Employees' gifts and prizes can result in a tax bill

If a company gives bonuses, awards, gifts or prizes to employees or customers, there can be complicated tax consequences. It's important to understand these so you don't have an unpleasant surprise later.

In general, any gifts made by a company to an employee are considered wages. They're subject to both employment tax and income tax, and must be reported on an employee's W-2 form.

Certain very minor forms of compensation are usually considered "perks" rather than wages. For instance, if a business allows its employees use its copying machines for personal purposes for free, that's a perk. But if a business gives an employee cash (or a cash equivalent), that's always considered wages, even if the amount is minor. So if a worker gets a $10 Starbucks gift card as a thank-you for working late, the $10 is taxable.

Stock options are also taxable, and can be subject to complex rules. It's a good idea to learn these before you make any decisions about what to do with the options. (There have been cases where workers have ended up owing more in taxes than they received from selling their stock.)

One exception to the general rule is employee awards for safety or for length of service. Employees who receive tangible gifts (but not cash) as a result of such an award might be able to avoid paying income tax on the value of the gift – but again, there are strict and complex rules.

In theory, it's possible that a present from a company's owner to an employee could be a purely personal gift and not a form of compensation. But according to the U.S. Tax Court, you'd have to show that the present "is completely unrelated to the employment relationship and reflects no expectation of a business benefit." That's a tough thing to prove, and it seldom works.

Gifts to non-employees (vendors, suppliers, customers, etc.) are typically not taxable as income to the recipient. However, if a gift is large enough and related closely enough to business dealings, there might be an exception.

For instance, in one case the president of a metals company gave the president of another company some extremely valuable sales leads. The other president responded by giving the first president a car.

The first president didn't report the value of the car as income, because he considered it a gift. But the U.S. Supreme Court ruled that the value of the car was subject to income tax because it wasn't really a gift; it was repayment for the sales leads and an inducement to provide additional information.