| Pub. 15-A, Employer's Supplemental Tax Guide |
2005 Tax Year |
Publication 15-A - Main Contents
Before you can know how to treat payments that you make to workers for services, you must first know the business relationship
that exists between
you and the person performing the services. The person performing the services may be:
This discussion explains these four categories. A later discussion, Employee or Independent Contractor? (section 2), points out the
differences between an independent contractor and an employee and gives examples from various types of occupations. If an
individual who works for you
is not an employee under the common-law rules (see section 2), you generally do not have to withhold federal income tax from
that individual's pay.
However, in some cases you may be required to withhold under backup withholding requirements on these payments. See Publication
15 (Circular E) for
information on backup withholding.
People such as lawyers, contractors, subcontractors, public stenographers, and auctioneers who follow an independent trade,
business, or profession
in which they offer their services to the public, are generally not employees. However, whether such people are employees
or independent contractors
depends on the facts in each case. The general rule is that an individual is an independent contractor if you, the person
for whom the services are
performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing
the result.
Under common-law rules, anyone who performs services for you is your employee if you have the right to control what will be
done and how it will be
done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the
details of how the services
are performed. For a discussion of facts that indicate whether an individual providing services is an independent contractor
or employee, see
Employee or Independent Contractor? (section 2).
If you have an employer-employee relationship, it makes no difference how it is labeled. The substance of the relationship,
not the label, governs
the worker's status. Nor does it matter whether the individual is employed full time or part time.
For employment tax purposes, no distinction is made between classes of employees. Superintendents, managers, and other supervisory
personnel are
all employees. An officer of a corporation is generally an employee; however, an officer who performs no services or only
minor services, and neither
receives nor is entitled to receive any pay, is not considered an employee. A director of a corporation is not an employee
with respect to services
performed as a director.
You generally have to withhold and pay income, social security, and Medicare taxes on wages that you pay to common-law employees.
However, the
wages of certain employees may be exempt from one or more of these taxes. See Employees of Exempt Organizations (section 3) and
Religious Exemptions (section 4).
Leased employees.
Under certain circumstances, a corporation furnishing workers to various professional people and firms is the employer
of those workers for
employment tax purposes. For example, a professional service corporation may provide the services of secretaries, nurses,
and other similarly trained
workers to its subscribers.
The service corporation enters into contracts with the subscribers under which the subscribers specify the services
to be provided and a fee is
paid to the service corporation for each individual furnished. The service corporation has the right to control and direct
the worker's services for
the subscriber, including the right to discharge or reassign the worker. The service corporation hires the workers, controls
the payment of their
wages, provides them with unemployment insurance and other benefits, and is the employer for employment tax purposes. For
information on employee
leasing as it relates to pension plan qualification requirements, see Leased employee in Publication 560, Retirement Plans for Small
Business (SEP, SIMPLE, and Qualified Plans).
Additional information.
For more information about the treatment of special types of employment, the treatment of special types of payments,
and similar subjects, refer to
Publication 15 (Circular E); or Publication 51 (Circular A) for agricultural employers.
If workers are independent contractors under the common law rules, such workers may nevertheless be treated as employees by
statute (“statutory
employees”) for certain employment tax purposes if they fall within any one of the following four categories and meet the
three conditions described under Social security and Medicare taxes, below.
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A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers
laundry or
dry cleaning, if the driver is your agent or is paid on commission.
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A full-time life insurance sales agent whose principal business activity is selling life insurance or annuity contracts, or
both, primarily
for one life insurance company.
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An individual who works at home on materials or goods that you supply and that must be returned to you or to a person you
name, if you also
furnish specifications for the work to be done.
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A full-time traveling or city salesperson who works on your behalf and turns in orders to you from wholesalers, retailers,
contractors, or
operators of hotels, restaurants, or other similar establishments. The goods sold must be merchandise for resale or supplies
for use in the buyer's
business operation. The work performed for you must be the salesperson's principal business activity. See Salesperson in section
2.
Social security and Medicare taxes.
Withhold social security and Medicare taxes from the wages of statutory employees if all three of the following conditions apply.
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The service contract states or implies that substantially all the services are to be performed personally by them.
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They do not have a substantial investment in the equipment and property used to perform the services (other than an investment
in
transportation facilities).
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The services are performed on a continuing basis for the same payer.
Federal unemployment (FUTA) tax.
