Employee rewards and taxes: What HR teams need to know

Recognition shouldn’t trigger an IRS headache. Get the basics of employee reward taxes so your HR team can focus on celebrating achievements instead of worrying about tax and compliance missteps.

Why this matters in 2025

In 2025, proper tax handling of employee rewards has become more critical than ever and frankly, more complicated. The Incentive Research Foundation (IRF) 2025 Trends Report shows that companies are operating under significant budget pressures, partially due to high uncertainty and inflation in 2024. It also highlights the expansion of reward programs, especially those aimed at keeping Gen Z and Millennials engaged with smaller, more frequent feedback.

Here's the thing: knowing the tax implications of monetary rewards versus non-monetary alternatives isn't just about staying compliant. It's about choosing rewards that deliver the most bang for your buck to employees while maximizing impact for the business. Get it wrong, and you could be leaving money on the table or creating unnecessary headaches come tax season.

IRS building blocks

For tax purposes, monetary rewards are generally treated as supplemental income, kind of like bonuses. This puts them squarely under the IRS's supplemental compensation rules, alongside other workplace perks like health benefits, tuition assistance, employee discounts, and wellness stipends. 

Perks like these are considered fringe benefits: they’re not part of an employee’s salary, but they are considered income. Whether they’re taxable depends entirely on what you're giving and why you're giving it.

Here's where things get potentially messy. Managers and HR teams need to watch out for what the IRS lovingly calls disguised compensation. These are payments, incentives, or gifts that look suspiciously like thinly-veiled attempts to dodge taxes. Think lavish gifts with no clear business purpose or rewards that seem more about executive perks than performance recognition. Fall into this gray area, and you're inviting compliance issues that nobody wants to deal with.

So what exactly does the IRS have to say about all this employee reward business?

Cash & cash-equivalent rewards: Always taxable

Cash and cash-equivalent rewards are always taxable, no matter the why or the how much of the reward. They include:

• Gift cards

• Gift certificates

• Gift coupons

• Checks

• Money orders

• Digital payments (e.g., PayPal, Venmo)

• Prepaid cards

There is one small exception: a gift certificate that can only be redeemed for a specific item, like a holiday turkey or a pair of work boots, is basically like handing the employee a physical gift. And items like these could escape taxation if you play your (non-gift) cards right.

De minimis fringe benefits + new $250 threshold (SECURE 2.0 update)

De minimis fringe benefits are small, non-cash perks that the IRS considers too minimal to track for tax purposes. The administrative burden of tracking these items outweighs their value, so they remain tax-free. 

To qualify as de minimis, these rewards must be tangible personal property given only occasionally.

De minimis benefits can be

• Coffee, snacks, or holiday gifts

• Flowers or fruit for special occasions

• Overtime meal money or local transport reimbursement

• Personal use of a company phone provided primarily for business

They can’t be:

• Cash or a cash equivalent

• A vacation

• Meals

• Lodging

• Stocks, bonds, or similar securities 

Generally, de minimis means gifts worth $100 or less. However, under SECURE 2.0, incentives up to $250 given specifically to encourage participation in 401(k) or 403(b) plans can qualify.

Cheat sheet: Is your reward taxable?

Is it cash or a cash equivalent? → Taxable

Is it travel, stocks, bonds, or securities? → Taxable

Is it tangible, occasional, and worth $100 or less? → Likely non-taxable

Is it tied to a retirement plan incentive and $250 or less? → Likely non-taxable

Is it disguised compensation or extravagant? → Taxable

Exclusions & gray areas

Employee incentive taxes are complex, and some situations don’t have a simple answer. Understanding these key details now will help you avoid any problems during tax season.

Personal gifts without business cause

The IRS allows you to give personal gifts unrelated to the business without taxation. However, proving an employer’s generosity is completely free of a business purpose is hard. Can you say for certain that a gift doesn’t improve morale or employee engagement, even for a single employee? If not, it’s probably better to steer clear of a “personal gift” label.

Employee achievement award caps ($1,600 qualified plan)

Employees who receive achievement awards can escape taxes on them if the rewards don’t exceed certain limits throughout the year. The limit depends on whether you give those rewards as a qualified or non-qualified award.

Qualified awards are part of an established, written award plan that doesn’t favor high-earning employees. The IRS defines high earners as those who are at least a 5% owner in the company at any time during the year or the preceding year or those who earned more than $155,000 in pay for the preceding year. The annual limit for qualified awards is $1,600.

All other awards are considered non-qualifying awards and have an annual limit of $400.

