Late in the year, a lot of owners want to say thank you: a cash bonus, a gift card, a ham, a party, a basket for the client who referred half the year's work. Each of those is generous, and each is treated differently by the IRS. The expensive mistakes come from treating a taxable bonus as a gift, which leaves payroll taxes unpaid and the W-2 wrong, or from recording a mostly nondeductible gift as if it were fully deductible.
This guide covers the rules the way a bookkeeper applies them: what is taxable to the person receiving it, what you can deduct, and how each item should be entered so the new year does not begin with corrections.
Cash bonuses are wages, every time
A bonus paid to an employee is wages. It is subject to federal income tax withholding, Social Security and Medicare taxes, and federal and state unemployment taxes, and it belongs on the employee's Form W-2. That is true whether you call it a bonus, a holiday gift, or a thank-you, and whether it goes out as a check, a direct deposit, or an envelope of cash. The way to pay it is through payroll, not as a bank transfer coded to a gifts account. If your payroll provider offers an off-cycle bonus run, use it: the bonus is coded as supplemental wages, the taxes are computed, and the W-2 comes out right.
Withholding on bonuses follows the supplemental wage rules. When a bonus is paid separately from regular wages and identified as supplemental, the employer can withhold federal income tax at a flat rate, currently 22 percent for most employees, or combine it with regular wages and withhold on the total. Either way, Social Security and Medicare apply in full. If you want an employee to take home a round number, say $500 in hand, the payroll system can gross up the bonus so the taxes come out of a larger gross; the grossed-up amount is the wage expense. In the books, a bonus run looks exactly like a normal payroll: gross wages to the wages expense account, the employer's share of payroll taxes to payroll tax expense, and withholdings and net pay through the payroll liability and bank accounts. One more thing: if you own an S corporation and want a year-end bonus yourself, that is a wage through payroll too. Taking extra cash as a distribution is not a bonus and does not count toward your reasonable compensation.
Gift cards, gifts, and what de minimis really means
Gift cards and anything else easily converted to cash are taxable wages regardless of amount. A $25 coffee card for each employee is, legally, $25 of wages for each of them, and it goes through payroll as a non-cash taxable benefit so the taxes are withheld from a regular check. The exception most owners are thinking of is the de minimis fringe benefit: property or services so small in value and so infrequent that accounting for them is unreasonable. A holiday turkey or ham, a box of chocolates, flowers for a birthday, occasional tickets to a game, the odd lunch brought in for the team. Those are not taxable to the employee and are deductible to you. The law sets no dollar amount, but the IRS has said that items worth around $100 are not de minimis, so the safe range is well below that, and the item has to be an actual thing, never cash or a card.
Larger non-cash gifts have their own rule. An employee achievement award, meaning tangible property given for length of service or safety under a written plan, can be excluded from wages up to limits, generally $1,600 under a qualified plan and $400 otherwise. Cash, gift cards, vacations, meals, and securities never qualify. If a gift fits neither the de minimis nor the achievement-award rules, it is wages at fair market value. Record the cost of de minimis gifts in an employee gifts or staff appreciation expense account, deductible in full. Keep the receipt and a note of who received what; it is the only way to show the gift was small and infrequent if anyone asks.
Contractors, clients, and the holiday party
A bonus to an independent contractor is simply more nonemployee compensation. Add it to the year's total for that contractor and include it on the Form 1099-NEC, which is due to the recipient and the IRS by January 31. For payments made in 2026 the reporting threshold is generally $2,000, so a holiday bonus can tip a small vendor over the line; check totals before the forms run. A gift to a contractor, a client, or a referral source is a business gift, and the deduction is limited to $25 per recipient per year. The limit is per person, not per gift, and it has not changed in decades, so a $150 basket for your best customer is a $150 expense in the books of which $25 is deductible. Incidental costs such as engraving, wrapping, and shipping do not count toward the $25, and branded items costing $4 or less that you hand out widely, pens and calendars with your logo, are outside the limit entirely. Track gifts in a dedicated gifts expense account with the recipient's name in the memo so your accountant can apply the limit without reconstructing the year.
The holiday party is the pleasant exception. A recreational or social event held primarily for employees, not just for owners and the highest-paid staff, is fully deductible, outside the 50 percent limit that applies to most business meals. Record it in its own account, something like employee events, rather than in meals, so it is not cut in half at tax time by default. If clients or vendors attend, the portion attributable to them falls under the ordinary meals and entertainment rules, so keep the guest list.
Timing, and getting it right before January
When the bonus is paid decides which year it belongs to. A bonus paid on December 31 is 2026 wages on the 2026 W-2; the same bonus paid on January 2 is 2027 wages. If you keep accrual books and want to deduct in 2026 a bonus paid early in 2027, the amount has to be fixed and owed by year end and paid within two and a half months after it, and bonuses to owners of closely held companies have tighter rules, so talk to your accountant before relying on that. Most small businesses keep it simple: pay before December 31 if you want it on this year's return.
Before year end, run a short review: every bonus went through payroll; every gift card to staff was added to a paycheck as a taxable benefit; de minimis items and party costs sit in their own accounts; contractor bonuses are in the 1099 totals; and client gifts carry a recipient name. That review is part of a normal month-end close, which is what Evolv Bookkeeping does for $199 per month flat, with your P&L and Balance Sheet delivered by day 2 of the following month and 1099 prep for your contractors at year end. If the books are behind, catch-up is $199 for each month behind, done within 2 days and guaranteed in writing. No contracts, cancel anytime, and an instant quote is on our homepage.