| Publication 535 |
2008 Tax Year |
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 hire individuals who meet certain requirements.
Reduce your deduction for employee wages by the amount of any employment credits you claim. For more information about these
credits, see
Publication 954, Tax Incentives for Distressed Communities.
Topics - This chapter discusses:
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Tests for deducting pay
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Kinds of pay
Useful Items - You may want to see:
Publication
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15
(Circular E), Employer's Tax Guide
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15-A
Employer's Supplemental Tax Guide
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15-B
Employer's Tax Guide to Fringe Benefits
See chapter 12 for information about getting publications and forms.
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.
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.
Factors to consider.
To determine if pay is reasonable, consider the following items and any other pertinent facts.
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The duties performed by the employee.
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The volume of business handled.
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The character and amount of responsibility.
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The complexities of your business.
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The amount of time required.
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The cost of living in the locality.
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The ability and achievements of the individual employee performing the service.
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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.
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Your policy regarding pay for all your employees.
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The history of pay for each employee.
Test 2—For Services Performed
You must be able to prove the payment was made for services actually performed.
Employee-shareholder salaries.
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.
Some of the ways you may provide pay to your employees in addition to regular wages or salaries are discussed next. For specialized
and detailed
information on employees' pay and the employment tax treatment of employees' pay, see Publication 15, Publication 15-A, and
Publication 15-B.
You can generally deduct amounts you pay to your employees as awards, whether paid in cash or property. If you give property
to an employee as an
employee achievement award, your deduction may be limited.
Achievement awards.
An achievement award is an item of tangible personal property that meets all the following requirements.
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It is given to an employee for length of service or safety achievement.
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It is awarded as part of a meaningful presentation.
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It is awarded under conditions and circumstances that do not create a significant likelihood of disguised pay.
Length-of-service award.
An award will qualify as a length-of-service award only if either of the following applies.
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The employee receives the award after his or her first 5 years of employment.
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The employee did not receive another length-of-service award (other than one of very small value) during the same year or
in any of the
prior 4 years.
Safety achievement award.
An award for safety achievement will qualify as an achievement award unless one of the following applies.
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It is given to a manager, administrator, clerical employee, or other professional employee.
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During the tax year, more than 10% of your employees, excluding those listed in (1), have already received a safety achievement
award (other
than one of very small value).
Deduction limit.
Your deduction for the cost of employee achievement awards given to any one employee during the tax year is limited
to the following.
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$400 for awards that are not qualified plan awards.
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$1,600 for all awards, whether or not qualified plan awards.
A qualified plan award is an achievement award given as part of an established written plan or program that does not
favor highly compensated
employees as to eligibility or benefits.
A highly compensated employee for 2007 is an employee who meets either of the following tests.
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The employee was a 5% owner at any time during the year or the preceding year.
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The employee received more than $100,000 in pay for the preceding year.
You can choose to ignore test (2) if the employee was not also in the top 20% of employees ranked by pay for the preceding
year.
An award is not a qualified plan award if the average cost of all the employee achievement awards given during the
tax year (that would be
qualified plan awards except for this limit) is more than $400. To figure this average cost, ignore awards of nominal value.
Deduct achievement awards as a nonwage business expense on your return or business schedule.
You may not owe employment taxes on the value of some achievement awards you provide to an employee. See Publication 15-B.
You can generally deduct a bonus paid to an employee if you intended the bonus as additional pay for services, not as a gift,
and the services were
performed. However, the total bonuses, salaries, and other pay must be reasonable for the services performed. If the bonus
is paid in property, see
Property, later.
Gifts of nominal value.
If, to promote employee goodwill, you distribute food, or merchandise of nominal value to your employees at
holidays, you can deduct the cost of these items as a nonwage business expense. Your deduction for de minimus gifts of food
or drink are not subject
to the 50% deduction limit that generally applies to meals. For more information on this deduction limit, see Meals and lodging, later.
If you pay or reimburse education expenses for an employee, you can deduct the payments if they are part of a qualified educational
assistance
program. Deduct them on the “Employee benefit programs” or other appropriate line of your tax return. For information on educational assistance
programs, see Educational Assistance in section 2 of Publication 15-B.
A fringe benefit is a form of pay for the performance of services. You can generally deduct the cost of fringe benefits.
You may be able to exclude all or part of the value of some fringe benefits from your employees' pay. You also may not owe
employment taxes on the
value of the fringe benefits. See Table 2-1 in Publication 15-B for details.
Your deduction for the cost of fringe benefits for activities generally considered entertainment, amusement, or recreation,
or for a facility used
in connection with such an activity (for example, a company aircraft) for certain officers, directors, and more-than-10% shareholders
is limited.
See Pub. 15-B for an extensive discussion of fringe benefits.
Meals and lodging.
You can usually deduct the cost of furnishing meals and lodging to your employees. Deduct the cost in whatever category
the expense falls. For
example, if you operate a restaurant, deduct the cost of the meals you furnish to employees as part of the cost of goods sold.
