Holiday cash bonuses must be reported for tax purposes

Practice Pointers. By Cathy B. Goldsticker, AMNews contributor. Dec. 18, 2006.

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Question: I am planning to give my staff holiday cash bonuses in the range of $100 to $1,000 per employee, depending on their past year's performance. In the past, I have put cash in an envelope and personally delivered one to each employee with my holiday wishes and a thank-you for all their hard work. Would this be a problem with the IRS?

Answer: Unfortunately, your methodology does not comply with the tax laws. Your practice can certainly give the employees a holiday cash treat. But it must be reported as supplemental wages, which are subject to federal, state and local payroll taxes.

It is allowable to provide noncash gifts of nominal value such as fruit baskets or small items, but anything that can be converted to cash, including gift certificates, must be reported as additional wages.

Reporting the cash payments as taxable employee wages will result in some unwelcome surprises. After you distribute the cash to your employee, you must subject the cash amount paid to taxes. If you add the gift amount to the employee's normal wages reported on the next scheduled payroll, it would be subject to federal income tax, Social Security and Medicare taxes, and state and local income tax withholdings.

These withholding taxes will be taken from your employee's normal net wages, and will result in their payroll check being substantially lower than usual. In addition, you must pay the matching employer Social Security and Medicare taxes, along with other employer taxes such as federal and state unemployment taxes.