that accounting for it would be unreasonable or impractical. This exception covers many small holiday gifts.

In determining whether the de minimis rule applies, consider the frequency and the value of the gifts. A critical factor is whether the benefit is occasional or unusual. Also, the gift can't be a form of disguised compensation.

If a benefit is too large to qualify as a de minimis benefit, the entire value is taxable to the employee, not just the excess over a designated de minimis amount. Previously, the IRS has ruled that items with a value exceeding $100 couldn't be considered a de minimis benefit, even under unusual circumstances.

Keep Holiday Giving Tax-Smart

Thoughtful holiday gifts are a great way to recognize employee contributions and strengthen workplace morale. But before finalizing gift plans, carefully review the tax implications for your business and your employees. Contact your tax advisor to ensure your generosity is structured in a tax-smart way.