What Makes for the Best Gift From an Employer?

Not all gift cards are created equal. Certain types are likely to work better than others for genuinely motivating employees.

Closed-loop vs. open-loop gift cards

Prepaid credit cards and other kinds of cards that function similar to cash — in other words, cards with credit that can be redeemed for just about anything — are called “open-loop” gift cards. By contrast, “closed-loop” gift cards can only be redeemed at a specific store or outlet or for a specific service.

It might seem counterintuitive, but closed-loop cards are a better motivational choice when it comes to gift cards for employees. Open-loop cards might be more popular with hourly employees, but closed-loop cards are likely to be perceived as less impersonal and therefore more meaningful, particularly by salaried employees.

The psychological impact of personalized gift cards

When focused on an employee’s needs and interests and given as part of an overall culture of valuing individual work, personalized gift cards can have a remarkable impact on motivation and engagement. They can provide the genuine sense of being treated to something unusual, and they can offer a chance to provide employee rewards with a personal touch.

In this regard, gift cards are comparable to experiential rewards, another popular and related contemporary trend in employee morale management. These rewards focus on providing unique experiences such as travel and entertainment. The key is to make them a part of a genuine commitment to employee rewards that are authentically personalized, relevant and of true value, and to pair them with explicit appreciation and recognition.

Well-structured gift card programs

To be certain that the gift cards you give your employees have the intended psychological effect, you need to make them part of a well-structured rewards program. Such a program should meet two key requirements:

• Don’t go overboard with choices. Seeing an enormous amount of options in a gift card rewards program can feel overwhelming, thus reducing the interest of employees in participating.
• Make sure your gift cards offer value in line with a store or outlet’s offerings. A $5 or $10 gift card for Starbucks makes sense in terms of the overall costs of what’s on offer, whereas a $30 gift card to a tech store where most products cost hundreds of dollars won’t be nearly as valued.

Are Gift Cards Taxed?

Using employee gift cards in a way that generates real excitement and engagement from your workforce is only one part of the puzzle. You’ll also need to consider the tax implications of your rewards program.

How gift cards are taxed

Whether they’re closed-loop or open-loop, gift cards are considered cash income by the IRS no matter the amount involved. The only potential exceptions to this are cards given for the purchase of specific items of minimal value, as determined in consultation with a tax professional. Otherwise, all gift cards should be counted and reported as part of employee income.

More specifically, gift cards are considered a form of supplemental income. This means that taxes on gift cards need to be withheld as with other types of supplemental compensation. This includes federal income, Social Security, Medicare, and where applicable, state income tax.

There are a couple of different strategies for withholding federal taxes on this type of supplemental income. The first is the percentage method, which withholds a flat 22% rate. The second is the aggregate method of adding the card amount to regular wages and then using that combined amount to withhold taxes.

Gift card amounts after taxes

Withholding the appropriate tax amounts from gift cards can lead to bizarre or random-looking balances that can be confusing to the final recipients. The best way to avoid this is to carry out a tax gross-up.

Simply put, to “gross up” means to pay out more than the originally promised amount so that once taxes are accounted for, the net pay comes out to the originally promised amount. Payroll software can be useful in calculating the specifics of how grossing up the amounts of gift cards should work.

A simple guideline to grossing up might look like this:

• Adding up all gift card-applicable tax rates
• Deriving the net percentage by converting the final rate into a decimal
• Subtracting that total rate decimal from 1
• Dividing the preferred amount by the net percentage to ascertain gross pay

That’s one possibility. It’s important to consult a chartered accountant to make sure you have the specific accounting solution that makes the most sense for your company’s approach.

Reporting gift card income

Gift card values should be recorded as part of employee wages on a W-2 form, included under the boxes for wages, tips and compensation, for Social Security wages, and for Medicare wages and tips. The total quantity of fringe benefits awarded to employees can be reported under “other” on the same W-2 form.

Taxes on gift cards outside the U.S.

The basic rules and parameters discussed above apply to American companies. Companies in other jurisdictions need to account for the tax rules that apply in those locations. Generally, gift cards are considered taxable in most jurisdictions, but the specific rules vary widely and should be carefully incorporated in your payroll processing.