If you operate a
nursing home, motel, or rental property, deduct the cost of furnishing lodging to an employee as expenses for utilities, linen
service, salaries,
depreciation, etc.
Deduction limit on meals.
You can generally deduct only 50% of the cost of furnishing meals to your employees. However, you can deduct the full
cost of the following meals.
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Meals whose value you include in an employee's wages.
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Meals that qualify as a de minimus fringe benefit as discussed in section 2 of Publication 15-B. This generally includes meals
you furnish
to employees at your place of business if more than half of these employees are provided the meals for your convenience.
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Meals you furnish to your employees at the work site when you operate a restaurant or catering service.
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Meals you furnish to your employees as part of the expense of providing recreational or social activities, such as a company
picnic.
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Meals you are required by federal law to furnish to crew members of certain commercial vessels (or would be required to furnish
if the
vessels were operated at sea). This does not include meals you furnish on vessels primarily providing luxury water transportation.
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Meals you furnish on an oil or gas platform or drilling rig located offshore or in Alaska. This includes meals you furnish
at a support camp
that is near and integral to an oil or gas drilling rig located in Alaska.
Employee benefit programs.
Employee benefit programs include the following.
You can generally deduct amounts you spend on employee benefit programs on the applicable line of your tax return.
For example, if you provide
dependent care by operating a dependent care facility for your employees, deduct your costs in whatever categories they fall
(utilities, salaries,
etc.).
Life insurance coverage.
You cannot deduct the cost of life insurance coverage for you, an employee, or any person with a financial interest
in your business, if you are
directly or indirectly the beneficiary of the policy. See Regulations section 1.264-1 for more information.
Welfare benefit funds.
A welfare benefit fund is a funded plan (or a funded arrangement having the effect of a plan) that provides welfare
benefits to your employees,
independent contractors, or their beneficiaries. Welfare benefits are any benefits other than deferred compensation or transfers
of restricted
property.
Your deduction for contributions to a welfare benefit fund is limited to the fund's qualified cost for the tax year.
If your contributions to the
fund are more than its qualified cost, carry the excess over to the next tax year.
Generally, the fund's “ qualified cost” is the total of the following amounts, reduced by the after-tax income of the fund.
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The cost you would have been able to deduct using the cash method of accounting if you had paid for the benefits directly.
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The contributions added to a reserve account that are needed to fund claims incurred but not paid as of the end of the year.
These claims
can be for supplemental unemployment benefits, severance pay, or disability, medical, or life insurance benefits.
For more information, see sections 419(c) and 419A of the Internal Revenue Code and the related regulations.
You generally can deduct as wages an advance you make to an employee for services performed if you do not expect the employee
to repay the advance.
However, if the employee performs no services, treat the amount you advanced as a loan. If the employee does not repay the
loan, treat it as income to
the employee.
Below-market interest rate loans.
On certain loans you make to an employee or shareholder, you are treated as having received interest income and as
having paid compensation or
dividends equal to that interest. See Below-Market Loans in chapter 4.
If you transfer property (including your company's stock) to an employee as payment for services, you can generally deduct
it as wages. The amount
you can deduct is the property's fair market value on the date of the transfer less any amount the employee paid for the property.
You can claim the deduction only for the tax year in which your employee includes the property's value in income. Your employee
is deemed to have
included the value in income if you report it on Form W-2 in a timely manner.
You treat the deductible amount as received in exchange for the property, and you must recognize any gain or loss realized
on the transfer, unless
it is the company's stock transferred as payment for services. Your gain or loss is the difference between the fair market
value of the property and
its adjusted basis on the date of transfer.
These rules also apply to property transferred to an independent contractor for services, generally reported on Form 1099-MISC.
Restricted property.
If the property you transfer for services is subject to restrictions that affect its value, you generally cannot deduct
it and do not report gain
or loss until it is substantially vested in the recipient. However, if the recipient pays for the property, you must report
any gain at the time of
the transfer up to the amount paid.
“ Substantially vested” means the property is not subject to a substantial risk of forfeiture. This means that the recipient is not likely to
have to give up his or her rights in the property in the future.
Reimbursements for Business Expenses
You can generally deduct the amount you pay or reimburse employees for business expenses incurred for your business. However,
your deduction may be
limited.
If you make the payment under an accountable plan, deduct it in the category of the expense paid. For example, if you pay
an employee for travel
expenses incurred on your behalf, deduct this payment as a travel expense. If you make the payment under a nonaccountable
plan, deduct it as wages and
include it in the employee's W-2.
See Reimbursement of Travel, Meals, and Entertainment in chapter 11 for more information about deducting reimbursements and an
explanation of accountable and nonaccountable plans.
Sick pay.
You can deduct amounts you pay to your employees for sickness and injury, including lump-sum amounts, as wages. However,
your deduction is limited
to amounts not compensated by insurance or other means.
Vacation pay.
Vacation pay is an employee benefit. It includes amounts paid for unused vacation leave. You can deduct vacation pay
only in the tax year in which
the employee actually receives it. This rule applies regardless of whether you use the cash or accrual method of accounting.
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