Giving gift cards to your employees for the holidays may be convenient for you, but not so simple, or desirable, for the employee.

I was reading a recent Women Entrepreneur column by Roni Lynn "The Tax Lady" Deutch on how small-business owners can benefit from a tax break when throwing a party or giving gifts to their employees during the holidays. As Lynn points out, the cost of throwing a party for employees is tax deductible (with some caveats). Entrepreneurs also can deduct up to $25 worth of gifts given to individual employees and/or customers each year.

And while gift cards seem like a quick and easy alternative to more personalized gifts, what you might not know is the Internal Revenue Service considers gift cards to be additional compensation, so it's taxable income. That's right. Employees will have to declare money, gift certificates or gift cards -- pretty much anything that can be converted into cash -- with their usual taxes. "You can give $5 or $500, it doesn't matter," says Gary Grush, partner at audit, tax and advisory firm Grant Thornton Ltd. "No matter the value, you have to tell your employees that their W-2 form will include the value of the gift as taxable income." 

Obviously, the greater the value of the gift card, the more each employee will owe in taxes. The exception to this rule, within certain limitations, is if a business owner gives gift cards or certificates that are redeemable only for the company's own merchandise, according to the IRS.

One way for small-business owners to avoid employee blow-back is by what Grush calls "grossing up," or adding the amount they'd have to pay in taxes to the value of the gift card. For instance, if you were planning on handing out $1,000 gift cards, and each employee would need to pay $250 in taxes on it, simply increase the value of each card to $1,250.

For cash-strapped entrepreneurs, there may not be any wiggle room in the budget for "grossing up." If that's the case for you, consider giving one of these non-taxable gifts (as defined by the IRS' Employer's Tax Guide to Fringe Benefits) instead:

  • Any item that costs about $25 or less is not taxable. This could include customized office supplies, or colorful gadgets like magnetic paperclip holders. Think personalization.
  • For the foodies in your company, consider an edible gift such as a holiday ham or baskets of assorted items like chocolate or coffee. 
  • Don't forget to consider throwing a holiday party for your employee and their guests.
  • Finally, you may be surprised to learn that occasional tickets to events are not considered taxable income, either. For sports fans, consider gifting a pair of reasonably-priced tickets to see their favorite team play. Or, if there is a theatergoer in your office, give them tickets to a coveted performance.