For FUTA tax, the term “ employee” means the same as it does for social security and Medicare taxes, except that it does not include statutory
employees in categories 2 and 3 above. Thus, any individual who is an employee under category 1 or 4 is also an employee for
FUTA tax purposes and
subject to FUTA tax.
Income tax.
Do not withhold federal income tax from the wages of statutory employees.
Reporting payments to statutory employees.
Furnish Form W-2 to a statutory employee, and check “ Statutory employee” in box 13. Show your payments to the employee as “ other
compensation” in box 1. Also, show social security wages in box 3, social security tax withheld in box 4, Medicare wages in box 5, and
Medicare tax
withheld in box 6. The statutory employee can deduct his or her trade or business expenses from the payments shown on Form
W-2. He or she reports
earnings as a statutory employee on line 1 of Schedule C or C-EZ (Form 1040). (A statutory employee's business expenses are
deductible on Schedule C
or C-EZ (Form 1040) and are not subject to the reduction by 2% of his or her adjusted gross income that applies to common-law
employees.)
There are three categories of statutory nonemployees: direct sellers, licensed real estate agents, and certain companion sitters.
Direct sellers
and licensed real estate agents are treated as self-employed for all federal tax purposes, including income and employment
taxes, if:
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Substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other
output, rather
than to the number of hours worked and
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Their services are performed under a written contract providing that they will not be treated as employees for federal tax
purposes.
Direct sellers.
Direct sellers include persons falling within any of the following three groups.
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Persons engaged in selling (or soliciting the sale of) consumer products in the home or place of business other than in a
permanent retail
establishment.
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Persons engaged in selling (or soliciting the sale of) consumer products to any buyer on a buy-sell basis, a deposit-commission
basis, or
any similar basis prescribed by regulations, for resale in the home or at a place of business other than in a permanent retail
establishment.
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Persons engaged in the trade or business of delivering or distributing newspapers or shopping news (including any services
directly related
to such delivery or distribution).
Direct selling includes activities of individuals who attempt to increase direct sales activities of their direct
sellers and who earn income based
on the productivity of their direct sellers. Such activities include providing motivation and encouragement; imparting skills,
knowledge, or
experience; and recruiting. For more information on direct sellers, see Publication 911, Direct Sellers.
Licensed real estate agents.
This category includes individuals engaged in appraisal activities for real estate sales if they earn income based
on sales or other output.
Companion sitters.
Companion sitters are individuals who furnish personal attendance, companionship, or household care services to children
or to individuals who are
elderly or disabled. A person engaged in the trade or business of putting the sitters in touch with individuals who wish to
employ them (that is, a
companion sitting placement service) will not be treated as the employer of the sitters if that person does not receive or
pay the salary or wages of
the sitters and is compensated by the sitters or the persons who employ them on a fee basis. Companion sitters who are not
employees of a companion
sitting placement service are generally treated as self-employed for all federal tax purposes.
Misclassification of Employees
Consequences of treating an employee as an independent contractor.
If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for
employment taxes for that worker (the relief provisions, discussed below, will not apply). See Internal Revenue Code section
3509 for more
information.
Relief provisions.
If you have a reasonable basis for not treating a worker as an employee, you may be relieved from having to pay employment
taxes for that worker.
To get this relief, you must file all required federal information returns on a basis consistent with your treatment of the
worker. You (or your
predecessor) must not have treated any worker holding a substantially similar position as an employee for any periods beginning
after 1977.
Technical service specialists.
This relief provision does not apply for a technical services specialist you provide to another business under an
arrangement between you and the
other business. A technical service specialist is an engineer, designer, drafter, computer programmer, systems analyst, or
other similarly skilled
worker engaged in a similar line of work.
This limit on the application of the rule does not affect the determination of whether such workers are employees
under the common-law rules. The
common-law rules control whether the specialist is treated as an employee or an independent contractor. However, if you directly
contract with a
technical service specialist to provide services for your business and not for another business, you may still be entitled
to the relief provision.
2. Employee or Independent Contractor?
An employer must generally withhold federal income taxes, withhold and pay social security and Medicare taxes, and pay unemployment
tax on wages
paid to an employee. An employer does not generally have to withhold or pay any taxes on payments to independent contractors.
To determine whether an individual is an employee or an independent contractor under the common law, the relationship of the
worker and the
business must be examined. In any employee-independent contractor determination, all information that provides evidence of
the degree of control and
the degree of independence must be considered.
