Gift cards, taxability, and W-2s.

We’ve covered the taxability of gift cards before, and the law hasn’t changed—with three exceptions, the face value of gift cards is always taxable because they’re cash equivalents:

• Gift cards aren’t taxable if they’re restricted to a specific item of personal property, which is minimal in value, provided infrequently and administratively impractical to account for. This is the classic definition of a tax-free de minimis fringe benefit.
• Gift cards aren’t taxable if managers dig into their own pockets for them for their subordinates, if they don’t seek reimbursement from the company. We can call this a personal gesture.
• Gift cards aren’t taxable if they’re provided to an employee for a special occasion (e.g., they’re getting married or having a baby) and all employees have contributed.

With these three exceptions in mind, let’s bust some myths. And we are deeply sorry about this, but yes, you will need to play the Grinch and deliver the bad news to employees about taxes and require HR to keep track of who won what at the holiday party.

Myth #1: Gift cards awarded randomly at a holiday party are exempt from taxes

Nice try, but no. It’s holiday party time and raffles are common.

Gift cards don’t have to be targeted to a specific employee for a specific reason, like employee of the month, to be taxable.

Myth #2: Gift cards provided by a vendor and awarded randomly at a holiday party are exempt from taxes

Interesting variation on Myth #1, but still no.

Vendor-supplied prizes and awards, including gift cards, distributed by the company are taxable to employees who win them because they’re provided within the context of an employment relationship.

Myth #3: Gift cards worth less than $75 are tax-free

Again, no. Regardless of the face value, gift cards are taxable.

We suspect whoever came up with this $75 cut-off misinterpreted the IRS’ de minimis rule for reimbursing employees’ business expenses.

As an administrative convenience to employers, the IRS has a de minimis rule under which employees don’t need to submit receipts for their business expenses. It had been set at $25, but final and temporary regulations issued in 1997 increased the de minimis amount from $25 to $75, where it stands today.

You say you don’t look good in Grinch green

Well, who does?

If you don’t want to play the Grinch, the company must pick up the taxes by grossing up.

Let’s say Harry wins a $100 gift card at Speedy’s holiday party and Speedy doesn’t want to tax it. Speedy must gross up:

$100
0.7035

The result is $142.15.

Harry gets his net $100 and the company picks up the $42.15 in federal taxes. Remember, Speedy would also have to include the state tax rate in the denominator.

On Harry’s W-2:

• $142.15 is added into Harry’s Box 1, 3 and 5 amounts.
• $31.27 ($142.15 × 22%) is added into his Box 2 amount.
• $8.81 ($142.15 × 6.2%) is added into his Box 4 amount.
• $2.06 ($142.15 × 1.45%) is added into his Box 6 amount.

The amounts don’t add up due to rounding.