Safety Scratch Offs

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Easy-to-implement program where you distribute scratch off cards worth points toward trips and prizes. Learn More

 

Online Points Program

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Customize your own points program and give employees the ability to redeem points online. Add it as an overlay to any BBS or safety program.

Is Your Incentive Program a Ticking Time Bomb?

By Bill Sims, Jr.
800-690-1860

You call this a bonus???
Hourly workers at Tower Automotive received $15 gift cards redeemable at Meijer grocery-retail stores before Thanksgiving. Then the automotive supplier decided the cards were "same as cash" gifts subject to federal and state income taxes totaling 36.75 percent.

That means the "gift" will take $5.51 out of the workers' next paychecks. "It's got a lot of people ticked off," said Donald McKee of Kingsley, a welding technician. "This is the lowest they've gone yet to give us something and then take it back."

United Auto Workers Local 5110, which represents about 300 hourly workers, has filed a contract grievance over the matter. Some workers also have returned the gift cards rather than pay the tax.

Courtesy Associated Press.

As the experience above clearly shows, employee recognition can have some very unexpected repercussions.

In this article, we’ll explore the most common mistakes managers make when it comes time to reward people for a job well done. Then you can examine your own firm and how it handles employee recognition to see if your policies are in compliance with IRS law.

Is your incentive program a ticking time bomb? Thousands of companies are at risk from an IRS audit in these areas. Here are the basic things you need to know to stay out of hot water...

Common Mistakes about Taxes and Employee Awards

Here is a list of the most common inaccurate beliefs that we encounter as we talk with managers at Fortune 500 companies....

Mistake Number One...
"Gift Certificates don't have to be taxed since they are not cash, right?"

WRONG. The IRS tax code section says...

"For purposes of paragraphs (b)(2)(iii) and (iv) of this section, the term "tangible personal property" does not include cash or any gift certificate...

Similarly except as otherwise provided in paragraph (d) of this section, a cash equivalent fringe benefit (such as a fringe benefit provided to an employee through the use of a gift certificate or charge or credit card) is generally not excludable under 132(a) even if the same property or service acquired (if provided in kind) would be excludable."

 

This is why Toyota spends $1,000,000 on Sears gift certificates per year, and pays $920,000 in income taxes so the $1,000,000 will not have to be taxed to the employees...can you believe $920,000 lost to taxes?

Some companies hope to hide the gift card by printing on it, "Not redeemable for cash." Actually this is just wishful thinking. The IRS rules state that if you can add more money to the card to get a better gift or if you can get change back it is a cash substitute. And should be taxed as such.

Hoping to sneak it by the IRS?
A life insurance company in South Carolina awarded its employees with gift $5 and $10 gift certificates to local department and discount stores without taxing them. The assumption was that they shouldn't be taxed, since they weren't being awarded cash. The Internal Revenue Service took a different view. Citing numerous laws and sections of the tax code, they argued that gift certificates are merely disguised compensation. The insurance company was forced to research and document every gift certificate awarded to every employee over a 4-year period since their incentive program began. When the smoke cleared, the original $65,000 worth of gift certificates cost this company well over $180,000 in taxes, penalties, interest, and legal fees to resolve the dispute.

Mistake Number Two...
"As long as you keep it under $400 per person per year, the government lets you award whatever you want tax free, correct?"

WRONG. The tax code limits these "qualified award plans" as follows....

* Awards must be tangible gift items, no cash or gift certificates or gift cards are allowed.

* Awards for safety can ONLY be awarded to 10% of your employees a year, e.g. if you have 500 people, only 50 can win something. That doesn't do you much good if you're trying to reward everyone (a fundamental ingredient in good incentive programs).. Service Award plans aren’t much better—you are limited to one award item given away every 5 years.

Mistake Number Three...
"Aren't logo'd gifts tax free?"

Actually, the tax code is quite clear here too. Logo'd gifts UNDER $4 US in value are tax-free. Anything OVER that is taxable---whether it has a logo or not is immaterial.

Mistake Number Four...
Big Ticket Items

All too often we hear from managers who have told employees they’ll be doing a drawing for a car or a cruise vacation. And the IRS is very clear that employers must withhold tax on this type of award. Since employees quickly become livid at their 5 figure income tax bill, usually the employer has to eat the tax and gross up the employee’s award.

One construction firm bought a $20,000 Harley Davidson Motorcycle and awarded it to an employee who won a safety contest. When he received his income tax bill, he filed a Union Grievance. The employer wound up paying another $17,000 in income taxes in addition to the cost of the motorcycle. Let’s hope they at least got a happy biker from their ordeal.

Mistake Number Five...
Confusing Recognition with Compensation

Surveys show that companies consistently use cash or cash substitutes (gift cards, Visa Debit Cards, etc.) as motivators.

Yet studies show that you have to award ten times as much cash to equal the recognition value of a tangible gift item. (Think about it...what wedding gifts do you remember most? That Anniversary clock that still faithfully ticks away on your mantle? Or the $50 bill your Aunt and Uncle gave you?) In an impressive study by Goodyear, two groups of 500 tire dealers were given identical sales award programs with only one difference - one group received cash, and the other one received merchandise awards. The merchandise group outperformed the cash group by a factor of three to one. (See www.billsims.com for the Goodyear Study),p> For over 20 years, employee surveys consistently rank a need for recognition as more important than more money.

So, a key question to ask about your award is: "Will this be perceived as a trophy?" or just viewed as a pay bonus?

Using a tax free award merchandise program will not only help reduce or eliminate taxes, it will help meet a basic employee need: recognition.

Mistake Number Six...
Our employees don’t make that much, so taxes will be lower for us than 40%...

Here are the hidden taxes managers conveniently forget...

 

  • 35% Federal Income Tax
  • 7% State Income Tax
  • 13% Unemployment Tax
  • Medicare, Social Security, and Workmen’s Comp costs (yes these are tied to payroll and can run as high as 25% for some industries.
  • Administrative expense to report, calculate and pay taxes on small awards

Mistake Number Seven...
Going Cold Turkey from Cash to a Non Cash Program

Once you start a large budget cash or gift card program, it’s very hard to take it away.

Many companies find out the hard way, when employees perceive the change as a negative, take away move.

Instead, work to slowly wean off of cash over a period of 3 years. Structuring the change carefully makes it easier to swallow for your employees.

Developing a Tax-Free Recognition Plan
Carefully structuring an award program to navigate around the legal landmines allows you to develop a program that is tax-free AND legal. Use a recognition consultant who knows the ropes to make sure that you avoid tax trouble.

Employee recognition programs are alive and well in the year 2004. We applaud managers who vigorously question the status quo and are not afraid to shake things up as they look for other ways to improve their recognition process.

As someone once said, "Sacred Cows make the best hamburgers."

Contact Information: Bill Sims, Jr. is President of Bill Sims Award of Excellence, an incentive consulting firm based in Columbia, S.C. Email: This e-mail address is being protected from spambots. You need JavaScript enabled to view it and website: http://www.billsims.com. Phone: 800 690 1860.