Paying bonuses to employees around the winter holidays is a common practice in businesses of all sizes. Many employers use holiday bonuses to boost morale among their team and thank employees for a good year.
According to the Internal Revenue Service (IRS), some types of holiday bonuses are taxable. Employers need to understand how to meet their tax obligations when awarding year-end bonuses. This guide will help you do so.
A holiday bonus is a gift employers award to their employees around the winter holidays. This bonus is not part of an employee’s standard salary or hourly pay and is usually a one-time occurrence.
There are two types of bonuses employers can award:
Holiday bonuses typically fall under the category of discretionary bonuses unless they occur regularly. Non-discretionary bonuses are usually performance-based and appear as part of an employee’s regular paycheck.
If your company offers both holiday and year-end bonuses, employees may be confused about the difference between the two. Generally, year-end bonuses are recurring non-discretionary payments, like performance bonuses, while holiday bonuses are one-time discretionary gifts. Many employers will distribute extra profits at the end of a good year as holiday bonuses.
The method of calculating how much each employee should receive in a year-end bonus varies across businesses. Some employers award a flat rate every year, while others increase bonuses each year an employee stays with the company. Others offer bonuses based on employee performance.
If your company wants to award both types of bonuses, it’s best to ensure your employees know which one they are receiving and when. One way to clear up confusion is to stagger the bonuses. Time them so that they will be different awards. For example, you could distribute holiday bonuses in late November or early December and year-end bonuses in late December or early January.
Holiday bonus pay can generate worthwhile results that benefit employees and the company. Here are the primary benefits:
How employers award holiday bonuses varies widely across businesses. Some companies give small fixed bonuses of $50 to $100 in gift cards, while others may add a percentage of their employee’s salary to their regular paycheck. The most common methods of awarding monetary bonuses include:
You can also award bonuses in forms other than money. Extra paid time off or personalized gifts are common ways employers can give back to their employees around the holiday season.
The IRS considers monetary bonuses to be supplemental income, so the tax rate for a holiday bonus will be different from that of regular wages. Most monetary bonuses are taxable, including physical gift cards and certificates. However, this depends on the type of bonus awarded. Specific non-discretionary bonuses may be tax-deductible.
Even holiday bonuses intended as gifts are not tax-deductible. You must report any discretionary monetary bonuses as taxable income on an employee’s W-2 form. The same goes for paid time off, which carries the same tax consequences as an employee’s regular work hours.
The IRS considers small non-monetary bonuses, like holiday gift baskets, to be de minimis fringe benefits, meaning their value is so small they are not worth taxing. If you know awarding a monetary bonus to all your employees might not be feasible this year, consider offering something small like a company logo gift instead.
Since the IRS classified employee bonuses as supplementary income, the flat rate of 22% federal income tax will apply for any compensation separate from a regular paycheck. The following taxes can also apply to holiday bonuses:
As the employer, you can manage bonus taxes using one of two methods:
The percentage method is usually less complicated, but the aggregate method could work better for certain companies.
Additionally, account for holiday bonuses in advance by including them in your yearly expenses. Keeping these records can prepare you for the upcoming tax season and serve as a reference for the next year. A tax attorney can help you save time by untangling the nuances of preparing for tax season, so consider reaching out to one for additional assistance.
Employers have many exciting holiday bonus options that are tax-deductible or offer reduced tax implications. Let’s explore a few best practices and some alternative holiday bonus ideas to help you provide bonuses that match your employees’ interests.
When it comes to holiday or year-end bonuses, you should apply the same rules to every employee and be transparent. Your workers should understand how bonuses work. If yearly bonuses are a normal occurrence at your business, make sure your employees understand the following:
Make this information easily accessible for every individual by including it in the handbook.
If, for any reason, you need to eliminate bonuses or change the type of bonus you award, give your employees proper advance notice. You should always explain that one-time holiday bonuses are singular events to avoid disappointing your team in later years.
The IRS considers holiday gifts within a reasonable price range to be de minimis fringe benefits. Many companies stay at around a $75 maximum for their employee gifts. If you plan to give to clients, however, staying at a $25 maximum will help you avoid taxes.
By distributing physical gifts, you can give back to your employees without worrying about additional tax paperwork. You might also get a discount if you buy certain items in bulk. Gifting company swag to your team is an excellent option for large businesses, especially since you might already have a lot of it on hand.
If you have a particularly small or close-knit team, consider tailoring your gifts for each employee. A customized gift basket filled with self-care goodies or merch from their favorite sports team could brighten their day and show you care.
The key to personalized gifts is knowing your recipient, which is why customized bonuses are best for smaller teams. Gift cards or certificates might be a more practical choice for larger or remote teams.
