Publication 15 (Circular E) provides a general discussion of taxable wages. Publication 15-B discusses fringe benefits. The following topics supplement those discussions.taxmap/pubs/p15a-004.htm#en_us_publink100052246
If an employee is given a temporary work assignment away from his or her regular place of work, certain travel expenses reimbursed or paid directly by the employer in accordance with an accountable plan (see section 5 in Publication 15 (Circular E)) may be excludable from the employee's wages. Generally, a temporary work assignment in a single location is one that is realistically expected to last (and does in fact last) for 1 year or less. If the employee's new work assignment is indefinite, any living expenses reimbursed or paid by the employer (other than qualified moving expenses) must be included in the employee's wages as compensation. For the travel expenses to be excludable:
- The new work location must be outside of the city or general area of the employee's regular work place or post of duty,
- The travel expenses must otherwise qualify as deductible by the employee, and
- The expenses must be for the period during which the employee is at the temporary work location.
If you reimburse or pay any personal expenses of an employee during his or her temporary work assignment, such as expenses for home leave for family members or for vacations, these amounts must be included in the employee's wages. See chapter 1 of Publication 463, Travel, Entertainment, Gift, and Car Expenses, and section 5 of Publication 15 (Circular E), for more information. These rules generally apply to temporary work assignments both inside and outside the U.S. taxmap/pubs/p15a-004.htm#en_us_publink100052247
Do not withhold federal income, social security, or Medicare taxes on the fair market value of an employee achievement award if it is excludable from your employee's gross income. To be excludable from your employee's gross income, the award must be tangible personal property (not cash, gift certificates, or securities) given to an employee for length of service or safety achievement, awarded as part of a meaningful presentation, and awarded under circumstances that do not indicate that the payment is disguised compensation. Excludable employee achievement awards also are not subject to FUTA tax. taxmap/pubs/p15a-004.htm#en_us_publink100052248
The most that you can exclude for the cost of all employee achievement awards to the same employee for the year is $400. A higher limit of $1,600 applies to qualified plan awards. Qualified plan awards are employee achievement awards under a written plan that does not discriminate in favor of highly compensated employees. An award cannot be treated as a qualified plan award if the average cost per recipient of all awards under all of your qualified plans is more than $400.
If during the year an employee receives awards not made under a qualified plan and also receives awards under a qualified plan, the exclusion for the total cost of all awards to that employee cannot be more than $1,600. The $400 and $1,600 limits cannot be added together to exclude more than $1,600 for the cost of awards to any one employee during the year.taxmap/pubs/p15a-004.htm#en_us_publink100052249
Only amounts that you pay as a qualified scholarship to a candidate for a degree may be excluded from the recipient's gross income. A qualified scholarship is any amount granted as a scholarship or fellowship that is used for:
- Tuition and fees required to enroll in, or to attend, an educational institution or
- Fees, books, supplies, and equipment that are required for courses at the educational institution.
The exclusion from income does not apply to the portion of any amount received that represents payment for teaching, research, or other services required as a condition of receiving the scholarship or tuition reduction. These amounts are reportable on Form W-2. However, the exclusion will still apply for any amount received under two specific programs—the National Health Service Corps Scholarship Program and the Armed Forces Health Professions Scholarship and Financial Assistance Program—despite any service condition attached to those amounts.
Any amounts that you pay for room and board are not excludable from the recipient's gross income. A qualified scholarship is not subject to social security, Medicare, and FUTA taxes, or federal income tax withholding. For more information, see Publication 970, Tax Benefits for Education. taxmap/pubs/p15a-004.htm#en_us_publink100052250
If you provide outplacement services to your employees to help them find new employment (such as career counseling, resume assistance, or skills assessment), the value of these benefits may be income to them and subject to all withholding taxes. However, the value of these services will not be subject to any employment taxes if:
- You derive a substantial business benefit from providing the services (such as improved employee morale or business image) separate from the benefit that you would receive from the mere payment of additional compensation and
- The employee would be able to deduct the cost of the services as employee business expenses if he or she had paid for them.
However, if you receive no additional benefit from providing the services, or if the services are not provided on the basis of employee need, then the value of the services is treated as wages and is subject to federal income tax withholding and social security and Medicare taxes. Similarly, if an employee receives the outplacement services in exchange for reduced severance pay (or other taxable compensation), then the amount the severance pay is reduced is treated as wages for employment tax purposes.taxmap/pubs/p15a-004.htm#en_us_publink100052251
Payments made under a voluntary guarantee to employees for idle time (any time during which an employee performs no services) are wages for the purposes of social security, Medicare, FUTA taxes, and federal income tax withholding. taxmap/pubs/p15a-004.htm#en_us_publink100052252
Treat back pay as wages in the year paid and withhold and pay employment taxes as required. If back pay was awarded by a court or government agency to enforce a federal or state statute protecting an employee's right to employment or wages, special rules apply for reporting those wages to the Social Security Administration. These rules also apply to litigation actions, and settlement agreements or agency directives that are resolved out of court and not under a court decree or order. Examples of pertinent statutes include, but are not limited to, the National Labor Relations Act, Fair Labor Standards Act, Equal Pay Act, and Age Discrimination in Employment Act. See Publication 957, Reporting Back Pay and Special Wage Payments to the Social Security Administration, and Form SSA-131, Employer Report of Special Wage Payments, for details.taxmap/pubs/p15a-004.htm#en_us_publink100052253
If you pay, under a plan, supplemental unemployment benefits to a former employee, all or part of the payments may be taxable and subject to federal income tax withholding, depending on how the plan is funded. Amounts that represent a return to the employee of amounts previously subject to tax are not taxable and are not subject to withholding. You should withhold federal income tax on the taxable part of the payments made, under a plan, to an employee who is involuntarily separated because of a reduction in force, discontinuance of a plant or operation, or other similar condition. It does not matter whether the separation is temporary or permanent.
