There is an old adage that says "No good deed goes unpunished," and so it can be for the unwary employer who pays a year-end or holiday gift or bonus. If not handled correctly, payment of such gifts and bonuses can give rise to both overtime and tax issues. With that in mind, here are a couple questions that we frequently get this time of year:
Does a holiday bonus or the value of a gift card given to employees for an achievement or for their years of service have to be added to the employees' wages for purposes of calculating overtime?
Usually not, but you need to be careful. The Fair Labor Standards Act allows employers to exclude discretionary bonuses and gifts from employees' wages when calculating overtime. In order to meet this exception, the bonus must truly be discretionary--both as to whether it is paid and as to how much is paid--and the bonus must not be part of an agreement or prior promise the employer made to the employee. So, an employer cannot pay employees a lower wage but promise them that they will receive a large year-end bonus to compensate them, without triggering overtime obligations. Similarly, employers may give their employees gifts or bonuses to reward them for their service, provided the amounts paid are not tied to hours worked, attendance, production or efficiency. If the gift or bonus is tied to one of those factors or if it is provided pursuant to a prior agreement, it is not a "gift" and must be included in the employee's regular rate of pay for overtime purposes. These exclusions apply only to overtime, and do not affect the taxable basis of this income. Employers should keep in mind that they cannot circumvent the wage-hour laws by giving gift certificates or gift cards in lieu of cash bonuses unless the gift card meets the requirements discussed above. If the certificate or card does not, its value must be included in the employee's regular rate of pay for overtime purposes.
Will the value of a gift certificate or gift card be included in an employee's gross income for purposes of income taxes?
It depends. Section 132(a)(4) of the Internal Revenue Code provides that de minimus fringe benefits do not have to be included in an employee's gross income. De minimus fringe benefits are defined as "any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer's employees) so small as to make accounting for it unreasonable or administratively impracticable." Under IRS regulations, cash and cash equivalents are not de minimus fringe benefits. The regulations include gift certificates within the definition of cash equivalents.
Notwithstanding the IRS's position, case law on the subject of gift certificates and gift cards has been divided. In one case, gift certificates of $25 and $15 denominations given as Christmas gifts were not included in employees' gross income because they were from the employer, a greeting card manufacturer, to be used only in stores that sold the employer's products (Hallmark Cards, Inc. v. United States, 9 AFTR 2d 391; 200 F. Supp. 847 (1955)). Because these gift certificates were of relatively small value, not convertible to cash, and were usable only to purchase merchandise at restricted stores, the gift certificates were not considered part of employees' reportable gross income. In another case, however, gift certificates were considered taxable income because they were readily transferable or easily converted into cash (American Airlines, Inc. v. United States, 81 AFTR 2d 98-1397; 40 Fed.Cl. 712 (1998)). The gift certificates were American Express cards, which were easily convertible to cash. Also, the gift certificates were not made out to individual employees and could be used at any restaurant. Because these gift certificates were "subject to virtually no restrictions" they were treated as cash equivalents.
In light of these cases and the IRS's position, employers who do not want to hassle with including the value of a gift card or gift certificate in the employee's income would be well advised to provide cards or certificates that are nontransferable (i.e., made out to a specific employee), accepted by only one or a limited number of merchants, redeemable only for merchandise, given at or around the holiday or on other special occasions to promote goodwill, and the cards or certificates should not be in large denominations.
If you have any questions regarding bonuses, wage-hour compliance or any other labor and employment matter, please feel free to contact any member of our Labor and Employment Practice Group.