The IRS considers gift cards to be a type of supplemental income, meaning they are taxable and must be reported on an employee’s W-2. Employers have two choices to make sure their employees get the full bonus:
If you’re determined to go the gift card route, make sure you file the relevant taxes correctly and on time. A small business tax attorney or accountant can help simplify the process for you so you can focus on your holiday sprint.
If appropriate for your workplace, consider throwing an office party. Workplace celebrations can help bring your team closer together and strengthen company culture. Additionally, they provide more opportunities to give out mini-bonuses, like door prizes or a raffle.
The IRS allows businesses to deduct 50% of the cost of business-related food and beverages and business-related entertainment expenses that provide amusement, recreation or entertainment. Some exciting options might include the theater, sporting clubs, social clubs, fishing trips or sports events.
Promote goodwill among your team members by scheduling fun team-building activities on relaxed days or after work.
Here are some festive ideas to get you started:
Because your contributions to these events are minimal, the IRS would consider them to be de minimis fringe benefits, meaning you don’t have to pay taxes on them. Plus, your team will get a valuable opportunity to learn more about each other and loosen up a little.
Like company-wide holiday parties, treating your staff to a meal is 50% deductible as long as you buy the food from a restaurant. The meal expense may include taxes and tips for the meal. Perhaps a dinner event isn’t logical for your company. Providing a meal to those working overtime is another 100% deductible way to give back during the end-of-year rush.
Some restaurants offer inexpensive holiday dinner bundles of several side dishes and a whole turkey or ham. Since meals purchased from restaurants are tax-deductible, you could buy some dinner bundles for your remote team and send them to their homes.
Providing holiday-specific benefits can help boost morale among your team members and increase retention rates. Investing in your employees is a great way to show your appreciation for their hard work.
For example, you could offer new opportunities for personal development, like tickets to attend a conference or listen to a prominent speaker in your industry. Or you could provide improved or updated work tools to your employees who regularly work from home. Generally, as long as they pertain to work, fringe benefits are de minimis and not taxable.
If the nature of your work allows for it, you could offer more work-from-home or flex scheduling options around the holidays. This way, employees can relax a little more during the holiday season while they wrap up the year’s final tasks.
Temporary flexible scheduling is advantageous because your payroll tax obligations will not change. As long as things return to normal after the holiday season is over, you will not have to do anything different regarding your employees’ paychecks. They will receive the correct pay for the hours they worked, and you will keep your regular routine.
Make sure your employees know this is a holiday-specific perk. You should always be transparent about how similar bonuses will work moving forward, so your team knows what to expect.
As long as your line of work allows it, you could provide your employees with additional time off during the holiday season. How much time you award is up to you, but giving a little extra allows employees to spend more time with loved ones and return to the office feeling refreshed and ready for the new year.
Since payroll is involved, paid time off counts as taxable hours. Essentially, you will need to withhold taxes for the time you award your employees regardless of their time off. However, since it is not supplemental income, the tax rate stays the same as it would be on an employee’s regular paycheck.
Additionally, unless you plan to make this bonus a regular occurrence, you should ensure your employees know this is a one-time perk.
Create an employee feedback system to understand what type of holiday bonuses interest and would benefit them most. For example, workers in more demanding industries may appreciate extra paid time off or gift cards for relaxing and healing activities. If the company has fewer than 100 employees, it may be easier to consider individual employee preferences. For instance, some may prefer verbal recognition and awards, while others may enjoy flexible scheduling opportunities.
Here are a few other common questions employers have about holiday bonuses.
Not all companies will give a holiday bonus, but some do. One study showed that 51% of companies planned to offer Christmas bonuses in 2023. However, the average amount of companies giving bonuses may vary based on your industry and its dynamics. For example, another study by the U.S. Bureau of Labor Statistics shows a higher percentage of construction workers receive holiday bonuses compared to employees who receive holiday bonuses in the leisure and hospitality industry.
Reporting holiday bonuses may be done through the standard payroll system, which involves reporting cash and non-cash bonuses on the W-2 Form in box 1. Depending on the amount, reporting bonuses may involve state and federal taxes, retirement plan contributions, Social Security and Medicare using either the percentage or aggregate method. It’s important to report bonuses accurately and apply any tax deductions to the relevant business expenses.
You may simplify the process by contacting a tax professional to help you report holiday bonus tax correctly.
The IRS requirements for Christmas bonuses are the same as for other holiday bonuses because Christmas bonuses can be monetary gifts or non-monetary gifts, such as food, gift cards or a gift parcel. These may be subject to taxes and the same tax deductions that apply to holiday bonuses. It may help to speak with a payroll tax professional to ensure you tax them correctly.
The holiday season is a great time to give back to your team. Polston Tax Resolution & Accounting is here to help you through the tax process so you can reward your team without stress. Schedule a free consultation online or call us at 844-841-9857 to speak with one of our experienced team members today.