Length-of-service and safety awards

These types of rewards are treated like achievement awards, and can be excluded from an employee’s income if they’re:

• Not cash or an equivalent

• Given as part of a meaningful presentation, like an award ceremony

• Can’t be interpreted as disguised wages

Length-of-service awards can’t be given before five years of service, and safety awards must be given to people in related roles (think machinists on the factory floor, not administrators).

Charitable donations & wellness stipends

Charitable donations have become popular among many employees, but their tax implications can be confusing.

Charitable donations are not taxable if the donation is made directly to a 501(c)(3) nonprofit, and the employee gains no personal benefit. If you give an employee a stipend for them to donate, it’s considered a form of income, and you’ll need to report it.

Wellness stipends are generally taxable, especially when issued as cash equivalents like gift cards or gym reimbursements. Non-taxable exceptions include direct medical support (such as via HSA or FSA contributions) and de minimis gifts, like water bottles and T-shirts.

State-level wrinkles

In addition to the IRS rules, states have their own rules about taxing employee rewards. For example:

See more about NY, CA, and TX.

Remote & multi-state employees — nexus considerations

If you have remote or traveling employees working in other states, you may trigger nexus laws. In short, that means certain states might get a say in how rewards are taxed. Generally speaking, employee rewards should be taxed using the laws where they live or work, not where your company headquarters are.

Reporting & withholding mechanics

If you determine that an employee reward is taxable, you’ll need to properly report it. All taxable rewards must be reported in gross wages on the W-2 (or 1099-NEC for contractors). This will ensure the IRS and any state and local governments get the heads up. For non-cash rewards, you’ll need to report the fair market value (FMV).

Supplemental-wage flat 22 % vs. aggregate method

You’ll also need to choose how you withhold taxes using one of two methods.

With the flat-rate method, you’ll calculate the award withholding separately on its own payroll transaction. Use the standard withholding amount of 22%. It’s a simple calculation, but it may result in less accurate withholdings.

Note that the 22% flat rate only applies to supplemental wages up to $1 million. For amounts over $1 million in a year, the rate increases to 37%.

With the aggregate method, you’ll add the taxable reward amount to the employee’s wages, then calculate their overall withholding for that pay period. This calculation is more complex, but less likely to cause surprises at tax time.

Step-by-step gross-up calculation example

When employees receive a taxable award, there's always a risk that they'll feel deflated once they see how much it impacts their take-home pay. To reduce the sticker shock, many employers give a little extra to balance out those taxes. This is called a gross-up calculation, and it ensures employees take home the full value of your award.

Here’s the gross-up calculation formula: Gross pay = net pay / (1 - tax rate)

For example, if you want the employee to net $100 after a 22% rate:
Gross award = $100 / (1 - 0.22) = $100 / 0.78 = $128.21

Benchmark data & best practices

Peeking over the fence at other companies' reward programs isn't nosy — it's savvy tax planning in disguise.

Latest IRF stats on incentive usage and preferences

Both are taxable, but gift cards can be given to more employees at a lower cost. That’s probably why $50 and $100 gift cards are the most common. The most popular gift card types include Amazon cards, big box store cards, coffee shop cards, and dining cards. 

Top 10 gift cards powering incentive programs in 2025

Read the article

Annual audit & policy review before W-2/1099 season

Think of the pre-tax season months as your last chance to fix everything before the IRS spotlight hits. Do the work now, or spend tax season playing frantic catch-up while your accountant sends you increasingly passive-aggressive emails.

Here are essential steps to ensure your reward program is audit-ready:

• Work with an accountant who stays current on rewards-based tax implications to determine whether your rewards are taxable or non-taxable. Tax treatment depends on individual situations and program structures, so lean on an expert.

• Audit your reward approval process to confirm that all approvals have been adequately documented. Missing documentation can turn a compliant reward program into a tax compliance nightmare if you face IRS inquiries.

• Verify the accuracy of employee information for W-2 and 1099 reporting, including names, Social Security numbers, and addresses, to avoid delays and administrative headaches.

• Finally, link performance metrics to rewards data to evaluate business impact and strengthen the business justification for your reward expenses if questioned during an audit.

Key takeaways

• Cash and cash-equivalent rewards (including gift cards) are taxable wages

• De minimis and qualified award programs can offer tax-friendly options, but limits apply

• State and local tax requirements may increase complexity

• Annual compliance reviews protect against penalties and strengthen program ROI

Plan and track employee rewards

Recognition is powerful, but so is staying compliant. If you’re managing employee rewards in-house, make sure your program is built on a solid tax foundation. And when you’re ready to simplify the delivery and tracking of rewards, explore how Tremendous can help.

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