HUMAN RESOURCES MANAGEMENT LETTER NO. 05-99-5

NEW TAX GUIDELINES FOR AWARDS

HUMAN RESOURCES MANAGEMENT LETTER NO. 05-99-5
ATTACHMENT A

NEW TAX GUIDELINES FOR AWARDS

1. Definitions

a. Cash Equivalent Awards: Cash equivalent awards are awards that can be
converted to cash or expensed like cash. Gift certificates and vouchers with a clear monetary value are examples of cash equivalents.

b. Non-monetary Awards: Non-monetary awards are memorabilia (e.g.,
merchandise) or trophy items (e.g., plaques, framed certificates) given to recognize accomplishments that might otherwise go unrecognized. Savings Bonds are considered non-monetary award items because they are Federal contracts that must be purchased and held for six months before they can be cashed.

2. Taxing Cash Equivalents and Non-monetary Awards: According to the rules of the Internal Revenue Service, cash equivalent awards are always taxable, regardless of the amount. Non-monetary awards are taxable unless they are de minimis. A non-monetary award will be de minimis if it has a fair market value or purchase price of $25 or less. Gift certificates and Savings Bonds are popular non-cash awards and are discussed below:

a. Gift Certificates: From a tax perspective, all gift certificates are
considered to be a cash-equivalent fringe benefit. Because of the expressed monetary value, gift certificates are cash equivalents even though they generally cannot be converted to cash, and the recipient often loses any difference between the face value of the certificate and the actual cost of a redeemed item when the item selected is priced less than the certificate's face value. As with a cash award of any amount, the agency must report as gross income and wages and withhold applicable taxes on any cash equivalent award. Tax withholding is based on the face value of the gift certificate.

b. Savings Bonds: A U.S. Savings Bond is a Federal contract that must be
purchased and held for six months before it can be cashed. Like a gift certificate it is a cash equivalent with a clear face value and, therefore, is always taxable. However, the face value is not the actual value of the Bond until it reaches maturity. Therefore, the value of the Bond at the time it is given to the employee, usually the Bond's cost to the employer, is the fair market value of the Bond rather than its face value. This is the amount on which tax withholding is based.

It is the employee's responsibility to report as income, and pay taxes on, the
interest earned on the Savings Bond between the time the employee receives it and later cashes it.

3. Determining Whether a Non-monetary Award Is De Minimis

a. For non-monetary awards, the principal tax exemption applicable to the Federal Government is the exclusion for a de minimis fringe benefit-this means "too small to bother with." The Internal Revenue Service has no specific dollar value associated with de minimis. But the Internal Revenue Code defines a de minimis fringe benefit as an item for which, taking into account the frequency with which it is given, the value is so small that accounting for it is unreasonable or too administratively impracticable. Consequently, even items of little value given frequently to the same person would not qualify as de minimis.

b. The determination as to whether or not an award is de minimis is made based on the fair market value of the item given. De minimis guidelines do not apply to cash or cash equivalent awards. They are always taxable.

Note: If through volume purchase an organization was able to purchase items at less than their fair market value, taxes would only need to be paid on the per unit purchase price (if greater than $25). No taxes would need to be paid if the per unit price was reduced to $25 or below, regardless of fair market value.

4. Approving Official (AO) Responsibilities for Certifying Non-monetary Awards for Tax Purposes

a. It is the responsibility of the AO to make the determination of fair
market value for tax purposes. Normally the purchase price will be the fair market value of an item. Again, non-monetary awards with a fair market value of greater than $25 are taxable.

b. Examples of non-monetary awards that normally have a de minimis fair market value might be ballpoint pens or mugs with a team motto that are given to every member of a project team for completing their assignment ahead of schedule and under cost. The fair market value of the item given to each individual is very small and it is administratively inefficient to report it as part of the employee's gross income and wages.

c. Once the determination of value has been made, the AO should certify that the non-monetary recognition is de minimis or that it is taxable. Certifications should be done on the modified VA Form 4659 (Attachment B). If an award is certified as de minimis, the certification should be kept by the local awards administrator for audit purposes for a period of two years from the approval date of the award. For those awards certified to be taxable, the value of the award and certification should be submitted to Fiscal by the AO.

