You can generally deduct the pay you give your employees for the services they perform. The pay may be in cash, property, or services. It may include wages, or salaries, or other compensation, such as vacation allowances, bonuses, commissions, and fringe benefits. For information about deducting employment taxes, see chapter 5.
You can claim the following employment credits if you pay wages to individuals who meet certain requirements.
- Work opportunity credit (claimed on Form 5884).
- Credit for affected Midwestern disaster area employers (claimed on Form 5884-A).
- Empowerment zone and renewal community employment credit (claimed on Form 8844).
- Indian employment credit (claimed on Form 8845).
- Welfare-to-work credit (claimed on Form 8861).
- Credit for employer differential wage payments (claimed on Form 8932; only for payments made in 2009).
Reduce your deduction for employee wages by the amount of any employment credits you claim. For more information about these credits, see the form on which the credit is claimed.
You may want to see:
Publication 15 (Circular E), Employer's Tax Guide 15-A Employer's Supplemental Tax Guide 15-B Employer's Tax Guide to Fringe Benefits 15-T New Wage Withholding and Advanced Earned Income Credit Payment Tables
See chapter 12 for information about getting publications and forms.taxmap/pubs/p535-005.htm#en_us_publink1000154151
To be deductible, your employees' pay must be an ordinary and necessary expense and you must pay or incur it. These and other requirements that apply to all business expenses are explained in chapter 1.
In addition, the pay must meet both of the following tests.
- Test 1. It must be reasonable.
- Test 2. It must be for services performed.
The form or method of figuring the pay does not affect its deductibility. For example, bonuses and commissions based on sales or earnings, and paid under an agreement made before the services were performed, are both deductible.
Determine the reasonableness of pay by the facts and circumstances. Generally, reasonable pay is the amount that like enterprises pay for the same, or similar, services.
You must be able to prove that the pay is reasonable. Base this determination on the circumstances that exist when you contract for the services, not those that exist when the reasonableness is questioned. If the pay is excessive, the excess is disallowed. taxmap/pubs/p535-005.htm#en_us_publink1000154153
To determine if pay is reasonable, consider the following items and any other pertinent facts.
- The duties performed by the employee.
- The volume of business handled.
- The character and amount of responsibility.
- The complexities of your business.
- The amount of time required.
- The cost of living in the locality.
- The ability and achievements of the individual employee performing the service.
- The pay compared with the gross and net income of the business, as well as with distributions to shareholders if the business is a corporation.
- Your policy regarding pay for all your employees.
- The history of pay for each employee.
You must be able to prove the payment was made for services actually performed. taxmap/pubs/p535-005.htm#en_us_publink1000154155
If a corporation pays an employee who is also a shareholder a salary that is unreasonably high considering the services actually performed, the excessive part of the salary may be treated as a constructive distribution to the employee-shareholder. For more information on corporate distributions to shareholders, see Publication 542, Corporations.