Achievement Awards Are a Great, Tax-Free Way to Reward Employees
- Viktoriya Barsukova, EA, MBA
- Oct 24
- 6 min read
There’s really nothing more valuable to a business than good employees, particularly those who stick with you for years and years.
One way to honor those employees is to give them a meaningful present or award.¹
The tax code includes a special carve-out for “employee achievement awards,” which means that when you buy something for your employees in recognition of their years of service, you get a tax break—and your employees do, too.
A lasting present for your valued employees, plus tax breaks all around—that should make for a pleasant day at the office.
Even better, if you operate your business as a C corporation, you can receive these tax-free awards yourself because even though you’re an owner, you’re an employee, too. And with the work you put into making your business hum and researching ways to cut your tax bill, we think you deserve some recognition.
But for some reason lawmakers filled this area of the law with bizarre—and ridiculous—traps, so you need to tread carefully. But as long as you know the basic rules, you can safely use this tax break to reduce the cost of your employee awards.
A Break from the Normal
Normally, the money or property you give to your employees for their work is compensation, even if you intend for it to be a gift.² For employees, that means taxable income (income taxes and payroll taxes). For you, compensation ordinarily gives rise to a tax deduction, but you also have to pay the employer’s share of payroll tax.
Let’s say you want to thank your employee for being a high performer, so you give him or her a $400 bonus. If that bonus doesn’t qualify for a special tax break, you deduct the payment as compensation and pay payroll taxes, and your employee pays taxes on it, too—meaning he or she walks away with significantly less than the face amount.
Although your employee is likely to be happy about the present, he or she would probably be a lot happier getting the full $400 tax-free.
The employee achievement award tax break can make that happen.
What Counts as Employee Achievement?
There are two main types of tax-free achievement awards that you can give to employees:³
Length-of-service awards
Safety awards
This article focuses on length-of-service awards, because the limitations on safety awards are usually prohibitive for small employers. The tax break doesn’t apply for safety awards you give to
managers,
administrators,
clerical employees,
professional employees,⁴ or
more than 10 percent of your otherwise-eligible employees in any single year.⁵
The 10 percent rule is a backbreaker. It means you need at least 10 eligible employees before you can think about giving a safety award. Suppose you have four eligible employees and give one safety award—that’s 25 percent of your employees. Numerically it’s just hard for small businesses to satisfy that requirement.
The Five-Year Thank-You
Length-of-service awards, on the other hand, can be very useful. You can give this award to an employee every five years. That is, an employee must work for your company for at least five years before you can give him or her one of these awards, and you have to wait at least five years before you can give that same employee the next such award.
So, what kind of award qualifies? There are four requirements:
Tangible property. The award must be tangible property—not cash or a cash equivalent. Think things like watches, cookware, and televisions. The rules expressly prohibit you from using this tax break to give cash, gift certificates, vacations, meals, tickets, lodging, or stock.⁶
Employees can choose their own awards, such as from a catalog that provides a list of options. Or you can simply ask your employee to tell you what he or she wants.
Meaningful presentation. You must give the award during a “meaningful presentation.” That doesn’t mean you have to put up streamers and serve champagne, but you should have some sort of “ceremonious observance” in which you recognize your employee for his or her service.⁷
Deduction limit. In general, tax law limits the deduction for achievement awards to no more than $400 per employee per year.⁸ The cost of the award can exceed that amount, but that means tax—both to you and to your employee—so it’s better to avoid this.
There’s an exception to this $400 limit when you set up a “qualified plan,” but there’s a big catch, which we’ll discuss later.
No disguised compensation. You can’t cut the employee’s salary simply to give a tax-free achievement award, or otherwise give the award as a disguise for normal compensation.⁹
How to Calculate the $400 Limit
The $400 limit refers to the cost to you, not the fair market value of the item.¹⁰ That could come in handy, because as a business owner you may be able to buy items for less than their market value.
Suppose you give your five-year employee a watch that cost you $350 but has a fair market value of $425. You’re in the clear. The award qualifies as a tax-free employee achievement award, so you get a full deduction for the $350 expense, and your employee pays no tax for receiving the item.¹¹
Caution. The tax code has an exception for items you obtain at steep discounts. If the cost of the award to you is “disproportionately” less than its fair market value, you might violate the $400 limit. There’s no exact percentage for what counts as disproportionate, but the offending example in the regulations involves an item that cost the employer $350 but had a fair market value of $900.¹²
What Happens When You Exceed the Limit
Example. You give an award that cost you $1,000, which is also its fair market value.
Your deduction is $400 for the award. You deduct the $600 excess as W-2 compensation to the employee.¹³ Your employee has $600 of W-2 compensation on this $1,000 gift.
Qualified Plan Exception
Tax law increases the $400 limit to $1,600 per employee if you give the award pursuant to a “qualified plan,” which is a written document that memorializes your award program and that doesn’t discriminate in favor of highly compensated employees.¹⁴
That sounds great, but there’s a big catch. Under the qualified plan rule, the average of all the employee achievement awards you give in a year cannot exceed $400, and to calculate that average, you must ignore any awards you give that cost $50 or less.¹⁵
Example. You have five employees who qualify for the five-year award. One employee has just completed 20 years with your company, and the other four have completed five years. The 20-year employee has not received an award from you in this year or the previous four years. You could give a $1,600 award to the 20-year employee and a $100 award to each of the five-year employees, as long as you have a qualified written plan. In this case, you gave $2,000 in awards, for an average of $400 ($2,000 ÷ 5).
For a sample qualified plan that you can use,
Treat Yourself
If you operate your business as a C corporation and you are an employee of that C corporation, your corporation can give you periodic employee achievement awards, the same as it could to any other employee.
Don’t forget to act surprised when you get your tax-free present.
S corporation owners and sole proprietors do not qualify to receive employee achievement awards.¹⁶ Remember that an S corporation owner includes anyone who owns at least 2 percent of the stock of the company (as well as the spouses, children, grandchildren, and parents of those 2 percent owners).¹⁷
Takeaways
If you have employees who have worked for you for years and years, you may want to give them something to show your appreciation.
For presents that qualify as employee achievement awards, tax law provides a nice break for you and your employees. The most useful of these awards for small-business owners is the one based on length of service.
You can give an employee a length-of-service achievement award every five years. The award must be tangible property, not cash, and is tax-free only to the extent it costs $400 or less.
The tangible property requirement may seem like a limitation, but there’s a positive side, too. While cash is great, it’s also impersonal, and once it’s gone, it’s gone. But a tangible present, like a watch, may be something your employee sees every day and can serve as a continuing reminder of your gratitude.
So, go out and make your employees happy. That may guarantee a lot more five-year anniversaries for you and your employees to look forward to.
New Feature: Client Letter on This Article for Use by Tax Pros,
References - Achievement Awards Are a Great, Tax-Free Way to Reward Employees
(2017)
Achievement Awards Are a Great, Tax-Free Way to Reward Employees. This information is based on materials from Bradford Tax Institute.
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