Know what's taxable

Certain types of gifts, given under the right circumstances (length-of-service awards, safety awards, etc.) are not subject to tax. Also, different rules apply to different types of bonuses, such as discretionary and non-discretionary.

I recommend: In its small-business section, the IRS Web site explains tax status of awards on its Employees' Pay page. Another good, concise resource is the American Institute of Professional Bookkeepers, which offers a free report titled "Bonuses, Gifts, Prizes and Awards: What's Taxable and What's Not", available only by calling 1-800-622-0121 or e-mailing info@aipb.org.

Cover their taxes

Some companies absorb the cost of employees' taxes on bonuses. And if you're giving a taxable non-cash award, such as a car, paying the tax definitely enhances the item's value. However, it's not as simple as paying the amount the employee would be taxed; there's a special calculation called a "gross-up," which determines the amount the employer must pay.

I recommend: The American Institute of Professional Bookkeepers has several calculators for determining gross-up amounts. Register at Paycheckcity.com to access a free bonus tax calculator, stock option calculator and gross-up calculator to help you determine the full amount you would need to pay should you choose to pay employees' bonus taxes for them.

Use merchandise incentives

Non-cash rewards (excluding gift cards and certificates) valued up to $1,600 per employee per year are non-taxable, if they meet certain criteria for reason given.

I recommend: To research merchandise award items and their suppliers, go to PotentialsMag.com.

If your company is public, SOX affects your gifts and bonuses

The Sarbanes-Oxley Act of 2002 requires public companies to document procedures and security controls of incentive programs. In short, this means tying every reward to a business outcome.

I recommend: The American Institute of Certified Public Accountants posts a summary of key sections of the 66-page piece of legislation. Download a SOX compliance toolkit from Sarbanes-Oxley-Forum.com.