pended on the recipient's marginal tax rate, and thus generally was greater in the case of higher-income taxpayers.

In light of these considerations, the Congress concluded that prizes and awards generally should be includible in gross income even if received because of achievement in fields such as the arts and sciences. This repeal of the special prior-law exclusion for certain awards was viewed as consistent with the Act's general objectives of fairness and economic neutrality.

In addition, the Congress was concerned about problems of complexity that had arisen as a result of the special prior-law exclusion under section 74(b). The questions of what constituted a qualifying form of achievement, whether an individual had initiated action to enter a contest or proceeding, and whether the conditions of receiving a prize or award involved rendering "substantial" services, had all caused some difficulty in this regard. Finally, in some circumstances the prior-law exclusion could have served as a possible vehicle for the payment of disguised compensation.

At the same time, the Congress recognized that in some instances the recipient of the type of prize or award described in section 74(b) may wish to assign the award to charity, rather than claiming it for personal consumption or use. Accordingly, the Act retains the prior-law exclusion for charitable achievement awards described in section 74(b) but only if the award is transferred by the payor, pursuant to a designation made by the winner of the prize or award, to a governmental unit or to a tax-exempt charitable, educational, religious, etc. organization contributions to which are deductible under section 170(c)(1) or section 170(c)(2), respectively.

Employee awards

An additional reason for change relates to the prior-law tax treatment of employee awards of tangible personal property given by reason of length of service, safety achievement, or productivity. Except for any item that might be able to qualify as a de minimis fringe benefit as defined by section 132(e), such employee awards were not excludable from the employee's gross income, and the deduction of their cost by the employer was not limited under section 274(b), if they could not qualify as gifts because of either the "detached generosity" standard applicable under section 102 or the rule of section 74(a) that prizes and awards generally are includible in income.

The Congress understood that uncertainty had arisen among some taxpayers concerning the proper tax treatment under prior law of an employee award. Such uncertainty could lead some employers to seek to replace amounts of taxable compensation (such as sales bonuses) with "award" programs of tangible personal property. The business and the employee might contend that such awards are not subject to income or social security taxes, but that the employer could still deduct the costs of the awards up to the section 274(b) limitations. In the case of highly compensated employees, who often might not be significantly inconvenienced by the fact that such awards would be made in the form of property rather than cash, an exclusion for transfers of property with respect to regular job performance (such as for productivity) could

serve as a means of providing tax-free compensation. As in the case of other exclusions or deductions, the tax benefit of such an exclusion for transfers to an employee would depend on the recipient's marginal tax rate, and thus generally would be greater for higherincome employees.

Accordingly, the Congress believed that it was desirable to provide express rules with regard to the tax treatment of amounts transferred by or for an employer to or for the benefit of an employee. The Congress concluded that, in general, an award to an employee from his or her employer does not constitute a "gift" comparable to such excludable items as intrafamily holiday gifts, and should be included in the employee's gross income for income tax purposes and in wages for withholding and employment tax

purposes.

However, the Congress believed that no serious potential for avoiding taxation on compensation arises from transfers by employers to employees of items of minimal value. Therefore, the Congress wished to clarify that... section 132(e) exclusion for de minimis fringe benefits can apply to employee awards of low value. The Congress also concluded that this exclusion should be viewed as applicable to traditional awards (such as a gold_watch) upon retirement after lengthy service for an employer. For example, in the case of an employee who has worked for an employer for 25 years, a retirement gift of a gold watch may qualify for exclusion as a de minimis fringe benefit even though gold watches given throughout the period of employment would not so qualify for exclusion. In that case, the award is not made in recognition of any particular achievement, relates to many years of employment, and does not reflect any expectation of or incentive for the recipient's rendering of future services.

