Bonuses. It is not necessary to give employees Christmas or Year-End bonuses. It’s entirely voluntary. But many business owners do; so here is how it works:
Non-Cash Gifts. If you give a turkey, a fruitcake, or any other food item, it is not income to the employee, but the cost is deductible to your business. Thus, any food, no matter how much it costs (don’t go overboard), falls under special, and very favorable, rules. It’s a deduction to the business, but not income to the employee.
However, any non-food gifts to employees with a value of more than $25.00 are just the opposite. While the business still gets a deduction, the value is income to the employee and has to go on his or her Form W-2 at the end of the year (no you cannot use a Form 1099). So, if you are thinking of giving an employee a valuable gift, you will have to do withholding on it. That includes Social Security and Medicare withholding, as well as regular income tax withholding, and you will have to pay the employer match. This is true even if the employee gift is not in cash, but a tangible item. Remember that food is exempt from this rule, regardless of the cost of that food, but it has to be actual food, not a gift certificate to a grocery store.
Cash, Checks, Gift Cards, Gift Certificates to Employees. If you want to give an employee a bonus or gift in cash, by check, or any cash-equivalent, it has to go through your payroll system. There are no exceptions, regardless of the amount. Just call your payroll service and do the regular tax processing.
Net Checks. You may want to give an employee a check for an even number, like $100.00 or $500.00, or whatever. Just call your payroll service and get them to do what is called a “net check.” Their software can easily figure out the payroll taxes backwards and give you a paycheck where the final amount is the even number you specify. For example, a check with a net of $100.00 would require a gross pay of at least $105.99. Computing a net check can be done manually, but payroll services have software that can do it automatically. However, you have to specifically ask for this service (though there is normally no extra charge).
Tax Withholding. How much do you withhold on a bonus check? Obviously, you take out Social Security at 6.2% and Medicare at 1.45%, but if you use the regular tables for the income tax withholding portion, you may get a weird result. The tables (both manual and computer) are designed for the pay period you use. If you have been paying weekly, the tables will think this extra amount will be part of weekly pay, and multiply it by 52 weeks, resulting in a much higher amount in tax withholding. That’s because the tables or the computer will think the employee is much richer and has moved up to a higher tax bracket. To keep this from happening, get your payroll service to use a percentage (probably 25% for lower paid employees and 28% or more for higher paid employees). Or you can get your payroll service to use the annual payment tables or the one-time payment tables to make the computation, instead of the tables for your normal pay periods.
Other than Christmas or Year-End. These rules apply just as much during all other times of the year. So if you give a non-food item, or cash, or a check, to employees for their birthdays, a bonus, or an incentive payment, or a prize, or on any other payment, keep these things in mind and run it all through your payroll system.