It’s officially the most wonderful time of the year, and in the workplace, the holidays often mean year-end or holiday employee bonuses. While this is a celebratory time, there are significant tax considerations for these earnings. Gift cards and awards also must be included in employee wages and it is important to correctly record all these transactions in payroll and on the employees’ W2’s*.
For employee tax purposes, the IRS only cares about when the employee receives payment, they do not care about the time period it was earned. In order for the bonus to be included in the employee’s 2016 W2, the check date (receipt of payment) must be on or before December 31, 2016.
Supplemental wages are defined by the IRS as wage payments to employees that are not regular wages. They include, but are not limited to bonuses, commissions, overtime pay, awards, and prizes. For federal income tax purposes, the IRS recommends taxing bonuses at the “supplemental” tax rate of 25%. Alternatively, bonuses can be included with the employee’s regular cycle paycheck. For those lucky few who have year-to-date supplemental income over $1 million, a mandatory 39.6% flat rate must be applied to all additional supplemental wages for the year. Some states like California also have special supplemental tax rates.
Employees may opt to have 401(k), 403(b), 457(b), or non qualified deferrals deducted from their bonuses. While these deferrals reduce the employee’s taxable wages for federal income tax, they do not reduce the employee’s social security or Medicare taxes. The employee should be taxed for social security and Medicare on the full amount of the bonus even if they opt for a deferral deduction.
Employees may become subject to additional Medicare with the additional bonus earnings. Employers are required to withhold this 0.9% tax once employee earnings exceed $ 200,000, regardless of the employee’s filing status.
Based on the tax considerations above, you can enter the holiday employee bonus on the employee’s regular cycle paycheck or on a separate check using a supplemental tax rate.
Even if you are paying the employee outside of the payroll system, you still need to record that payment in your payroll system so that the correct taxes are calculated and deposited with the agencies, and so that it is reflected in the employee’s W2. It is best to update your payroll system before issuing any payments, making sure that entry will not generate actual pay to the employee.
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According to the IRS, cash or cash equivalent items provided by an employer, including gift cards, need to be included as employee income. The amount can be entered on the employee’s regular check, together with an offsetting after tax deduction. This will result in recording the income to the employee without creating additional pay. An example would be if Bob was given a $100 gift card to a grocery store for the holidays. We could have a fully taxable earnings code called “Gift Card,” and an after tax deduction called “Gift Card” offset. We could enter the transaction on a regular payroll before the end of the year as follows:
Regular Pay – $ 1,500
Gift Card (Taxable) – $100
Gift Card Offset (After Tax) – $100
This will properly record the earnings to the employee and collect the taxes. An alternative would be to enter “gross up” earnings where you enter the gift amount plus all of the employee taxes as earnings. The net pay amount would be equal to the amount of the gift card.
There is much to consider when issuing holiday employee bonuses and gifts. It is important to plan ahead and make sure these transactions are properly recorded in your payroll system in the correct tax year. This will help ensure you not only have a Happy New Year but also a happy year-end. Speaking of year-end, in my next post I want to highlight some important information to validate in the payroll system before the end of the year.
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W2: Form W2 is a Wage and Tax statement employers are required to provide employees and file with the Internal Revenue Service at the end of each year. It contains wages earned and taxes withheld for the year, based on the date the employee received payment (check date). All checks dated 01/01/2016 to 12/31/2016 should be included in the 2016 W2.