Taxation of Christmas Bonuses for Your Employees

Christmas BonusAre you thinking of giving your employees a Christmas bonus, holiday bonus, or year-end bonus? What’s the best way to handle these year-end bonuses? Can they be handled ‘under the table’? Do you have to include them as wages on their W-2?

The answer to this question is quite simple. Any additional compensation to your employees over and above their standard salary or hourly rates is considered to be taxable compensation. The bonus is considered wages and must be reported as payroll on the employee’s W-2 and is subject to all applicable payroll taxes – federal and state withholding, FICA, Medicare and the related employer taxes.

On your books and records, the bonus is reported as wages on the income statement and it is fully deductible as a valid tax deduction if it is handled this way.  Payments to your employees made in cash (and not reported) or recorded as other expenses are not tax deductible, and may cause unforeseen issues if the IRS or state audits your books.

Many employers like to give a flat dollar bonus amount. You can do this by choosing the amount of the bonus you want hand to your employee and “gross-up” the amount. Most payroll services and payroll software can handle this calculation. By grossing up the flat dollar net amount, you are including the estimated taxes into the amount so that, after taxes, the amount is what you want to provide your employee.

The only way you can exclude the bonus payment from the employees’ W-2, not pay associated employer payroll taxes, and still get a tax deduction on your business tax return, is to make the bonus as a profit sharing bonus through your 401(k) profit sharing plan. Although your employees don’t get the bonus in cash or check, the bonus is completely non-taxable to the employee until they withdraw the funds from their plan, and you avoid paying the payroll taxes associated with paying the bonus in cash or check and including it on their W-2.

Steve Trojan, CPA is owner of SMT & Associates, Inc. (www.smt-associates.com), a Crystal Lake IL based tax and accounting firm, and Complete Payroll, Inc. (www.completepayrollinc.com). He specializes in tax and accounting issues affecting business owners and investors.

Share

About Steve Trojan, CPA

Steve Trojan, CPA is owner of SMT & Associates, Inc. (www.smt-associates.com), a Crystal Lake IL based tax and accounting firm. He can be reached at 815-788-5114.
This entry was posted in Business taxes, Payroll. Bookmark the permalink.

3 Responses to Taxation of Christmas Bonuses for Your Employees

  1. Pingback: Are Holiday Bonuses Taxable? | OSYB Number Crunch! Bookkeeping Tips from Outsouce Your Books.

  2. Brian Huber says:

    My colleagues pointed out that a few exceptions exist to reporting bonuses as wages. I reminded myself about them by reviewing some free sample EA exam questions at http://fastforwardacademy.com/enrolled-agent-exam-prep.htm. Employers need to make the payments in limited amounts for such non-discriminatory matters as length of service or attendance. I never can remember the dollar ceilings. Just goes to show how tax pros can benefit from ongoing tax education — or making acquaintance with recently licensed Enrolled Agents who can recall these weird details.

  3. Pingback: Blogs Every Startup Owner Should Read for Legal, Human Resources, and Accounting Info - UpCounsel Blog

Leave a Reply

Your email address will not be published.


*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>