Ask Fred: Are Prizes and Awards Taxable?

Question: Throughout the year, my employer provides employees with various types of awards, like “employee of the month” or “top sales earner,” or for length of service. Some of the awards are cash, while others are personal items such as a gold watch or artwork. Are these items taxable?

Answer: Any time an employer provides employees with tangible property, it more than likely will be taxable income. As discussed in a previous article, cash will most always be taxable income.

Here, we are talking about prizes and awards. Some of the most common prizes are those distributed during a company function like an annual employee picnic or holiday party. The first thing to look at is the type of prize being provided. If a company has an annual summer picnic and there are only small nominal prizes given to children, there should be no concern that the prizes are taxable income to the recipients or related employees. However, if significant door prizes that do not qualify as de minimis are handed out, they should be treated as taxable income.

Like prizes, there are several types of awards. To promote comradery, team building, and employee morale, employers often provide awards as recognition for a job well done. Examples might include employee of the month or salesperson of the year. Regardless of what it is for, it will more than likely be considered taxable income because it is a reward for doing something.

When teaching this subject, I often said the best way to determine if something is taxable is to figure out how or why the employee was given the award. If the employer says to the employee “if you do this for the company, the company will do this for you,” then the reward is taxable. For example, if the employer says to the team “the first person to complete their monthly reports will be given a 43-inch flat screen TV,” then the value of that TV would be taxable income to the employee receiving it because the employee earns it for work performed.

Not every prize or award is taxable. Internal Revenue Code Sections 74(c) and 274(j) say length-of-service and safety achievement awards can be excluded from income under certain circumstances.

Both types of awards can be classified as a qualified or nonqualified plan award. For a length-of-service award to be qualified, the award must be made after an employee’s first five years of employment, and the employee cannot have received another length-of-service award during the year or the previous four years.

For a safety achievement award to be qualified, no more than 10% of employees can be given a safety achievement award during the year, and it must be given to an employee who is not a manager, administrator, clerical employee, or other professional employee.

As an example of a qualified safety achievement award, imagine an employer with 20 departments that each have five employees. The employer promises to give a TV to each of the employees of a department that has no accidents in a month. During the month, 19 departments had accidents and only one did not. Since 10% of those eligible equals 10 employees, and only five won the award, those five awards would be qualified safety achievement awards. However, if three departments had no accidents in a month, the number of eligible employees would exceed the 10% threshold, so the resulting awards would not be qualified.

For both length-of-service and safety achievement awards to be qualified plan awards, the employer must award employees as part of a meaningful presentation and under conditions that do not create a significant likelihood of it being disguised pay.

If your boss comes into your office and presents you with a gold watch in recognition of your years of service, that is not a meaningful presentation and could be construed as a form of disguised compensation. Instead, have the boss present the award in a ceremony with others present who can witness the event.

From a qualified plan, the cumulative amount of awards given to an employee cannot exceed $1,600 dollars in one year, and the average cost or fair market value of the individual awards cannot exceed $400 each. This is calculated by dividing the total cost of all awards by the number of awards given to that employee.

For example, if the company provides an employee with a $600 watch and a $100 bracelet, the average value of each award is $350 ($700 total divided by two). Because this is less than $400, both items can be excluded from income.

An award that does not meet the qualified criteria is a nonqualified award and can be excluded only if it is valued at no more than $400. Any amount above $400 is taxable income.

As a reminder, these exclusions are only for tangible items such as watches, jewelry, or artwork. Anything that is cash in nature, including gift cards, vouchers, and checks, is 100% taxable.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information Fred A. Basehore, Jr., CPP is owner of F.A. Basehore & Associates offering payroll and payroll tax compliance services and a member of the Bloomberg Tax Payroll Advisory Board. Do you have a payroll question for Ask Fred? Send it to fabjrcpp@yahoo.com.