What expense category is Employee Awards?

Recognizing employees for their hard work and dedication with awards is a great way to boost morale and foster loyalty. While the costs of these awards are a legitimate business expense, the IRS has very specific rules that determine their deductibility for the employer and their taxability for the employee.

The tax treatment of an award depends entirely on what you give: tangible property or cash. This guide explains how to categorize employee awards in accordance with IRS rules, the critical distinctions to make, and how to track these expenses for full compliance.

Employee Awards Category

The costs of qualifying employee awards are a deductible business expense. IRS Publication 535 explains that you can generally deduct amounts you pay to your employees as awards. These are typically categorized under Other expenses on a business tax return.

However, if an award does not meet the specific IRS criteria for a non-taxable achievement award, it is treated as wages. In this case, the cost is deducted as a Salaries and wages expense, and the value must be included on the employee's Form W-2.

Important Considerations When Classifying Employee Awards

The most critical factor is distinguishing between a non-taxable achievement award and a taxable cash or cash-equivalent award.

What is a Qualifying Achievement Award?

According to Publication 535, for an award to be treated as a non-taxable achievement award, it must be an item of tangible personal property given to an employee for either length of service or safety achievement.

Tangible Property vs. Cash and Gift Cards

This is the most important rule.

• Tangible Personal Property: This includes items such as watches, plaques, and other physical merchandise. The cost is deductible within limits.
• Not Tangible Personal Property: Publication 535 is very clear that cash, gift cards, gift certificates, vacations, meals, lodging, and tickets to events are not considered tangible personal property. These items are almost always treated as taxable wages.

Length-of-Service and Safety Rules

For a tangible property award to qualify, it must also meet these tests:

• Length-of-Service: Cannot be given during the employee's first 5 years of employment or if the employee received another length-of-service award in the last 4 years.
• Safety Achievement: Cannot be given to a manager, administrator, or clerical/professional employee. Additionally, no more than 10% of your eligible employees can have already received a safety award during the year.

Tax Implications and Recordkeeping

The tax treatment for both the employer and employee depends entirely on the type of award.

Employer Deduction Limits

Publication 535 sets the following limits on the amount you can deduct for qualifying tangible property awards given to any one employee during the year:

• $400 for awards that are not part of a qualified plan.
• $1,600 for all awards given under a qualified, written plan that does not discriminate in favor of highly compensated employees.

Taxability for the Employee

• Qualifying Achievement Awards: The value of a qualifying tangible property award is generally excludable from the employee's income and is not subject to employment taxes.
• Cash, Gift Cards, and Other Awards: The value of these awards is considered taxable compensation. You must include the amount in the employee's wages on their Form W-2 and withhold all applicable income and employment taxes.

How to Report the Deduction

• Deductible Awards: For a sole proprietor, the cost of qualifying awards is reported on Schedule C (Form 1040), Part V, Other Expenses.
• Taxable Awards: The cost of cash or gift card awards is included with other wages on Line 26, Wages.

How Fyle Can Automate Tracking for Employee Awards

Fyle helps you manage and document all your employee award spending, ensuring every item is correctly categorized for tax purposes.

• Capture All Award Purchases: Instantly capture receipts for tangible awards or gift cards using the Fyle mobile app or email forwarding.
• Track by Employee: Code each award to a specific employee to easily monitor annual spending and deduction limits.
• Enforce Award Policies: Fyle’s policy engine can flag cash-equivalent awards, such as gift cards, to ensure they are routed for proper tax treatment as wages.
• Automate Your Accounting: Sync deductible awards to an Employee Awards expense account and taxable awards to payroll for correct W-2 reporting.