Are Bonuses and Awards Subject to Withholding?

Bonuses are subject to withholding. Bonuses you pay to an employee as compensation for the performance of services are taxable wages subject to federal income tax withholding. This includes bonuses for production, incentive bonuses, and non-deferred profit sharing. Bonus payments are subject to withholding even when paid after an employee retires, but not when paid to a beneficiary if the employee dies while still employed.

For FICA and FUTA purposes, bonuses are generally wages if they are paid for services rendered by an employee for an employer. The payments need not be made in cash.

Treat as supplemental wage payment. Bonuses paid in the same calendar year in which regular wages have been paid are treated as supplemental wages for computing the amount of federal income tax to be withheld. The supplemental withholding rate is a flat 25 percent.

Note:  If you wish to pay the income tax on a bonus distribution and give what is, in effect, a tax-free bonus, you can gross-up the bonus to account for the income tax.

Awards and prizes are subject to withholding. Prizes awarded to employees for outstanding performance or achievement are generally taxable income since they are presented in return for the employee's performance or services. Cash awards and the fair market value of noncash awards are thus generally subject to federal income tax withholding, FICA, and FUTA taxes. However, there are exceptions for awards that meet specific requirements.

Exception: Limited-amount service and safety awards. Awards of tangible personal property given to employees for length-of-service or safety achievement are not considered employee income if the value of the award does not exceed specified limits. The value limits are:

• $400 per employee per year for all awards presented under a nonqualified plan; or
• $1,600 per employee per year under a qualified written plan that does not favor highly compensated employees and that has an average benefit award of $400 or less per employee over the year.

In determining the $400 average cost, awards of nominal value are not taken into account.

If the cost of the award is larger than the limits provided above, the employee must include in gross income the higher of (1) the amount by which the award's cost exceeds the limit (but not greater than the value of the award); or (2) the amount by which the value of the award exceeds the allowable limit.

How can a service or safety award be excluded from income? In establishing a service or safety award program, in order to exclude the award from employee's gross income, you must:

Exception: awards to retail commission salespersons. You can elect not to withhold federal income tax on noncash awards paid for services performed by a retail commission salesperson if the salesperson is ordinarily paid solely by cash commissions. The election applies only for federal income tax withholding purposes. The fair market value of the prizes is still subject to FICA and FUTA taxes.

Regardless of whether you elect to withhold on the merchandise awards, the fair market value of the awards must be included in the total wages reported on the employee's Wage and Tax Statement, Form W-2. The amount is not to be reported on separate Forms 1099.

Suggestion awards are subject to withholding. Many companies reward employees whose suggestions for improving efficiency, production, or working conditions are accepted and put into use. These awards are uniformly held to constitute wages subject to FICA, FUTA, and federal income tax withholding as long as they are made in connection with, and as a result of, an employment relationship that exists between the payer and the recipient.

Sales awards are subject to withholding. Cash awards paid to salespersons or their spouses in recognition of outstanding sales efforts are wages for FICA, FUTA, and federal income tax withholding purposes. The fair market value of noncash awards, such as golf clubs, TVs, radios or watches, are also wages for FICA and FUTA purposes and generally for federal income tax withholding purposes. It makes no difference whether the prizes are given directly to the salespersons or to their spouses. If an employee is given an award that is subject to withholding, you must apply withholding even though the employee is no longer employed with your company.

Employer-employee relationship must exist. For an award to be considered wages subject to employment taxes, there must be an employer-employee relationship existing between the one making the award and the recipient of the award. If no such relationship exists, the award will not constitute wages.