What Are Qualified Plan Awards? The $1,600 Cap and Average Cost Test

A qualified plan award is an employee achievement award given under a written, non-discriminatory employer program that recognizes length of service or safety, made in tangible personal property. Setting up qualified plan awards raises the employer’s deduction cap and the employee’s income exclusion from $400 to $1,600 per employee per year under Internal Revenue Code Section 274(j).¹ Miss any requirement and the award drops back to the $400 cap, or falls out of Section 274(j) entirely and becomes ordinary taxable wages.

What Makes a Plan Qualified

Two conditions turn an ordinary achievement award program into a qualified plan:

The employer has an established written program governing the awards.
The program does not discriminate in favor of highly compensated employees, either in who is eligible or in the benefits provided. Highly compensated status is defined under Section 414(q); for the 2026 plan year, that generally means anyone earning over $160,000 in the prior year.¹

If either piece is missing, the plan is not qualified. The award may still be deductible up to $400 as a regular (non-qualified) achievement award, provided the underlying award rules are met.

The $1,600 Cap and How It Combines With Other Awards

Under a qualified plan, the employer can deduct up to $1,600 per employee per year, and the employee excludes the same amount from gross income. The $1,600 is a ceiling on all achievement awards to that employee for the year, not just the ones given through the qualified plan. A $300 non-qualified award plus a $1,400 qualified plan award to the same employee totals $1,700, and the employer’s deduction is capped at $1,600.¹

The Average Cost Test That Can Sink the Higher Cap

A written, non-discriminatory plan is not enough on its own. If the average cost of all awards given under the plan for the year exceeds $400, the plan loses qualified status for that year and every award reverts to the $400 cap. The average includes the full cost of every award, but awards of nominal value are ignored in the calculation.¹

An example from IRS guidance: three awards costing $1,500, $800, and $600 have an average of $967. Because $967 exceeds $400, none of the three qualify for the $1,600 cap, and the deduction is limited to $400 per employee.² Employers who plan to give a small number of high-value awards need to be aware of this arithmetic before the year closes.

What the Award Itself Has to Be

The qualified plan cap only applies if the award independently meets the Section 274(j) definition of an employee achievement award. Three things are required.

Tangible Personal Property

The award must be tangible personal property. The statute expressly excludes cash, cash equivalents, gift cards, gift coupons, gift certificates, vacations, meals, lodging, tickets to sporting events or theater performances, stocks, bonds, and other securities.¹ The Tax Cuts and Jobs Act of 2017 wrote those exclusions directly into the code.³ Items that do qualify include a watch, a piece of jewelry, a golf set, or a plaque.

Letting the employee pick from an employer-curated, limited catalog of tangible items is fine. Handing them a general-purpose gift card is not.¹

Length of Service or Safety, Nothing Else

The award must recognize length of service or safety achievement. No other purpose qualifies. It also has to be presented as part of a meaningful ceremony or occasion, under circumstances that don’t look like disguised compensation.¹

Length-of-service awards carry two timing rules that both have to be met. The employee must have completed at least five years of service, and cannot have received another length-of-service award in the current year or any of the four prior years. Awards of nominal value, such as a certificate or a small pin, don’t count against the five-year spacing.²

Safety awards carry two restrictions of their own. Managers, administrators, clerical employees, and other professional employees are ineligible to receive them on a tax-advantaged basis. And no more than 10% of the employer’s eligible workforce (excluding those same ineligible groups from the denominator) can receive a safety award in any tax year. Nominal-value awards don’t count toward the 10% cap.¹

How the Limits Translate for the Employee

When the employer’s cost of the award does not exceed the applicable cap ($1,600 for a qualified plan award, $400 otherwise), the employee excludes the entire value from gross income.⁴

When the cost exceeds the cap, the employee includes in income the greater of:

The portion of the employer’s cost above the cap (but no more than the award’s fair market value), or
The amount by which fair market value exceeds the cap.⁴

Most of the time an employer pays retail, so cost and value line up. A $2,000 watch given as a qualified plan award produces $400 of taxable income to the employee ($2,000 minus $1,600), and the rest is excluded. The “greater of” formula matters when the employer got a wholesale price. If a watch cost the employer $1,800 but has a $2,200 retail value, the employee compares $200 ($1,800 minus $1,600) against $600 ($2,200 minus $1,600) and reports $600.

When an Award Doesn’t Qualify

An award that misses any Section 274(j) requirement is treated as ordinary taxable compensation. Common ways this happens: giving cash or gift cards instead of tangible property, recognizing an employee before their fifth year, giving a second service award inside the five-year window, or breaching the 10% cap on safety awards.⁵

The full fair market value goes into the employee’s gross income, subject to income tax withholding, Social Security, and Medicare. The employer still deducts the cost, but as regular wages rather than as an achievement award, subject to the usual reasonableness standards for compensation.

Reporting the Taxable Portion

Any taxable portion of an achievement award is reported as wages on Form W-2 and run through payroll for federal income tax withholding and employment taxes. The employer calculates which portion is excludable and which is taxable using the statutory formula. That calculation happens regardless of whether the employer actually claimed the deduction; an employer that chose to forgo the deduction still creates taxable income for the employee on any amount above the applicable cap.⁴

1
Office of the Law Revision Counsel. 26 USC 274 – Disallowance of Certain Entertainment, Etc., Expenses
2
Internal Revenue Service. Publication 535 – Business Expenses
3
Internal Revenue Service. Tax Cuts and Jobs Act: A Comparison for Businesses
4
Office of the Law Revision Counsel. 26 USC 74 – Prizes and Awards
5
Internal Revenue Service. Employee Achievement Awards