Want to show your employees you appreciate their hard work throughout the year? You might decide to distribute gift cards to your employees. But before you start doling them out, you need to know …. Are gift cards taxable?
First, the technical stuff
This IRS has rules on employee gifts and benefits, like gift cards. A gift card, or gift certificate, is a type of fringe benefit. Fringe benefits are benefits you can give employees in addition to their regular wages.
A fringe benefit can be taxable or nontaxable, depending on what it is. Taxable fringe benefits are subject to federal taxes:
- Social Security
- Federal unemployment (FUTA)
Nontaxable fringe benefits may be excluded from one, some, or all types of taxes. Some nontaxable fringe benefits are classified as de minimis fringe benefits.
A de minimis fringe benefit is an item with low value that you give to employees infrequently. Don’t withhold taxes from or account for de minimis benefits. Some examples of de minimis benefits include fruit baskets, holiday hams, and company parties.
Keep in mind that cash is never considered a de minimis fringe benefit. Cash is considered a supplemental wage (e.g., bonus). If you want to give an employee cash, you must withhold taxes and record them.
So, which is it? Are gift cards taxable income, like cash, or are they de minimis fringe benefits, like fruit baskets?
Are gift cards taxable?
Yes, gift cards are taxable. According to the IRS, gift cards for employees are considered cash-equivalent items. Like cash, include gift cards in an employee’s taxable income—regardless of how little the gift card value is.
But, there is an exception. You might be able to exclude gift cards you give employees for a specific item of minimal value (e.g., a ham). Check with a tax professional if you have questions about whether you need to withhold taxes on gift cards.
For all other gift cards, record the value and pay the appropriate amount of taxes.
How are gift cards taxed?
A gift card is a type of supplemental wage. So, you need to withhold taxes on gift cards the same way as any other supplemental pay.
Withhold federal income, Social Security, and Medicare taxes from an employee’s gift card amount. If applicable, you may need to withhold state income tax.
You can withhold federal income taxes on supplemental wages—aka gift cards—in one of two ways:
- Percentage method: Withhold a flat rate of 22% for taxes
- Aggregate method: Add gift card amount to regular wages and withhold taxes on the combined amount
Like federal income tax, many states also have their own supplemental withholding tax rate for state income tax. Withhold Social Security tax (6.2%) and Medicare tax (1.45%) like normal.
Taxing those gift cards: Example
Let’s say you wanted to give an employee a $100 gift card for the holidays. You decide to use the percentage method for federal income tax.
Follow these steps to determine how much to withhold from the gift card for taxes:
First, multiply the gift card value by 22% to find the federal income tax:
$100 X 0.22 = $22.00
Now, multiply the gift card value by 6.2% to find the Social Security tax (unless the employee has reached the Social Security wage base):
$100 X 0.062 = $6.20
Next, multiply the gift card value by 1.45% to find the Medicare tax (unless the employee is responsible for additional Medicare tax):
$100 X 0.0145 = $1.45
Last but not least, add up all the tax amounts and subtract from the gift card value of $100:
$22.00 + $6.20 + $1.45 = $29.65
$100 – $29.65 = $70.35
If there are state and/or local income taxes for your business, withhold those as well.
So, after federal income, Social Security, and Medicare taxes, your employee would receive a gift card for $70.35. Not the ideal amount, right?
What to do about random gift card amounts after taxes: Gross up!
Sure, your employees will probably be grateful for whatever amount you decide to give them. But, you probably didn’t envision giving employees gift cards with random balances. Your employees might even think you took their gift card for a joy ride before giving it to them.
What’s an employer to do? Keep guessing until you get a “normal” gift card amount? Thankfully, you don’t have to play the guessing game. You can do a tax gross up.
To account for the taxes you must withhold from employees’ gift cards, gross up the amounts.
Grossing up a gift card is a relatively easy process (it’s even easier if you have payroll software).
Use the following steps to do a gross-up calculation:
- Add up all the tax rates that apply to the gift card
- Turn the total tax rate into a decimal (if you haven’t done it already)
- Subtract the total tax rate decimal from 1 to get your net percent
- Divide your desired gift card amount by the net percent to get your gross pay amount
Grossing up gift cards: Example
Everything’s always a little bit easier with an example, right? Let’s go back to the $100 gift card amount.
Step 1: Add up all the tax rates that apply to the gift card
Let’s say your business is in a state without state or local income taxes. Add together the tax rates of 22% (federal income tax), 6.2% (Social Security tax), and 1.45% (Medicare tax).
22% + 6.2% + 1.45% = 29.65%
Step 2: Turn the total tax rate into a decimal
Now, turn 29.65% into a decimal: 0.2965.
Step 3: Subtract the total tax rate decimal from 1 to get your net percent
Subtract your decimal of 0.2965 from 1.
1 – 0.2965 = 0.7035
Step 4: Divide your desired gift card amount by the net percent to get your gross pay amount
Almost there. Next, divide the amount you want to give the employee, $100, by 0.7035.
100 / 0.7035 = 142.15
To give your employees a gift card with a value of $100 after taxes, record it as $142.15 gross and withhold $42.15 for taxes.
Accounting for gift cards given to employees
When you give gift cards to employees, include the value in the employee’s wages on Form W-2.
Include the amount in box 1 (Wages, tips, other compensation), box 3 (Social Security wages), and box 5 (Medicare wages and tips).
You can also report the total amount of fringe benefits you give employees in box 14 (Other) on Form W-2.
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This article has been updated from its original publication date of December 13, 2017.
This is not intended as legal advice; for more information, please click here.