Circular E provides a general discussion of taxable wages. The
following topics supplement that discussion.
Employee Achievement Awards
Do not withhold 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 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.
Limits.
The most 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. These 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 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.
Educational Assistance Programs
The income exclusion from employee gross income is limited to
$5,250 per employee in educational assistance during a calendar year.
The excludable amount is not subject to income tax withholding or
other employment taxes. The education need not be job related.
However, the exclusion does not apply to graduate level courses. For
more information on educational assistance programs, see Regulations
section 1.127-2. The exclusion expires for courses beginning on or
after December 31, 2001.
Scholarship and Fellowship Payments
Only amounts 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.
Any amounts you pay for room and board, and any amounts you pay for
teaching, research, or other services required as a condition of
receiving the scholarship, are not excludable from the recipient's
gross income. A qualified scholarship is not subject to social
security, Medicare, and FUTA taxes, or income tax withholding. For
more information, see Pub. 520, Scholarships and
Fellowships.
Outplacement Services
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 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 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.
Dependent Care Assistance Programs
The maximum amount you can exclude from your employee's gross
income for dependent care assistance is $5,000 ($2,500 for married
taxpayers filing separate returns). The excluded amount is not subject
to social security, Medicare, and FUTA taxes, or income tax
withholding. If the dependent is cared for in a facility at your place
of business, the amount to exclude from the employee's income is based
on his or her use of the facility and the value of the services
provided. Report dependent care assistance payments in box 10 on Form
W-2. For more information, see Pub. 15-B, Employer's Tax
Guide to Fringe Benefits.
Dependent care providers.
If you were the provider of dependent care or pay the provider
directly, your employee may ask you for help in getting a completed
Form W-10, Dependent Care Provider's Identification and
Certification. The dependent care credit and the exclusion for
employer-provided dependent care assistance benefits generally cannot
be claimed by your employee unless the dependent care provider is
identified by name, address, and (if not an exempt organization)
taxpayer identification number. The dependent care recipient may use
Form W-10 to request this information.
Adoption Assistance Plans
Your employees may be able to exclude from gross income payments or
reimbursements you make under an adoption assistance program. Amounts
you pay or incur for an employee's qualified adoption expenses are not
subject to income tax withholding. However, these amounts (including
adoption benefits paid from a cafeteria plan, but not including
adoption benefits forfeited from a cafeteria plan) are subject to
social security, Medicare, and FUTA taxes. If the adoption assistance
benefits are part of a cafeteria plan, they are still subject to these
employment taxes. Report adoption benefits in box 13, using code T, on
Form W-2 (box 12 on the 2001 Form W-2). See Pub. 968, Tax
Benefits for Adoption, for more information.
Withholding for Idle Time
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, and
FUTA taxes, and income tax withholding.
Back Pay
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. Get
Pub. 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.
Supplemental Unemployment Benefits
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 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 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. The taxable part is not
subject to social security, Medicare, or FUTA taxes.
Withholding on taxable supplemental unemployment benefits must be
based on the withholding certificate (Form W-4) the employee gave you.
Golden Parachutes (Excessive Termination Payments)
A golden parachute is a contract entered into by a corporation and
key personnel under which the corporation agrees to pay certain
amounts to the key personnel in the event of a change in ownership or
control of the corporation. Payments under golden parachute contracts,
like any termination pay, are subject to social security, Medicare,
and FUTA taxes, and income tax withholding.
Beginning with payments under contracts entered into, significantly
amended, or renewed after June 14, 1984, no deduction is allowed to
the corporation for excess parachute payments. The employee
is subject to a 20% nondeductible excise tax to be withheld by the
corporation on all excess payments. The payment is generally
considered an excess parachute payment if it equals or exceeds three
times the average annual compensation of the recipient over the
previous 5-year period. The amount over the average is the excess
parachute payment.
Example.
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).
Exempt payments.
Most small business corporations are exempt from the golden
parachute rules. See Code section 280G for more information.
Interest-Free and Below-Market-Interest-Rate Loans
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 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 1-800-829-1040 or by
accessing the IRS's Internet Web Site at www.irs.gov. For
more information, see Pub. 15-B.
