Rewarding high achievers can help retain them and raise the bar on other employees. Employers can deduct amounts they pay as employee bonuses as a business expense. If your business uses a cash accounting basis, you can deduct bonuses this year if you pay them before the end of the year. If your business uses accrual accounting, you can pay bonuses next year and still get the deduction this year if you declare the bonuses this year. Paying bonuses to a business owner or a member of an owner’s immediate family can create sticky tax situations, so consider the tax consequences. To avoid problems, be sure to document your bonus declaration in corporate minutes.
Employers must show any money they pay as bonuses or awards to employees on the employee’s Form W-2. Employees must report any bonuses or awards they receive as income. If you give employees goods or services (such as a vacation trip) as an award, they must include the fair market value of the goods or services in their income. Any promised bonuses or awards do not become taxable to employees until they actually receive the award or have it made available to them.
Cash bonuses include cash and equivalents, such as cash and gift certificates.
Employers have other ways of rewarding employees for good performance:
Profit-sharing plans: Profit-sharing plans allow employers to decide (within limits) from year to year whether to make profit-sharing contributions on behalf of participants. If you make contributions, you must do so according to a pre-determined formula. Contributions will be accounted for separately for each employee. You can subject contributions to a vesting schedule, which can help with employee retention. Employees can also contribute to their profit-sharing plan, if you so choose.
Employers can deduct contributions to the plan as a business expense. Employees do not have to pay taxes on their contributions until they are distributed. Business owners can use profit-sharing plans to maximize their tax-favored retirement savings. For 2015, the annual defined contribution limit rises to $53,000 (employer and employee combined). Individuals age 50 and older have a higher limit, $59,000 for 2015.
Profit-sharing plans must meet specific disclosure and administration rules. Although employers can decide which employees can participate in the plan, the plan cannot be discriminatory, or favor only highly compensated employees. To ensure your plan passes nondiscrimination tests, you must allow a substantial number of rank-and-file employees to participate.
Employee stock ownership plans (ESOPs)
An ESOP is a type of tax-qualified employee benefit plan in which most or all of the assets are invested in stock of the employer. Like profit-sharing and 401(k) plans, which are governed by many of the same laws, an ESOP generally must include at least all full-time employees meeting certain age and service requirements. The employer sets up a trust fund, and contributes new shares of its own stock or cash to buy existing shares. Alternatively, the ESOP borrows cash, which it uses to buy company shares or shares of existing owners. The company then makes tax-deductible contributions to the ESOP to repay the loan, meaning both principal and interest are deductible.
Employees gradually vest in their accounts and receive their benefits when they leave the company (although there may be distributions prior to that). Employees are taxed when distributions are made.
Employees who receive tangible personal property (other than cash, a gift certificate, or an equivalent item) as an award for length of service or safety achievement can generally exclude these items from income. However, the excludable amount cannot exceed $1,600 ($400 for awards that are not qualified plan awards) for all such awards you receive during the year.
To meet the definition of a “qualified plan award,” the employer must make the award as part of a meaningful presentation, under conditions and circumstances that do not create a significant likelihood of it being disguised pay. The exclusion does not apply to the following awards:
- Length-of-service awards for less than five years of service or for employees who have received another length-of-service award during the year or the previous four years.
- Safety achievement awards for managers, administrators, clerical employees or other professional employees.
- Safety achievement awards, if received by more than 10 percent of eligible employees during the year.
De Minimis Benefits
De minimis benefits are occasional small gestures, such as buying the office lunch, bringing a birthday cake in for an employee’s birthday, or the occasional dozen doughnuts. The value of such benefits must be small—so small in fact, that determining the fair market value of the benefit is more trouble than its worth. De minimis benefits do not count towards an employee’s taxable income.
IRS regulations make it clear that season tickets to the local ball team or providing a company vehicle more than one day a month exceed the de minimis limit. The IRS would consider this type of benefit includible in the employee’s taxable income.
Psychologically, the occasional perk can be more effective than an everyday benefit. Employees are surprised, feel that the perk is special and appreciate it more.
Employee benefits are an important part of compensation.
This information is not intended as tax advice. Before taking any action, consult with your accountant or other qualified tax advisor.