There are special rules that apply in determining whether benefits qualify as supplemental unemployment benefits that are excluded from wages for social security, Medicare, and FUTA purposes. To qualify as supplemental unemployment benefits for these purposes, the benefits must meet the following requirements.
- Benefits are paid only to unemployed former employees who are laid off by the employer.
- Eligibility for benefits depends on meeting prescribed conditions after termination.
- The amount of weekly benefits payable is based upon state unemployment benefits, other compensation allowable under state law, and the amount of regular weekly pay.
- The right to benefits does not accrue until a prescribed period after termination.
- Benefits are not attributable to the performance of particular services.
- No employee has any right to the benefits until qualified and eligible to receive benefits.
- Benefits may not be paid in a lump sum.
Withholding on taxable supplemental unemployment benefits must be based on the withholding certificate (Form W-4) that the employee gave to you. taxmap/pubs/p15a-004.htm#en_us_publink100052254
A golden parachute payment, in general, is a payment made under a contract entered into by a corporation and key personnel. Under the agreement, the corporation agrees to pay certain amounts to its key personnel in the event of a change in ownership or control of the corporation. Payments to employees under golden parachute contracts are subject to social security, Medicare, FUTA taxes, and federal income tax withholding.
No deduction is allowed to the corporation for any excess parachute payment. To determine the amount of the excess parachute payment, you must first determine if there is a parachute payment for purposes of section 280G. A parachute payment for purposes of section 280G is any payment that meets all of the following.
- The payment is in the nature of compensation.
- The payment is to, or for the benefit of, a disqualified individual (defined below).
- The payment is contingent on a change in ownership of the corporation, the effective control of the corporation, or the ownership of a substantial portion of the assets of the corporation.
- The payment has an aggregate present value of at least three times the individual's base amount. The base amount is the average annual compensation for service includible in the individual's gross income over the most recent 5 taxable years.
A disqualified individual is anyone who at any time during the 12-month period prior to and ending on the date of the change in ownership or control of the corporation (the disqualified individual determination period) was an employee or independent contractor and was, in regard to that corporation, a shareholder, an officer, or highly compensated individual.
An excess parachute payment amount is the excess of any parachute payment over the base amount. For more information, see Regulations section 1.280G-1. The recipient of an excess parachute payment is subject to a 20% nondeductible excise tax. If the recipient is an employee, the 20% excise tax is to be withheld by the corporation.taxmap/pubs/p15a-004.htm#en_us_publink100052255
An officer of a corporation receives a golden parachute payment of $400,000. This is more than three times greater than his or her average compensation of $100,000 over the previous 5-year period. The excess parachute payment is $300,000 ($400,000 minus $100,000). The corporation cannot deduct the $300,000 and must withhold the excise tax of $60,000 (20% of $300,000).taxmap/pubs/p15a-004.htm#en_us_publink100052256
Golden parachute payments to employees must be reported on Form W-2. See the Instructions for Forms W-2 and W-3 for details. For nonemployee reporting of these payments, see Box 7 in the Instructions for Form 1099-MISC.taxmap/pubs/p15a-004.htm#en_us_publink100052257
Most small business corporations are exempt from the golden parachute rules. See Regulations section 1.280G-1 for more information. taxmap/pubs/p15a-004.htm#en_us_publink100052258
In general, if an employer lends an employee more than $10,000 at an interest rate less than the current applicable federal rate (AFR), the difference between the interest paid and the interest that would be paid under the AFR is considered additional compensation to the employee. This rule applies to a loan of $10,000 or less if one of its principal purposes is the avoidance of federal tax.
This additional compensation to the employee is subject to social security, Medicare, and FUTA taxes, but not to federal income tax withholding. Include it in compensation on Form W-2 (or Form 1099-MISC for an independent contractor). The AFR is established monthly and published by the IRS each month in the Internal Revenue Bulletin. You can get these rates by calling 1-800-829-4933 or by visiting the IRS website at www.irs.gov
. For more information, see section 7872 and its related regulations.