Group-Term Life Insurance
You may exclude the cost of life insurance benefits for the first
$50,000 of coverage for each employee, if your plan meets the
following requirements.
- It provides a general death benefit that is not included in
income.
- You provide it to a group of employees.
- It provides an amount of insurance to each employee based on
a formula that prevents individual selection, using factors such as
age, years of service, pay, or position.
- You provide it under a policy you carry directly or
indirectly. Even if you do not pay any of the policy's cost, you are
considered to carry it if you arrange for payment of its cost by your
employees and charge at least one employee less than, and at least one
employee more than, the cost of his or her insurance. Determine the
cost of the insurance, for this purpose, using the table for the
monthly cost per $1,000 of insurance below. Note: Until
January 1, 2003, you may use the table previously in effect to make
this determination. See Reg. 1.79-1 or the January 1999 revision of
Pub. 15-A.
- It meets certain nondiscrimination requirements. See
Pub. 15-B for more information.
The tax treatment is the same if the premiums are paid through
a cafeteria plan (section 125). See Cafeteria Plans, later.
This taxable insurance cost can be treated as paid by the pay period,
by the quarter, or on any basis as long as the cost is treated as paid
at least once a year.
Benefits extending beyond one year.
Group-term life insurance may be provided as part of a policy that
includes permanent benefits. Permanent benefits are any
benefits that extend beyond one policy year, such as insurance with a
paid-up or cash surrender value.
If your policy includes permanent benefits, you must include in
your employees' wages the cost of the permanent benefits minus the
amount the employee pays for them.
For more information, see section 1.79-1(d) of the Regulations.
Amount included in wages.
Include in wages the cost of group-term life insurance you provided
to an employee for more than $50,000 of coverage, or for coverage that
discriminated in favor of the employee. This amount is subject to
social security and Medicare taxes, but not FUTA tax or income tax
withholding.
Monthly cost.
If the group-term life insurance plan meets the exclusion
requirements listed above, figure the monthly cost of this insurance
on the amount of coverage exceeding $50,000. The taxable cost is based
on the following table rather than on the employer's actual premium
costs for the insurance coverage. You determine the monthly cost of
group-term life insurance by multiplying the number of thousands of
dollars of insurance coverage (figured to the nearest 10th) by the
appropriate cost per thousand per month. You determine age on the last
day of the tax year. If you provide group-term life insurance for a
period of coverage of less than 1 month, you prorate the monthly cost
over that period. The monthly cost of each $1,000 of group-term life
insurance protection is as follows:
| Age
|
Monthly Cost
|
| Under 25 |
$ .05 |
| 25 through 29 |
.06 |
| 30 through 34 |
.08 |
| 35 through 39 |
.09 |
| 40 through 44 |
.10 |
| 45 through 49 |
.15 |
| 50 through 54 |
.23 |
| 55 through 59 |
.43 |
| 60 through 64 |
.66 |
| 65 through 69 |
1.27 |
| 70 and over |
2.06 |
Coverage for dependents.
Group-term life insurance coverage paid by the employer for the
spouse or dependents of an employee may be excludable from income as a
de minimis fringe benefit (see section 6). This part of the coverage
that the employee paid on an after-tax basis is also excludable from
income. For this purpose, the cost is figured using the monthly cost
table above.
Former employees.
For group-term life insurance over $50,000 provided to former
employees (including retirees), the former employees must pay the
employee's share of social security and Medicare taxes with their
income tax returns. You are not required to collect those taxes. Use
the table above to determine the amount of social security and
Medicare taxes owed by the former employee for coverage provided after
separation from service. Report those uncollected amounts separately
in box 13 on Form W-2 using codes M and N (box 12 on the 2001 Form
W-2). See the Instructions for Form W-2 and Form W-3.
