Cash Awards: They cost more than you may have expected
When a company presents their employee with a cash award, the Internal Revenue Service requires that the cash amount must be treated as ordinary income by the employer. What are the implications of this?
For the employee, ordinary income is subject to Federal and State payroll withholding taxes, and FICA Social Security and Medicare withholding. For the employer, ordinary income is subject to the employer’s contribution toward FICA Social Security and Medicare, and State and Federal Unemployment Insurance. In addition, the employer usually has insurance costs for Workers Compensation and Short/Long Term Disability as an obligation based upon employee earnegend wages.
Applying some percentages to “ordinary income” wages, let me summarize what the obligations in the previous paragraph amount to:
Federal Withholding Tax 15% (This actually ranges from 15-35% based upon income level)
State Tax 5% (I have used the State of Illinois rate for illustration)
FICA Social Security 4.2% (Note, this rate was reduced from 6.2% for 2011)
FICA Medicare 1.45%
FICA Social Security 6.2%
FICA Medicare 1.45%
State Unemployment 1.0% (This varies by state and job…In Illinois it ranges from .7 – 8.4%)
Federal Unemployment 0.8%
Worker Compensation 1.0% (This actually is in a range of 1.0 – 10% by job category)
Short/Long Term Disability ??
What does a cash award really cost? The implications of the above are:
If you want your employee to “net” (“cash to spend” )$50.00… the employer will need to “gross” pay their employee $67.25 and an additional $6.54 would need to be paid out by the employer to cover their obligation as noted above. Thus, a $50.00 net to your employee will cost your company $73.79. It costs the employer $1.48 for each dollar they want the employee to receive in spendable cash.
Perhaps you don’t care what your employee nets and your intention is to give a $50.00 (gross pay)cash award. Applying the employee obligation from above, the employee will net $37.18 in spendable cash. Also, it will cost the employer $4.87 to cover their obligation as noted above. Thus, it costs the employer $54.87 and the employee nets $37.18. Once again, it costs the employer $1.48 for each dollar they hope to give their employee in purchasing power. Keep in mind that your employee will also pay sales tax when they use this money to make a purchase for themselves. The net purchasing power in a gift ends up being less than $37.18 by the amount for sales tax.
How does the above discussion stack up against an employer choice to give gift awards versus cash awards to acknowledge employee length of service?
- Gift awards in a qualified plan do not carry the tax and fee obligations of a cash award (that is treated as ordinary income) as noted in the previous paragraphs. (A gift item will incur a sales tax charge to the employer.)
- Gift awards are deductable as a business expense to the employer – refer to IRS Publication 535 “Business Expenses,” page 6 & 7 to read about gifts in a qualified plan.
- An employee will view a gift item as a “gift” and is less likely to equate their years of service with a dollar amount as in a cash award. For example, a $50 cash award for 5 years of service…the obvious association for the employee becomes, “I’m worth $10 to my company for a year of my dedication to my company!” Engendering these thoughts probably result in a behavioral response completely contrary to what an employer hopes to achieve in recognizing employee years of service.
- Smaller cash awards will most likely be spent by the employee on necessities like food or gasoline…the emotional remembrance of the employee to the employer will be quickly forgotten
- A gift item will be a tangible personal item that the employee will hold in their possession…a constant emotional reminder of the employee to the employer.
- The employee has no income tax liability for a gift item award in a qualified plan.
Here are some examples for illustration of the financial implications of cash versus gifts for a company that has 500 anniversary employees in a year:
Example A: The company wants their employee to net (after withholding taxes and FICA) $10 per every year of their service, as compared to the same company making a choice of giving gifts instead of cash. The company will save $26,851 or 34% by giving gifts!
Example B: The company will give their employee $10 (gross pay) per every year of their service, as compared to the same company making a choice of giving gifts of comparable value instead of cash. The company will save $17,683 or 29% by giving gifts!
Example C: The company will give their employee $10 (gross pay) per every year of their service, as compared to the same company making a choice of giving gifts of 45% greater value instead of cash. The company will spend the same amount of money!