Referral bonuses are taxable. Whether you pay your bonuses in cash or gift cards, they need to be reported to the IRS and taxes need to be withheld. But how? Should you use a W-2 or a 1099? Is the withholding rate for bonuses different from the rate for regular income?
To answer these and other common questions about referral bonus taxes, we consulted with Joseph Smith, president and founder of TravelTax, a company that specializes in tax preparation for travel nurses and other travel professionals, as well as tax consulting for healthcare staffing agencies.
Referral bonus taxes for ambassadors on your payroll
If you pay referral bonuses to ambassadors who are also your employees, any amount over $25 is considered part of an employee’s wages and should be reported on their W-2.
Best practices
- For cash bonuses, add the bonus to the employee’s regular paycheck so that taxes are withheld like usual.
- For bonuses paid as gift cards, use the employee’s W-4 on file to determine the appropriate taxes and withhold that amount from their next paycheck.
Common questions
Can we use a 1099 instead?
Many staffing agencies want to treat referral bonuses like self-employment income and issue a 1099, even for their current employees. This may seem convenient, but it isn’t accurate, and it can cause problems down the road, especially for your employees.
When you pay an employee through payroll, the federal payroll taxes on their wages are split 50/50 – your agency pays half and the employee pays half. If you issue a 1099, the employee is responsible for 100% of the payroll taxes, which means they will end up paying double what they actually owe. The employee’s tax preparer can fix this by having the employee fill out Form 8919, but the best plan is to avoid the complication entirely by using a W-2.
Is there a different withholding rate for referral bonuses?
If you include the bonus in an employee’s paycheck, the withholding amounts are the same as for their regular pay. You can use the employee’s W-4 on file to correctly calculate how much to withhold.
Can we pay the referral bonus separately and count it as supplemental income?
Some agencies choose to pay referral bonuses separately from a regular paycheck. In this case, the bonus is considered supplemental income, which is subject to a flat 22% federal tax rate. For large bonuses (e.g., $10,000), this method can provide a tax advantage for the ambassador. But for the size of the referral bonuses typically given in the staffing industry, it usually makes more sense to just include the bonus in the regular paycheck.
If we pay using a gift card, do we have to withhold taxes from the next paycheck? Or is there a grace period?
The best practice is to withhold the taxes immediately. But that’s not always feasible. The IRS stipulates that taxes must be withheld “contemporaneously,” which can be interpreted as “as soon as possible.” The most important thing is that the taxes are withheld within the same calendar year as the referral bonus is paid.
Referral bonus taxes for ambassadors not on your payroll
If you pay referral bonuses to ambassadors who are not on your payroll, any amount over $600 is taxable and should be reported on a 1099-MISC. This is true whether you pay in cash or using a gift card.
Best practice
- Use a 1099-MISC (miscellaneous) rather than a 1099-NEC (non-employee compensation).
The 1099-MISC is used for things like gifts and prizes, while the 1099-NEC is for self-employment income. Since a referral bonus is more like a prize than self-employment income, the 1099-MISC is the correct form. Miscellaneous income is not subject to payroll taxes, so using this form will save your ambassadors roughly 15% in taxes.
Communicating with ambassadors about taxes
Taxes on referral bonuses can be confusing, especially for W-2 employees who are used to seeing the same amount on every paycheck.
Here are a couple of example scenarios:
- You have an employee making $1,000 per week ($52,000/year), and they just earned a $1,000 referral bonus. You pay your bonuses through your regular payroll, which means their next check will be for $2,000. When this happens, the tax withholding calculations will assume that the employee is now making $104,000/year, which puts them into a higher tax bracket, so more taxes than usual will be withheld from that paycheck.
- You pay an employee a $500 referral bonus using a gift card and withhold the taxes from their next paycheck, which means the check is smaller than usual.
These types of situations can cause ambassadors to feel frustrated if they come as a surprise. The best way to prevent frustration is to communicate in advance that referral bonuses are subject to the same taxes as regular wages. You can do this in several different ways – such as including it in the terms and conditions for your referral program or sending an email when an ambassador earns a bonus. The important thing is to be transparent so that your ambassadors know what to expect.
Another way to prevent frustration is to give net bonuses. This means that if the bonus amount is $1,000, you give a larger bonus so that your ambassador takes home $1,000. You’d have to take the extra step of calculating the correct gross amount, but your ambassadors will be delighted!
A completely legal way to avoid taxes on referral bonuses
There is one way to avoid taxes on referral bonuses completely. Rather than giving cash or a cash equivalent, you can offer ambassadors something that would be considered a reimbursable expense. For example, if you place travel nurses, you could give them a gift certificate to purchase scrubs or continuing education unit (CEU) courses, or you could pay for their registration for TravCon. Anything that’s directly job-related is not subject to income taxes.
Staffing Referrals