Workers' Compensation--Public Employees
State and local government employees, such as police officers and
firefighters, sometimes receive payments due to injury in the line of
duty under a statute that is not the general workers'
compensation law of a state. If the statute limits benefits to
work-related injuries or sickness and does not base payments on the
employee's age, length of service, or prior contributions, the statute
is "in the nature of" a workers' compensation law. Payments under
the statute are not subject to FUTA tax or income tax withholding, but
they are subject to social security and Medicare taxes to the same
extent as the employee's regular wages. However, the payments are no
longer subject to social security and Medicare taxes after the
expiration of 6 months following the last calendar month in which the
employee worked for the employer.
Leave Sharing Plans
If you establish a leave sharing plan for your employees that
allows them to donate 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 income tax withholding. Do not include these amounts in the
income of the donors.
Cafeteria Plans
Cafeteria plans, including flexible spending arrangements, are
benefit plans under which all participants are employees who can
choose from among cash and certain qualified benefits. If the employee
elects qualified benefits, employer contributions are excluded from
the employee's wages if the benefits are excludable from gross income
under a specific section of the Internal Revenue Code (other than
scholarship and fellowship grants under section 117, employee fringe
benefits under section 132, and educational assistance programs under
section 127). The cost of group-term life insurance that is includible
in income only because the insurance exceeds $50,000 of coverage is
considered a qualified benefit under a special rule.
Generally, qualified benefits under a cafeteria plan are not
subject to social security, Medicare, and FUTA taxes, or income tax
withholding. However, group-term life insurance that exceeds $50,000
of coverage is subject to social security and Medicare taxes, but not
FUTA tax or income tax withholding, even when provided as qualified
benefits in a cafeteria plan. Adoption assistance benefits provided in
a cafeteria plan are subject to social security, Medicare, and FUTA
taxes, but not income tax withholding. If an employee elects to
receive cash instead of any qualified benefit, it is treated as wages
subject to all employment taxes. For more information, see Pub.15-B.
Nonqualified Deferred Compensation Plans
Social security, Medicare, and FUTA taxes.
Employer contributions to nonqualified deferred compensation or
nonqualified pension plans 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. This is true whether the plan is
funded or unfunded.
Amounts deferred are subject to social security, Medicare, and FUTA
taxes unless the value of the amount deferred cannot be determined;
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
determinable, you may estimate the value of the future benefit and
withhold and pay social security, Medicare, and FUTA taxes on that
amount. If amounts that were not determinable in prior periods are now
determinable, 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(v)(2)-1.
Income tax withholding.
Amounts deferred under nonqualified deferred compensation plans are
not subject to income taxes until benefit payments begin. Withhold
income tax on nonqualified plans as follows:
- Funded plan. Withhold when the employees' rights
to amounts are not subject to substantial risk of forfeiture or are
transferable free of such risk. A funded plan is one in which an
employer irrevocably contributes the deferred compensation
to a separate fund, such as an irrevocable trust.
- Unfunded plan. Generally, withhold when you make
payments to the employee, either constructively or actually.
For more information, see Regulations section 31.3121(v)-1.
Employee Stock Options
There are three classes of stock options--incentive stock
options, employee stock purchase plan options, and nonstatutory
options. Generally, incentive stock options and employee stock
purchase plan options are not taxable to the employee either when the
options are granted or when they are exercised (unless the stock is
disposed of in a disqualifying disposition). However, the spread
(between the exercise price and fair market value of the stock at the
time of exercise) on employee stock purchase plan options is subject
to social security, Medicare, and FUTA taxes when the options are
exercised. Additionally, the spread on nonstatutory options normally
is taxable to the employee as wages when the options are exercised
(see Regulations section 1.83-7). These wages are subject to
social security, Medicare, and FUTA taxes, and income tax withholding.
Tax-Sheltered Annuities
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. They are not included in box 1 on Form W-2
in the year the deferrals are made and are not subject to income tax
withholding.
Contributions to a Simplified Employee Pension (SEP)
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, and FUTA taxes, or 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 FUTA. See Pub. 560, for more information about SEPs.
Salary reduction simplified employee pensions (SARSEP)
repealed.
You may not establish a SARSEP after 1996. However, SARSEPs
established before January 1, 1997, may continue to receive
contributions.
SIMPLE Retirement Plans
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 Pub. 560.
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