If you establish a leave sharing plan for your employees that allows them to transfer leave to other employees for medical emergencies, the amounts paid to the recipients of the leave are considered wages. These amounts are includible in the gross income of the recipients and are subject to social security, Medicare, and FUTA taxes, and federal income tax withholding. Do not include these amounts in the income of the transferors. These rules apply only to leave sharing plans that permit employees to transfer leave to other employees for medical emergencies.taxmap/pubs/p15a-004.htm#en_us_publink100052260taxmap/pubs/p15a-004.htm#en_us_publink100052261
Section 409A provides that all amounts deferred under a nonqualified deferred compensation (NQDC) plan for all tax years are currently includible in gross income (to the extent not subject to a substantial risk of forfeiture and not previously included in gross income) and subject to additional taxes, unless certain requirements are met pertaining to, among other things, elections to defer compensation and distributions under a NQDC plan. Section 409A also includes rules that apply to certain trusts or similar arrangements associated with NQDC plans if the trusts or arrangements are located outside of the United States, are restricted to the provision of benefits in connection with a decline in the financial health of the plan sponsor, or contributions are made to the trust during certain periods such as when a qualified plan of the service recipient is underfunded. Employers must withhold federal income tax (but not the additional Section 409A taxes) on any amount includible in gross income under section 409A. Other changes to the Internal Revenue Code provide that the deferrals under a NQDC plan must be reported separately on Form W-2 or Form 1099-MISC, whichever applies. Specific rules for reporting are provided in the instructions to the forms. The provisions do not affect the application or reporting of social security, Medicare, or FUTA taxes.
The provisions do not prevent the inclusion of amounts in income or wages under other provisions of the Internal Revenue Code or common law principles, such as when amounts are actually or constructively received or irrevocably contributed to a separate fund. For more information about nonqualified deferred compensation plans, see Regulations sections 1.409A-1 through 1.409A-6. Notice 2008-115 provides rules for reporting deferrals and reporting income includable under section 409A for 2008 and for income tax withholding for amounts includable in gross income under section 409A for 2008. See Notice 2008-115, 2008-52 I.R.B. 1367, available at www.irs.gov/irb/2008-52_IRB/ar10.html
. Notice 2008-113 provides guidance on the correction of certain operation failures of a NQDC plan. See Notice 2008-113, 2008-51 I.R.B. 1305, available at www.irs.gov/irb/2008-51_IRB/ar12.html
Employer contributions to nonqualified deferred compensation (NQDC) plans, as defined in the applicable regulations, are treated as social security, Medicare, and FUTA wages when the services are performed or the employee no longer has a substantial risk of forfeiting the right to the deferred compensation, whichever is later.
Amounts deferred are subject to social security, Medicare, and FUTA taxes at that time unless the amount that is deferred cannot be reasonably ascertained; for example, if benefits are based on final pay. If the value of the future benefit is based on any factors that are not yet reasonably ascertainable, you may choose to estimate the value of the future benefit and withhold and pay social security, Medicare, and FUTA taxes on that amount. You will have to determine later, when the amount is reasonably ascertainable, whether any additional taxes are required. If taxes are not paid before the amounts become reasonably ascertainable, when the amounts become reasonably ascertainable they are subject to social security, Medicare, and FUTA taxes on the amounts deferred plus the income attributable to those amounts deferred. For more information, see Regulations sections 31.3121(v)(2)-1 and 31.3306(r)(2)-1.taxmap/pubs/p15a-004.htm#en_us_publink100052263
Employer payments made by an educational institution or a tax-exempt organization to purchase a tax-sheltered annuity for an employee (annual deferrals) are included in the employee's social security and Medicare wages if the payments are made because of a salary reduction agreement. However, they are not included in box 1 on Form W-2 in the year the deferrals are made and are not subject to federal income tax withholding. See Regulations section 31.3121(a)(5)-2 for the definition of a salary reduction agreement.taxmap/pubs/p15a-004.htm#en_us_publink100052264
An employer's SEP contributions to an employee's individual retirement arrangement (IRA) are excluded from the employee's gross income. These excluded amounts are not subject to social security, Medicare, FUTA taxes, or federal income tax withholding. However, any SEP contributions paid under a salary reduction agreement (SARSEP) are included in wages for purposes of social security and Medicare taxes and for FUTA. See Publication 560 for more information about SEPs.taxmap/pubs/p15a-004.htm#en_us_publink100052265
You may not establish a SARSEP after 1996. However, SARSEPs established before January 1, 1997, may continue to receive contributions. taxmap/pubs/p15a-004.htm#en_us_publink100052266
Employer and employee contributions to a savings incentive match plan for employees (SIMPLE) retirement account (subject to limitations) are excludable from the employee's income and are exempt from federal income tax withholding. An employer's nonelective (2%) or matching contributions are exempt from social security, Medicare, and FUTA taxes. However, an employee's salary reduction contributions to a SIMPLE are subject to social security, Medicare, and FUTA taxes. For more information about SIMPLE retirement plans, see Publication 560.