5. Withholding Income Tax and "Grossing Up"

a. When a non-monetary award is not de minimis, then the item is taxable. The fair market value of the item must be reported as gross income and wages, and the applicable taxes withheld.

b. It is the employer's choice whether to increase (gross up) the employee's award amount in order to cover the employee's taxes due (i.e., income taxes and the employee's share of FICA taxes) on an award. The employer's share of FICA is paid by the agency regardless of whether the award amount is "grossed up." When an award amount is "grossed up" to cover the taxes, both the value of the award and the "grossed up" tax coverage amount must be included in the employee's gross income and wages and the tax coverage amount will further reduce your awards budget.

c. In order to gross-up an award, divide the net amount by (1 minus the percent of taxes). For example, in order to gross-up a net award of $50 for an employee under retirement code 1, divide $50 by (1 -.3345, or .6655). The total grossed-up award would be $ 75.13. In order to gross-up a net award of $50 for an employee under retirement code K, divide $50 by (1 -.3965, or .6035). In this case, the total grossed-up award would be $ 82.85.

d. The following shows how the taxation percentages used in the above examples are derived:

(1) For retirement codes 1, 6, R, T: 1.45% Medicare + 28% Federal + 4% state = 33.45% or .3345

(2) For retirement codes K, C, E, M, 2: 1.45% Medicare + 6.20% OASDI + 28% Federal + 4% state = 39.65% or .3965

Note: Generally, 4% is used for state tax purposes but there is no standard. Depending on the state, the facility may want to change the percent to a more precise rate.

e. Within the limits of their delegated authority, AOs may "gross up" all taxable non-monetary recognition and cash awards per the guidelines above, to avoid diminishing the value of the award.

6. When to Gross Up Awards

a. The size of an award should be substantial enough to be meaningful and appropriately recognize an employee's accomplishment(s). If you gross up a large cash award for an employee, it will take an inordinately big bite out of your awards budget. Therefore, grossing up should be done judiciously to ensure that there is enough money left in the awards budget to recognize other deserving performance during the year. As a general guideline, we recommend you do not gross up cash awards above $200. Even though substantial income tax is withheld from, e.g., a $2000 cash award, the net (after tax) amount is still enough to be a meaningful award. Also remember that the total amount of the award, including the portion "grossed up" to cover taxes, cannot exceed the maximum value of the award as specified in Appendix B of VA Handbook 5451 or the AOs delegation of authority.

b. We recommend you gross up all taxable non-monetary recognition. Since the employee is in receipt of something that is not cash, it might diminish the effect of the recognition if the employee ends up with a reduced paycheck because he/she had to pay taxes on a non-monetary award.

7. IRS' Doctrine of Constructive Receipt

a. VA award programs should continue to uphold the practice where recommending officials make the choice between cash and time off or Quality Step Increases (QSIs), rather than the employee receiving the award. If an employee is given the opportunity to choose, it would create adverse tax implications for the employee and administrative problems related to the PAID system.

b. Any time an employee is allowed to decide between a cash award and a
time off award or QSI, and the employee does not choose the cash, the Internal

Revenue Service rules that the employee is considered to be in constructive receipt of the cash, and taxes must be withheld accordingly. Whenever an employee could have had the cash, taxes are due on the amount of cash that was offered and that amount must be withheld. This "up-front" tax payment is supposed to be offset by not withholding taxes when the "other-than-lump-sum-cash" award is collected by the employee, i.e., in the pay period where the time off was used. It should be noted that this rule does not preclude a supervisor informally "polling" employees regarding award preferences, providing the supervisor makes the decision as to which type of award will be given.

8. Summary

a. Cash and cash equivalents are always taxable

b. Non-monetary awards are now taxable if their fair market value is greater than $25

c. Approving Officials are responsible for certifying non-monetary awards as
taxable or de minimus

d. Supervisors may choose to "gross up" taxable non-monetary and cash or cash equivalent awards

e. Supervisors should continue to make the decision on whether an awardee receives time off or a QSI in lieu of a cash award

CPDF CODE DESCRIPTION

GROSSING UP TABLES