Q. (cont.) Service award gifts (e.g., five-year, ten-year etc.): Same question – if employee purchases his or her own gift, is it considered taxable income to employee?
A. We spoke with IRS information specialist Ms. Sutton (#1002213914). Per IRS Publication 525, Taxable and Nontaxable Income, this is considered an “employee achievement award”: “If you receive tangible property (other than cash, a gift certificate, or an equivalent item) as an award for length of service...you can generally exclude its value from your income. However, the amount you can exclude is limited to your employer's cost and cannot be more than $1,600 ($400 for awards that are not qualified plan awards) for all such awards you receive during the year.”
The publication goes on to say that you must make the award as part of a meaningful presentation, and not create a situation in which it is disguised pay. Also, the employee cannot have received the award for less than five years of service or have received another length-of-service award during the current year or the previous four years.
Something you must also consider is whether any of the recipients are “highly compensated,” per the IRS definition on page 4 of Publication 15-B, Employer's Guide to Fringe Benefits. If so, then the retirement awards may well be taxable.
Although the publications do not specifically address the reimbursement vs. outright purchase issue, the employee ended up with tangible property and not cash. If the reimbursement was for tangible property and not for a gift card or certificate, if the spending limit was not exceeded (whether or not for a qualified plan, as above), no other such award was given during the current or previous four years, and the employee was not highly compensated, then this would be considered nontaxable to the employee, per Ms. Sutton.
Also note that any excess reimbursement over the cost of the item purchased would be taxable income; therefore, you should obtain receipts from the employees to ensure you have documentation that the reimbursement exactly matched the purchase price.
There is further discussion of how much you as an employer can deduct for these awards within Publication 535, Business Expenses.