Are Employee Rewards a Taxable Benefit?

Disclaimer: The advice shared in this publication is intended for informational purposes only. It does not replace the expertise of accredited professionals. Please review the governing tax laws in your jurisdiction and consult your finance team.‍

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Implementing an effective employee recognition program can have a lasting impact on your business.  

While recognition should always come first, adding an employee rewards component to your program can be a low-cost benefit that reminds your team they are valued and appreciated.

That said, when employees redeem points for rewards, the tax implications are not always clear-cut. When it comes to Kudos Rewards specifically, a question that always comes up is, "Should we consider the rewards in Kudos a taxable benefit?"

The short answer is - it depends!

What constitutes a taxable benefit differs by country, state, province, company type, and many other unique factors.

Technically most gifts given to employees (including Kudos Rewards) are considered taxable benefits. That means that they are considered additional income, and the value of the reward should be included in your employee's year-end tax forms. But ultimately, this is at the discretion of your finance team.  

The good news is, while understanding taxable benefits might be new to you, it's basic language for your finance team.  

“They deal with these concepts regularly and will be able to support you every step of the way. Whether it's calculating the tax impact or ensuring compliance with IRS guidelines, your finance team has the expertise to handle it smoothly.” - Asif Samnani, Director of Financial Planning and Analysis at Kudos.  

What are taxable benefits?

Taxable benefits are any perks or rewards given to employees that the government considers part of their compensation. These benefits can include things like:

• Cash bonuses

• Gift cards

• Other rewards that have a monetary value

Essentially, if the reward is something that can be converted to cash, it's likely taxable.

Are taxable benefits part of employee compensation?

Yes! Think of taxable benefits as an extension of your employees' salaries. Just like health benefits or retirement contributions, taxable benefits are a part of the total compensation package.

Budgeting for taxable benefits

From a budgeting perspective, taxable benefits should be factored into your overall compensation strategy. This means planning for the tax implications just as you would for other employee benefits. For example, if you give a $100 gift card to an employee, it's not just the cost of the gift card you need to budget for, but also the associated taxes.

How to calculate taxable benefits

Calculating taxable benefits might sound daunting, but it's not too complicated. To start, let’s get some terminology out of the way:  

1. Cash Equivalents: If the reward is cash or can be easily converted to cash (like gift cards), it's taxable. These need to be reported and taxed just like regular income.

2. Tangible Personal Property Awards: These are rewards that are not easily converted to cash, such as a physical trophy or a plaque. These are typically not considered taxable if they are of nominal value and given infrequently.

Employee rewards that are cash equivalent are taxable, so they can be calculated similarly to a cash bonus. Here’s a detailed example:

Scenario: You give an employee a $500 cash bonus.

Gross Up Method: To ensure your employee receives the full $500 after taxes, you need to calculate the gross amount.

1. Let's say the tax rate is 30%.

2. The formula to calculate the gross amount is: Net Amount / (1 - Tax Rate)

3. So, $500 / (1 - 0.30) = $500 / 0.70 = $714.29.

4. Therefore, you need to budget $714.29 to cover the $500 bonus and the taxes.

Regular Calculation: Alternatively, if you simply add $500 to the employee's income, it will be taxed at their regular income tax rate.

1. If their tax rate is 30%, the employee will receive $500 - ($500 * 0.30) = $500 - $150 = $350 after taxes.

2. This method means the employee gets $350 after tax, and you only need to budget for the $500.

Your finance team can help you decide which method to use and ensure accurate calculations for your employee rewards budget.

Fitting taxable benefits into your employee rewards strategy

To better understand how taxable benefits fit into your recognition and rewards strategy, here’s a simple breakdown:

Scenario: You want to give each of your 500 employees a $100 gift card as a reward.

1. Determine the Reward Value:

• Each employee receives a $100 gift card.
• Total reward value for 500 employees: 500 employees * $100 = $50,000.

2. Calculate the Tax Impact:

• Suppose the average tax rate for your employees is 30%.
• Tax per employee: $100 * 0.30 = $30.
• Total tax for 500 employees: 500 employees * $30 = $15,000

3. Calculate the Total Budget:

• Total reward value: $50,000.
• Total tax amount: $15,000.
• Total budget needed: $50,000 (reward value) + $15,000 (tax) = $65,000.

How this is added to employee compensation

When you provide a taxable benefit like employee rewards, it is added to the employee’s total compensation for the year. Here’s how:

• Income Reporting: The value of the gift card ($100) is added to the employee’s gross income on their W-2 form (or T4 form in Canada).

• Tax Withholding: The appropriate taxes are withheld based on the employee’s tax bracket. In this example, if the tax rate is 30%, $30 is withheld for taxes, and the employee effectively receives $70 after taxes.

• Total Compensation: The total compensation for the employee includes their regular salary plus any taxable benefits. For instance, if an employee has a salary of $50,000, the $100 gift card increases their reportable income to $50,100.

Overview of tax implications for employee rewards in the US

TL;DR:

• US: According to the IRS, all cash and cash-equivalent rewards are taxable. Non-cash awards might not be taxable if they are of nominal value and given infrequently.

• Canada: The CRA has similar rules. Most gifts and awards that are cash or near-cash are considered taxable. Non-cash gifts and awards may be non-taxable under certain conditions.

Generally speaking, rewards, bonuses, and gifts are all taxable, with some limited exceptions. If you give an employee cash or a cash equivalent such as a gift card, it is taxable regardless of the amount or the purpose. Employers must record taxable income on the employee's W-2 at the end of the year.

Businesses can deduct up to $400 for all awards of tangible personal property given to any one employee annually, such as company swag and holiday gifts. Gift cards don't count as awards for this deduction because they aren’t considered personal property.

Rewards that are not personal property are considered compensation (including gift cards) and should be subject to federal and state income taxes, as well as FICA taxes (Social Security and Medicare) for both employee and employer.

How Kudos clients do it

Generally, Kudos clients approach the situation in two ways:  

1. Some do not deduct anything based on points redeemed, relying on the standard exemptions highlighted above, resulting in a tax-free scenario.  

2. The others (the vast majority) treat all redeemed points as taxable and keep the calculation and tracking simple by making the payroll deduction once per year. Some also choose to make monthly or quarterly deductions if the rewards are a significant proportion of their total compensation.  

Kudos is designed in a way that points have no dollar value until they are redeemed. For instance, if an employee leaves with a remaining balance of points, they hold no value and have no tax implications. If employees redeem points for a reward, in most cases, the value should be accounted for as a taxable benefit, i.e., as income for your employees.

Charitable donations

When employees use their Kudos points toward a charitable donation, your company makes the donation on behalf of that employee. So, in this case, the employee never actually receives cash at any point in the transaction, meaning no tax implications for the employee, and your company may be eligible for a tax deduction for the donation. The employee is simply asking the company to direct reward points to a charity they care about.

These are just some examples of how Kudos clients manage the tax implications of their program. Your finance team will have its own approach and preferences, but Kudos is here to support you along the way and guide you to success.  

Key takeaways

The most important thing is to make sure your employees are aware of the tax implications from the beginning. We suggest you make it part of your onboarding process; it's easy to explain that perks, such as gift cards, are treated as income and subject to taxes.

Finally, Kudos is a recognition-first platform – that's at the core of what we do. If you're concerned about the tax implications of a rewards program, with Kudos, you can turn off the rewards functionality entirely without sacrificing the platform's benefits.

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Originally published July 2021. Last updated August 2024.