Publication 15a |
2001 Tax Year |
Chapter 5 Wages & Other Compensation
Circular E provides a general discussion of taxable wages. The
following topics supplement those discussions.
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.
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.
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. 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 duration of the benefits is affected by the fund level and employee seniority.
-
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) 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.
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.
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.
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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