Also, the Congress concluded that, in certain narrowly defined circumstanes, it is appropriate to recognize traditional business practices of making awards of tangible personal property for length of service or safety achievement. These traditional practices may involve, for example, awards of items that identify or symbolize the awarding employer or the achievement being recognized, and that do not merely provide an economic benefit to the employee. Such practices were not entirely equivalent, for example, to providing either a bonus in cash or an allowance of a dollar amount toward the purchase of ordinary merchandise. The Congress believed that the double income tax benefit of excludability and deductibility is acceptable for such types of employee achievement awards under rules intended to prevent abuse and limit the scope of the double benefit.

In light of these considerations, the Act restricts the double benefit through dollar limitations, limits the frequency with which length of service awards can be made to the same employee, and limits safety achievement awards to the employer's work force (other than administrators, professionals, etc. whose work ordinarily does not involve significant safety concerns) and to no more than 10 percent of such eligible recipients in one year. In addition, the exclusion applies only if the item of tangible personal property is awarded under conditions and circumstances that do not create a significant likelihood of the payment of disguised compensation.

The Act removes the prior-law uncertainty concerning the tax treatment of some employee awards by making clear that the fair market value of any employee award that does not constitute either a length of service award or a safety achievement award qualifying under the Act or a de minimis fringe benefit described in section 132(e)(1) is includible in gross income for income tax purposes and in wages or compensation for employment tax and withholding purposes. The Congress believed that this general rule of includibility is consistent with the Act's objectives of fairness and economic neutrality.

Explanation of Provisions

Charitable achievement awards

Under the Act, the prior-law limited exclusion under section 74(b) for a prize or award for certain charitable, religious, scientific, educational, artistic, literary, or civic achievement (a "charitable achievement award") is further restricted to apply only if the recipient designates that the award is to be transferred by the payor to a governmental unit or a tax-exempt charitable, educational, religious, etc. organization that is eligible to receive contributions that are deductible under sections 170(c) (1) or 170(c)(2), respectively. If such designation is made and if the charitable achievement award is so transferred to the designated governmental unit or charitable organization by the payor, the award is not included in the winner's gross income, and no charitable deduction is allowed either to the winner or to the payor on account of the transfer to the governmental unit or charitable organization.

For purposes of determining whether a charitable achievement award that is so transferred qualifies as excludable under the Act, the prior-law rules concerning the scope of section 74(b) are retained without change. (Thus, for example, the exclusion is available only if the award winner had not specifically applied for the award, and was not required to render substantial services as a condition of receiving it.) In addition, in order to qualify for the section 74(b) exclusion as modified by the Act, the designation must be made by the taxpayer (the award recipient), and must be carried out by the party making the prize or award, before the taxpayer uses the item that is awarded (e.g., in the case of an award of money, before the taxpayer spends, deposits, invests, or otherwise uses the money)

Disqualifying uses by the taxpayer include such uses of the property with the permission of the taxpayer or by one associated with the taxpayer (e.g., a member of the taxpayer's family). Absent a disqualifying use, however, the taxpayer can make the required designation of the governmental unit or charitable organization (to which the award is to be transferred by the payor) after receipt of the prize or award.

Employee awards

In general

The Act provides an exclusion from gross income (Code sec. 74(c)), subject to certain dollar limitations, for an "employee

achievement award" that satisfies the requirements set forth in the Act. The Act defines an employee achievement award (Code sec. 274(j)) as an item of tangible personal property transferred by an employer to an employee for length of service achievement or for safety achievement, 14 but only if the item (1) is awarded as part of a me ingful presentation, and (2) is awarded under conditions and ci: umstances that do not create a significant likelihood of the payment of disguised compensation.15 The exclusion applies only for awards of tangible personal property and is not available for awards of cash, gift certificates, or equivalent items, or for awards of intangible property or real property.

An award for length of service cannot qualify for the exclusion if it is received during the employee's first five years of employment for the employer making the award, or if the employee has received a length of service achievement award (other than an award excludable under sec. 132(e)(1)) from the employer during the year or any of the preceding four years. An award for safety achievement cannot qualify for the exclusion if made to an individual who is not an eligible employee, or if, during the taxable year, employee awards for safety achievement (other than awards excludable under sec. 132(e)(1)) have previously been awarded by the employer to more than 10 percent of the employer's eligible employees. That is, no more than 10 percent of an employer's eligible employees may receive excludable safety achievement awards in any taxable year (even if all the awards are made simultaneously).16 For this purpose, eligible employees are all employees of the taxpayer other than managers, administrators, clerical workers, and other professional employees.

