With just a few weeks to go in the year, ‘tis the season for bonuses, holiday gifts, and other perks at the office. It can be challenging to navigate the niceties, but figuring out the tax consequences shouldn’t dash your holiday spirits. Here’s what you need to know.
Bonuses
Many companies pay out bonuses at year-end. If you receive a bonus from your employer, no matter how it’s paid out—cash, check, or crypto—you must report it as income in the year it’s received unless an exception applies.
You may be tempted to tuck it in your desk drawer until the new year, but you can’t skip out on reporting under Section 451(c)(4)(C), which makes clear that “an item of gross income is received by the taxpayer if it is actually or constructively received, or if it is due and payable to the taxpayer.” In other words, the IRS considers income yours when it’s made available, not when you pocket or deposit it.
There’s often a great deal of hand-wringing over bonus income because of the suggestion that it’s taxed at a different rate—only that’s not the case. A significant bonus could push you into a higher tax bracket, but the higher tax rate would only apply to the amount over the threshold. In other words, it’s taxed the same as any other additional income.
The confusion about taxing bonuses is likely tied to the withholding rules. When you are paid, your employer is required to withhold federal income tax—that applies to bonus income, too. But the rules can be a little different.
For purposes of withholding, bonuses can be lumped together in a bucket of income called “supplemental wages.” Those kinds of wages also include commissions, overtime pay, payments for accumulated sick leave, severance pay, awards, prizes, back pay, reported tips, retroactive pay increases, and payments for nondeductible moving expenses. There is some wiggle room when it comes to certain kinds of wages. The IRS lays those out in the Regulations at Section 31.3402(g)-1, but generally, supplemental wages can be described as additional payments that aren’t considered regular wages.
When it comes to supplemental wages, the payroll tax rules for Social Security and Medicare apply as usual. But depending on the amount in play, the federal income tax withholding could vary. Those rules can be complicated depending on which bucket you fall into:
- Taxpayers who receive more than $1 million in supplemental wages during the tax year; and
- All other taxpayers.
If you receive more than $1 million in supplemental wages during the year, the amount over $1 million is subject to withholding at the highest income tax rate for the year—currently 37%. For the rest of those wages—the amount under $1 million—the normal withholding rules apply.
If you receive $1 million or less in total supplemental wages, the withholding rules depend on how your bonus is paid:
- If your bonus is paid with your regular wages—a lump payment—your withholding is made as part of regular payroll.
- If your bonus is paid separately from your regular wages or if it’s paid together but broken out in the documentation, such as a single check with the bonus amount clearly stated, your employer has a little flexibility. The employer can either withhold a flat 22% on your bonus or use a formula based on combined withholding amounts.
While this seems complicated, remember that withholding can differ from your tax rate, and you can sort it out at tax time. If your employer withholds 22% of your bonus and your tax rate turns out to be 15%, you’ll be entitled to a refund. On the other hand, if your tax rate is 25%, you’ll have to pay the difference. The critical takeaway is that your tax rate remains the same; the withholding is what might change.
One more thing: Not all bonuses are paid out by year-end. If your employer promises to pay you a bonus in the future, that’s different from cash in hand. You won’t report it until it’s made available to you. That means a bonus paid in 2023 for a job well done in 2022 will show up on your 2023 Form W-2, and you’ll report it when you file your taxes in 2024.
Gifts
Workplace gifts are commonplace, from Secret Santa bags to white elephant gifts. Whether those gifts are taxable typically depends on who is making the gift.
As a general rule, gifts from coworkers given out of love and affection, and even those made out of a sense of obligation, are non-taxable. However, it’s worth noting that I’m focusing on income tax consequences and not gift tax since I’m assuming that your coworkers, no matter how generous, aren’t making gifts that exceed the $16,000 annual gift tax exclusion for 2022. (But if not, we all want to know where you work.)
Gifts from your employer are treated differently. The IRS considers most gifts made to employees compensation. As a result, those gifts are included in income for tax purposes, and withholding rules apply. This is always the case for cash and cash-equivalent gifts such as gift cards and gift certificates.
Some exceptions apply to certain non-cash gifts from your employer. Small tokens, such as fruit baskets, chocolates, and some branded swag, are considered de minimis—that’s Latin for “of minimal value.” The IRS exempts de minimis gifts from tax since they are “so small as to make accounting for it unreasonable or impractical.” There’s no official dollar threshold, but the IRS Fringe Benefits Guide refers to those with a “low FMV"—the same guide notes that “the IRS gave advice at least once, in 2001, that a benefit of $100 did not qualify as de minimis.” You can read that guidance here.
Non-cash gifts that are clearly not de minimis, such as a fancy briefcase or Taylor Swift tickets, are considered taxable income and are reportable.
Perks
What about holiday season perks? A firm holiday party or office dinner generally doesn’t result in tax consequences to employees—reasonable holiday parties are not considered taxable. And a plus to the employer? A holiday party for the benefit of all employees is considered a recreational, social, or similar activity and is deductible under Section 274. It’s a win-win for the entire office.
Final Word
The holidays can be tricky to navigate at the office. But don’t let the IRS make you grinchy. If you have questions about the treatment of bonuses, gifts, or perks, check with your tax professional.
This is a regular column from Kelly Phillips Erb, the Taxgirl. Erb offers commentary on the latest in tax news, tax law, and tax policy. Look for Erb’s column every week from Bloomberg Tax and follow her on Twitter at @taxgirl or Mastodon at @taxgirl@c.im.
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