Holiday cash bonuses must be reported for tax purposes

Question: I am planning to give my staff holiday cash bonuses in the range of $100 to $1,000 per employee, depending on their past year's performance. In the past, I have put cash in an envelope and personally delivered one to each employee with my holiday wishes and a thank-you for all their hard work. Would this be a problem with the IRS?

Answer: Unfortunately, your methodology does not comply with the tax laws. Your practice can certainly give the employees a holiday cash treat. But it must be reported as supplemental wages, which are subject to federal, state and local payroll taxes.

It is allowable to provide noncash gifts of nominal value such as fruit baskets or small items, but anything that can be converted to cash, including gift certificates, must be reported as additional wages.

Reporting the cash payments as taxable employee wages will result in some unwelcome surprises. After you distribute the cash to your employee, you must subject the cash amount paid to taxes. If you add the gift amount to the employee's normal wages reported on the next scheduled payroll, it would be subject to federal income tax, Social Security and Medicare taxes, and state and local income tax withholdings.

These withholding taxes will be taken from your employee's normal net wages, and will result in their payroll check being substantially lower than usual. In addition, you must pay the matching employer Social Security and Medicare taxes, along with other employer taxes such as federal and state unemployment taxes.

The results from your good intentions are an unhappy employee with a smaller paycheck, and a hefty employer tax bill to fund. Your share of employer payroll taxes is unavoidable. But your employee can be relieved, depending on your generosity level.

If your true intentions are to enrich your staff with the full $100 to $1,000 gift, then you should "gross up" the face amount of the gift with the necessary tax withholdings. By grossing up the gift, your practice is paying all taxes, and the result is no change to the employee's normal paycheck. Your gift became more costly, but the employee will not receive any unwelcome surprises. Unfortunately tax law compliance doesn't come cheaply.

Question: I heard something about a telephone tax refund and am wondering if I am entitled to it. If so, how do I get the refund?

Answer: The taxpayers won the tax battle with the IRS when it was determined that the federal tax imposed on long-distance service based on elapsed time and not distance was disallowed. Therefore, for the period after Feb. 28, 2003, through July 31, 2006, you and your practice are each eligible for a federal telephone tax refund.

For your personal tax refund, if you can't determine how much federal telephone tax you paid for the qualifying period, you may request a refund based on your personal exemptions claimed on your 2006 income tax return, which translates to a scheduled table amount.

The Internal Revenue Service recently issued a simplified procedure for determining your practice's tax refund amount if you don't have adequate records to make the actual calculation.

The simplified procedure sets forth a formula method for businesses which includes sole proprietors, corporations and partnerships.

According to the procedure, you should use the telephone expense and taxes paid for the months of April and September 2006 and calculate the telephone tax paid as a percentage of the corresponding expense as a basis for calculating the federal tax refund for the whole refund period.

The calculation is simple, and the resulting refund cannot exceed 2% of the telephone expenses for the period for businesses with 250 or fewer employees (1% for larger businesses). Alternatively, your practice can estimate your telephone expenses based on amounts reported on previously filed income tax returns and make the necessary refund calculations on these amounts.

Question: I am 55 years old and am considering making immediate gifts of assets to my children. Is it worth doing, or should I leave the assets in my estate?

Answer: You can make an annual gift of $12,000 tax free to as many family members as you wish.

If you have four children, and each of them is married, and you have six grandchildren, and you wish to gift them the maximum tax-free amount, you may transfer $168,000 per year.

In addition, your spouse can gift them $168,000 per year.

If you and your spouse make the maximum gifts on Dec. 31 and Jan. 1, 2007, to all these recipients, you have just removed $672,000 from your estate within a two-day span without paying any transfer taxes.

In 2008 and in each year thereafter, you can continue to make similar gifts to further decrease your taxable estate.

Remember, any earnings on your gifts are not yours, so as a result will not be included in your estate. But this type of gifting program is certainly worthwhile, and your family probably won't mind a bit.

If you wish to gift larger amounts to anyone, you do have a lifetime gift and estate tax exemption that also can be used.

By using this exemption, you have successfully transferred post-gift date appreciation in addition to the original gift amount out of your estate. Gifting is a solid and successful estate-planning program.