Tax consequences of employer gifts to employees

Editor: Mo Bell-Jacobs, J.D.

It is common for employers to provide their employees small tokens of recognition for their birthday, their work anniversary, or another personal or work-related event. The tax treatment of such “gifts” can vary depending on their form and the circumstances surrounding the transfer. While employers often incorrectly assume gifts to employees (and even to other service providers, such as independent contractors, hereafter collectively referenced as “employees”) are nontaxable to the employee and fully deductible by the employer, the facts and circumstances of each case determine the correct tax treatment.

While Sec. 102 provides a general exclusion from gross income for gifts and inheritances, under the general rule of Sec. 102(c), any amount transferred by an employer to or for the benefit of an employee is not excluded from the employee’s gross income unless another Code section specifically excludes that benefit. Thus, the default rule is that “gifts” provided to employees should be reported as taxable compensation, but employers might be able to provide some gifts tax-free under one of several exceptions.

Prop. Regs. Sec. 1.102-1(f)(1) lists several of the typical exclusions for items given to employees. These are well known and frequently used by employers, including Sec. 74 employee achievement awards, Sec. 132 de minimis fringe benefits, and Sec. 117 qualified scholarships. Together, Secs. 74(c) and 274(j) govern tax-free employee achievement awards (for length of service or safety achievement). Employers need to keep a number of requirements in mind to qualify for any of these tax-free exceptions, which vary depending on the type of award.

De minimis fringe benefits under Sec. 132(e) include almost any low-value property or service that is provided infrequently and would be administratively impracticable to track. An example would be giving employees a T-shirt or water bottle infrequently. However, gift cards are almost always excluded from the de minimis rules, no matter how low the dollar amount because they are cash equivalents. Regs. Sec. 1.132-6 provides other exceptions under the de minimis rules if the frequency requirements are satisfied, including group meals (such as if a manager takes a group of employees out to celebrate an employee’s birthday), flowers, and even occasional theater or sporting event tickets.

In addition, Sec. 139, which governs disaster relief payments, also permits excludable personal payments to employees under very narrow circumstances. Sec. 139 provides a special rule under which an employer can provide significant personal assistance to an employee if the employee has been substantially affected by a presidentially declared federal disaster (such as a major hurricane). However, payments made by a company or executive after more individual or personal calamities, such as assistance to an employee after a house fire, are likely taxable if the assistance is provided by the company or by management (i.e., having a manager or executive write a personal check to the employee does not prevent the payment from being taxable compensation if the payment is made in connection with an employment relationship).

Under Duberstein, 363 U.S. 278 (1960), and the line of cases following it, most “gifts” to service providers from a company (or management) are not likely to be viewed as being made because of “disinterested generosity.” Instead, when there is an underlying employment relationship, the general assumption is that the transfer of property is at least in part based on anticipated benefits or economic return rather than because of disinterested generosity.

However, under a narrow set of facts, the employer may have a supportable argument to treat a transfer to an employee as a Sec. 102 gift that is excludable from gross income. Prop. Regs. Sec. 1.102-1(f)(2) provides that Sec. 102(c) will not apply to amounts transferred between related parties (e.g., father and son) if the purpose of the transfer can be substantially attributed to the familial relationship and not to the circumstances of their employment.

Example: D is an executive of X Inc., and D’s son also works for X. D makes a transfer of $20,000 of X stock to his son for his birthday and did not make similar transfers to other, unrelated employees. This transfer is likely made because of the blood relationship rather than the employment relationship and thus can generally be treated as a gift. Of course, given the amount of the gift, D may have to consider gift tax issues.

The courts have occasionally acknowledged that an employee may sometimes receive an item from an employer that is indeed a Sec. 102 gift even though there is no specific blood relationship. However, that conclusion depends on finding another relationship between the employer and employee (in addition to the employment relationship) supporting the argument that the transfer was made for personal reasons and was unrelated to the employment relationship. In most cases, these have been quasi-familial relationships (such as a “significant other” or an employee who has become “like a family member” to an owner). Merely being fond of an employee and having a close working relationship (such as being a mentor) is not likely to override Sec. 102(c). Given the starting point under Sec. 102(c), providing that a “gift” from an employer to an employee is generally treated as compensation, any alternate treatment needs to be supported with extraordinarily strong facts regarding the nature of their relationship outside of employment.

The courts have dealt with several fact patterns in which individuals argued that a payment from an employer was out of affection rather than because of the employment relationship.

In Hatch, T.C. Memo. 2012-50, the Tax Court held that payments received by the taxpayer and reported on Form 1099-MISC, Miscellaneous Income, were compensation in exchange for clerical services provided. While the taxpayer argued that she was an employee and should not have been issued a Form 1099-MISC, the court held that it made no difference whether the wages were earned in the context of being an employee or a contractor. As there was no evidence to suggest the amounts paid were anything other than wages for the clerical services performed, they were not excludable from income.

In Hajek, T.C. Summ. 2005-179, the Tax Court held that payments the taxpayer received were compensation for managerial services provided. The company was owned by the taxpayer’s father-in-law, the payments were issued from company funds, and there was no written agreement suggesting the payments should be characterized as anything other than compensation for managerial services rendered. Although there was a familial connection, the facts were not strong enough to support a conclusion that the payments were a Sec. 102 gift.

In Caglia, T.C. Memo. 1989-143, the Tax Court held that a $15,000 payment the taxpayer received from the operator of the company for which she worked was a Sec. 102 gift and excluded from her gross income. Beyond their employment relationship, the taxpayer and her employer often went on gambling trips together because they enjoyed each other’s company. There was no evidence to suggest the payment represented a bonus for the taxpayer’s services rendered as an employee. Further, as an employee, the taxpayer received a yearly salary, which did not increase during the years in dispute, as the company was financially strapped. The court determined that the relationship outside employment was strong enough to support a conclusion that the payment was made based on the outside relationship and therefore constituted a gift. The court distinguished this payment from other payments that were compensation or loans.

An employer can explore several avenues to potentially provide tax-free gifts to employees, but each comes with its own requirements to qualify for preferential tax treatment. When in doubt, or if they are not willing to obtain significant support for the details of an “outside of employment” relationship, employers generally choose to include the value of any “gifts” provided to employees as taxable compensation unless they are confident that the requirements for exclusion have been satisfied.

Editor Notes

Mo Bell-Jacobs, J.D., is a senior manager with RSM US LLP.

For additional information about these items, contact the author(s) of this item: Karen Field, J.D. (Karen.Field@rsmus.com), Washington D.C., and Nicole Kelley, CPA, MST (Nicole.Kelley@rsmus.com), McLean, Va..

Contributors are members of or associated with RSM US LLP.