TRAVEL AWARD OR MEETING?
A common question for incentive travel programs is whether the trip can be excluded from income for attending a business meeting. Unfortunately, the IRS does not provide clear guidelines and broadly states it depends on all the facts and circumstances. Merely holding a 1-hour meeting on day 2 will not make a 5-night trip to the Caribbean non-taxable for the winners. Brightspot has seen some companies evaluate the total hours of the itinerary that are spent in business functions (such as a 3-hour welcome reception that could be considered business networking, any structured business meetings, the awards celebration dinner that recognizes top performers, team building activities, and even mandatory group tours, for example, a catamaran sail attended by the entire group) compared to the sum of the 8-hour days included in the trip. If the business hours are greater than 50% of the total workday hours, some companies determine the trip’s primary purpose is a business meeting and non-taxable to the attendees. Contact us if you want a copy of this “tax agenda.”
SPOUSES AND GUESTS
Even if the employee portion of the incentive trip is deemed a business meeting and not taxable to the attendee (notice we did not say “winner”), the value of the trip attributable to a spouse or guest is always taxable because their presence is unnecessary for a business meeting.
EMPLOYEE ACHIEVEMENT AWARDS
The IRS created a special exemption from tax for qualified “employee achievement awards.” IRS Publication 525 states: If you receive tangible personal property (other than cash, a gift certificate, or an equivalent item) as an award for length of service or safety achievement, you may generally exclude its value from your income. However, the amount you can exclude can’t be more than $1,600 for all such awards you receive during the year. Your employer must make the award as part of a meaningful presentation, under conditions and circumstances that don’t create a significant likelihood of it being disguised pay. However, the exclusion doesn’t apply to the following awards.
- A length-of-service award if you received it for less than 5 years of service or if you received another length-of-service award during the year or the previous 4 years.
- A safety achievement award if you’re a manager, administrator, clerical employee, or other professional employee or if more than 10% of eligible employees previously received safety achievement awards during the year.
INCOME TAX REPORTING REQUIREMENTS
If the recipient of a prize or award is an employee, the fair market value of the prize or award is deemed to be wages earned that are reported on their Form W-2 and are subject to federal and state payroll tax withholding. Technically, this imputed income should be reported quarterly to include it in a company’s quarterly payroll tax returns.
If the recipient of the award is an independent contractor (a dealer, distributor, independent sales agent, channel partner sales representative, and so forth), the FMV of the award is reported on their Form 1099-MISC if the aggregate value of all compensation to the individual is $600 or more in the calendar year. The payer is not required to issue Form 1099 to a corporation. The IRS does not require withholding of payroll taxes for independent contractors.
Brightspot recommends using an incentive software platform, such as Ignite, to capture an independent contractor’s social security number (SSN) via a secure online form and then store the SSN in an encrypted database. Good incentive companies offer the professional expertise to calculate the lowest FMV, which saves the company and participant on taxes. Further, they can assist with filing the Form 1099s.
TIMING OF EARNINGS
As a general rule, the recipient of an award is deemed to have received it for income tax purposes when it is credited to their account, set apart for them, or made unconditionally available to them. Treas. Reg. § 1.451-2. Therefore, as a practical matter, the prize or award could be deemed taxable to the employee or independent contractor as soon as they can use it without substantial restrictions or limitations.
Point programs are tricky. Are points taxable when credited to the participant account or actually redeemed? Common sense is when something is actually received, whether it’s travel, merchandise, or a gift card, and most recipients expect they will be taxed when they redeem. The IRS says income is “constructively received” and taxable if it is credited to a taxpayer’s account, set apart for them, and available to draw upon. However, it is not constructively received if it is subject to substantial limitations, restrictions, or risk of forfeiture.
Most companies will report the points as taxable income upon redemption rather than upon crediting points. Most incentive programs require certain thresholds must be achieved for redemption and require that the participant (and possibly their company) must continue to qualify for the program. The requirement to continuously qualify for eligibility creates a risk of forfeiture. The potential forfeiture of points upon the termination of employment is another common risk of forfeiture. Even a participant possibly forgetting about their points (or, in IRS legal language, declining to accept their award) is another valid reason to tax points only when redeemed.
CONCLUSIONS AND SOME OBSERVATIONS
The valuation percentages set forth above are only guidelines that an employer or any other person giving prizes or awards may use in determining the fair market value of merchandise and travel awards. The studies by Carlson are an attempt to interpret technical IRS regulations regarding valuation. Each employer or other taxpayer is entitled to determine the FMV of prizes or awards, as long as its methodology is defensible.
Nonetheless, awards given in the form of travel or merchandise instead of cash or cash equivalents may be preferable for tax and business reasons. One tax advantage of merchandise or travel is that its fair market value for reporting on Form W-2 or 1099-MISC may be lower than its cost to the employer. Thus, the amount of tax payable by the recipient would be lower than if cash were used. Cash awards cannot provide any such tax savings to the recipient. In addition, merchandise has the added non-tax benefits of providing continued motivation and encouraging saving for a reward (the recipient can earn points for a more valuable prize and then can use that prize, whether it be electronic, housewares, or golf clubs, for years), creating an emotional attachment for the recipient or having “trophy” value (the recipient can point to having earned something tangible), and requiring the recipient to visualize a prize and work toward receiving it. On the other hand, an employee or independent contractor may view cash simply as additional pay that can be relatively insignificant. Moreover, an employee or independent contractor may also see a cash award as part of their compensation, which may create a disincentive if it is not received in later years as well.
Acknowledgment – Certain portions of these guidelines were originally written by George B. Delta, Esq. and published by an industry trade group named the Incentive Performance Center. The IPC ceased and the website has been removed, but Brightspot believed this incentive industry resource was extremely valuable and that it should be archived here. We give credit and appreciation to both Mr. Delta and IPC. Through the years, Brightspot has expanded the original content with additional tax information.