REWARD
Are donated prizes taxable?
Sally Hilton CPP, director of payroll training for the American Payroll Association , answers this recurring question posed in the USA
A frequently asked payroll question is the following: ‘My company receives many items donated by vendors and local businesses for our annual charitable campaign. We’ll raise money through a raffle and employees can win these items. Must these prizes be included in taxable wages?’ Many employers will be surprised to learn that, yes, these items are taxable to the recipient even if these items were donated or purchased at a significant discount. Internal Revenue code section 61 defines gross income as “all income from whatever source derived, including (but not limited to) compensation for services, including fees, commissions, fringe benefits, and similar items…”. The Inland Revenue Service (IRS) gave guidance, which further explains that “gross income means all income from whatever source derived, unless excluded by law. Gross income includes income realized in any form. … Income may be realized, therefore, in the forms of services, meals, accommodations, stock, or other property, as well as in cash.” This basically translates to mean that whatever the employee receives as part of the employer-employee relationship is taxable, unless a law specifically excludes the item or benefit. There are no exclusions in the law for gifts and prizes, unless they qualify as a length-of-service award or a safety award. Now that we understand these items are taxable, what amount should be included in income? The amount to include in the employee’s taxable income is the amount by which the fair market value (FMV) of the prize exceeds the amount the employee paid
for the prize, less any amount the law excludes. Here’s the formula: FMV - EPA - AEL = IFBA where: EPA means ‘employee paid amount after taxes’ AEL means ‘amount excluded by law’, and IFBA means ‘includable fringe benefit amount (included in income which translates to taxable)’ Example An employer receives a 70” flat-screen television for free, perhaps through a donation or by using points from a corporate credit card. The television will be included in a company raffle to raise funds for a local charity. Regardless of how the employer obtained the television or whether the employer paid for it, this television has a value. Therefore, the recipient, an employee, must be taxed on the value using the formula above. The FMV is the amount the employee would pay if he or she purchased the exact same model of television on their own. This is known as at ‘an arm’s length transaction’. Let’s say this television retails for $750. If the employee purchased $25 of raffle tickets for this television, the taxable value would be $725 ($750 FMV - $25 EPA - $0 AEL = $725 IFBA), so $725 would need to be added to the employee’s taxable income by the end of the year in which the prize was received and reported in Form W-2 in boxes 1, 3, and 5 as well as boxes 16 and 18 if applicable. Prizes are also subject to unemployment taxes. The employer may either gross-up and pay the taxes on behalf of the employee or impute the value of the prize, whereas adding $725 of non-cash taxable fringe benefits to
the employee’s regular wages, withholding taxes on the combined amount, then subtracting the $725 non-cash fringe. If the award is provided as a length of service or safety achievement award, some or all of the award may be excluded from income if certain conditions are met. See section 3.4 – Awards and Prizes – of the APA’s The Payroll Source , and the IRS’s publication 15-B, Employer’s Tax Guide to Fringe Benefits , Achievement Awards, for details (www.irs.gov/ publications/p15b). n
This article was published in the February 2020 issue of the APA’s PAYTECH magazine.
The American Payroll Association (APA), www.americanpayroll.org, is the U.S. leader in payroll education, publications, and training. This nonprofit association conducts more than 300 payroll training conferences and seminars across the country each year and publishes a complete library of resource texts and newsletters. Representing more than 21,000 members, the APA is the industry’s highly respected and collective voice in Washington, D.C. Get more information at www.americanpayroll. org. The Global Payroll Management Institute (GPMI), www.GPMInstitute.com, spearheads the APA’s global initiatives to provide the world with a leading community of payroll leaders, managers, practitioners, researchers, and technology experts. Subscribers connect with each other through networking discussions, collaborative opportunities, and access to education and publications dedicated to global payroll strategies, knowledge, research, employment, and training. GPMI also publishes several global payroll texts and white papers as a benefit to subscribers. Get more information at www. GPMInstitute.com.
...whatever the employee receives as part of the employer-employee relationship is taxable...
| Professional in Payroll, Pensions and Reward | September 2020 | Issue 63 42
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