Deduction limitations

Under section 274 as amended by the Act, an employer's deduction for the cost of all employee achievement awards (both safety and length of service) provided to the same employee during the taxable year generally cannot exceed $400. In the case of one or more qualified plan awards awarded to the same employee during the taxable year, however, the employer's deduction limitation for all such qualified plan awards (both safety and length of service) is $1,600. In addition to these separate $400/$1,600 limitations, the $1,600 limitation applies in the aggregate if during the year an employee receives one or more qualified plan awards and also one or more employee achievement awards that are not qualified plan awards; i.e., the $400 and $1,600 limitations cannot be added together to allow deductions exceeding $1,600 in the aggregate for

14 Thus, an employee award for productivity, or for any other purpose not specified in sec. 274(j), is not excludable under sec. 74(c).

15 The types of conditions and circumstances that are to be deemed to create a significant likelihood of payment of disguised compensation include, for example, the making of employee awards at the time of annual salary adjustments or as a substitute for a prior program of awarding cash bonuses, or the providing of employee awards in a way that discriminates in favor of highly paid employees.

16 Accordingly, no exclusion for safety achievement awards is available in the case of an employer with nine or fewer eligible employees.

employee achievement awards made to the same employee in a taxable 17 year.

A qualified plan award is defined as an employee achievement award provided under a qualified award plan, i.e., an established, written plan or program of the taxpayer that does not discriminate in favor of highly compensated employees (within the meaning of sec. 414(q)) as to eligibility or benefits. However, an item cannot be treated as a qualified plan award if the average cost per recipient of all employee achievement awards made under all qualified award plans of the employer during the taxable year exceeds $400. In making this calculation of average cost, qualified plan awards of nominal value are not to be included in the calculation (i.e., are not to be added into the total of award costs under the plan in computing average cost). In the case of a qualified plan award the cost of which exceeds $1,600, the entire cost of the item is to be added into the total of qualified plan award costs in computing average cost, notwithstanding that only $1,600 (or less) of such cost is deductible.

Excludable amount

In the case of an employee achievement award the cost of which is deductible in full by the employer under the dollar limitations of section 274 (as amended by the Act), 18 the fair market value of the award is fully excludable from gross income by the employee. For example, assume that an employer makes a length of service achievement award (other than a qualified plan award) to an employee in the form of a crystal bowl, that the employer makes no other length of service awards or safety achievement awards to that employee in the same year, and that the employee has not received a length of service award from the employer during the prior four years. Assume further that the cost of the bowl to the employer is $375, and that the fair market value of the bowl is $415. The full fair market value of $415 is excludable from the employee's gross income for income tax purposes under section 74 as amended by the Act.

However, if any part of the cost of an employee achievement award exceeds the amount allowable as a deduction by an employer because of the dollar limitations of section 274, then the exclusion does not apply to the entire fair market value of the award. In such a case, the employee must include in gross income the greater of (i) an amount equal to the portion of the cost to the employer of the award that is not allowable as a deduction to the employer (but not an amount in excess of the fair market value of the award) or (ii) the amount by which the fair market value of the award exceeds the maximum dollar amount allowable as a deduction to the employer. The remaining portion of the fair market value of the award is not included in the employee's gross income for income tax purposes.

17 In the case of an employee award provided by a partnership, the deduction limitations of section 274(j) apply to the partnership as well as to each partner. The new employee achieve ment award exclusion is not available for any award made by a sole proprietorship to the sole proprietor; consequently, the deduction limitations in sec. 274(j) do not apply with respect to such an includible award.

18 In the case of a tax-exempt employer, the deduction limitation amount is that amount that would be deductible if the employer were not exempt from taxation (sec. 74(c)(3)).