Issue

Cash gifts to employees at Christmas – or anytime during the year – are taxable to the employee, require payroll taxes to be paid, and are includable on Form W-2.

Situation

Marathon Bible College (MBC) is a private college exempt under Internal Revenue Code section 501(c)(3) and section 170(b)(1)(A)(ii).  They are required to file Form 990 annually.

This December, MBC’s president gave – out of his budget – each of his ten staff people Christmas cards with $100 bills in them as “gifts” from the college.  MBC’s Controller calls us to ask how this should be handled for tax purposes.

We tell her that the gifts are generally taxable compensation and must be included in each employee’s Form W-2 for the year in which they received the cash.  An alternative could be to have the president “absorb” all of the gifts in his compensation and consider the $100 bills to be “personal gifts” from him to the staff.  If the latter alternative is chosen, MBC should carefully navigate the issues surrounding the reasonableness of the president’s compensation and any potential gift tax implications.

In either case, the $100 payments must be “grossed up” to cover the employee’s share of any federal income tax withholding (optional) and “FICA”.

Rules

When “grossing up” an employee’s compensation (in either of the situations above) the formula will generally be:

Step 1: 100% minus Payroll tax % = Gross up %

Step 2: Amount of cash payment divided by Gross up % = Grossed-up wages

Step 3: Check the amount by multiplying Grossed-up wages by Payroll tax %

So, in the situation above, with respect to employees, if we presume the 7.65% employee “FICA” (6.2% social security and 1.45% Medicare) plus a 10% federal income tax withholding amount, (resulting in a Payroll tax % of 17.65) the calculation would be as follows:

Step 1: 100% minus 17.65 % = 82.35 %

Step 2: $100 divided by 82.35% = $121.43

Step 3: $121.43 times 17.65% = $21.43

Then, you must make sure that you properly reflect these amounts on quarterly payroll reports and Forms W-2.

From Revenue Ruling 86-14:

Payments by an employer of employee FICA tax without deduction from employee’s wages under an agreement between them are additional wages for FICA purposes, the total amount of wages to be determined by a formula. The additional FICA wages so determined are includible in the employee’s gross income and are wages for purposes of income-tax withholding.

Bottom Line

Cash gifts can be a tricky endeavor.  Are employees ready for the extra income and potential taxes?  Check this out with your skilled, knowledgeable, and experience tax advisor.  He or she will be able to help your school navigate the intricacies of the reporting requirements.

Specific questions? Email Dave Moja.

The information provided herein presents general information and should not be relied on as accounting, tax, or legal advice when analyzing and resolving a specific tax issue. If you have specific questions regarding a particular fact situation, please consult with competent accounting, tax, and/or legal counsel about the facts and laws that apply.