Facts that provide evidence of the degree of control and independence fall into three categories: behavioral control, financial
control, and the
type of relationship of the parties. These facts are discussed below.
Behavioral control.
Facts that show whether the business has a right to direct and control how the worker does the task for which the
worker is hired include the type
and degree of:
Instructions that the business gives to the worker.
An employee is generally subject to the business' instructions about when, where, and how to work. All of the following
are examples of types of
instructions about how to do work.
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When and where to do the work.
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What tools or equipment to use.
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What workers to hire or to assist with the work.
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Where to purchase supplies and services.
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What work must be performed by a specified individual.
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What order or sequence to follow.
The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral
control may exist if the
employer has the right to control how the work results are achieved. A business may lack the knowledge to instruct some highly
specialized
professionals; in other cases, the task may require little or no instruction. The key consideration is whether the business
has retained the right to
control the details of a worker's performance or instead has given up that right.
Training that the business gives to the worker.
An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their
own methods.
Financial control.
Facts that show whether the business has a right to control the business aspects of the worker's job include:
The extent to which the worker has unreimbursed business expenses.
Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs that
are incurred regardless of
whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses
in connection with the
services that they perform for their business.
The extent of the worker's investment.
An independent contractor often has a significant investment in the facilities he or she uses in performing services
for someone else. However, a
significant investment is not necessary for independent contractor status.
The extent to which the worker makes his or her services available to the relevant market.
An independent contractor is generally free to seek out business opportunities. Independent contractors often advertise,
maintain a visible
business location, and are available to work in the relevant market.
How the business pays the worker.
An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. This usually
indicates that a worker is
an employee, even when the wage or salary is supplemented by a commission. An independent contractor is usually paid by a
flat fee for the job.
However, it is common in some professions, such as law, to pay independent contractors hourly.
The extent to which the worker can realize a profit or loss.
An independent contractor can make a profit or loss.
Type of relationship.
Facts that show the parties' type of relationship include:
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Written contracts describing the relationship the parties intended to create.
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Whether or not the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay,
or sick
pay.
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The permanency of the relationship. If you engage a worker with the expectation that the relationship will continue indefinitely,
rather than for a specific project or period, this is generally considered evidence that your intent was to create an employer-employee
relationship.
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The extent to which services performed by the worker are a key aspect of the regular business of the company. If a worker
provides services that are a key aspect of your regular business activity, it is more likely that you will have the right
to direct and control his or
her activities. For example, if a law firm hires an attorney, it is likely that it will present the attorney's work as its
own and would have the
right to control or direct that work. This would indicate an employer-employee relationship.
IRS help.
If you want the IRS to determine whether or not a worker is an employee, file Form SS-8, Determination of Worker Status
for Purposes of Federal
Employment Taxes and Income Tax Withholding, with the IRS.
The following examples may help you properly classify your workers:
Building and Construction Industry
Example 1.
Jerry Jones has an agreement with Wilma White to supervise the remodeling of her house. She did not advance funds to help
him carry on the work.
She makes direct payments to the suppliers for all necessary materials. She carries liability and workers' compensation insurance
covering Jerry and
others that he engaged to assist him. She pays them an hourly rate and exercises almost constant supervision over the work.
Jerry is not free to
transfer his assistants to other jobs. He may not work on other jobs while working for Wilma. He assumes no responsibility
to complete the work and
will incur no contractual liability if he fails to do so. He and his assistants perform personal services for hourly wages.
Jerry Jones and his
assistants are employees of Wilma White.
Example 2.
Milton Manning, an experienced tilesetter, orally agreed with a corporation to perform full-time services at construction
sites. He uses his own
tools and performs services in the order designated by the corporation and according to its specifications. The corporation
supplies all materials,
makes frequent inspections of his work, pays him on a piecework basis, and carries workers' compensation insurance on him.
He does not have a place of
business or hold himself out to perform similar services for others. Either party can end the services at any time. Milton
Manning is an employee of
the corporation.
Example 3.
Wallace Black agreed with the Sawdust Co. to supply the construction labor for a group of houses. The company agreed to pay
all construction costs.
However, he supplies all the tools and equipment. He performs personal services as a carpenter and mechanic for an hourly
wage. He also acts as
superintendent and foreman and engages other individuals to assist him. The company has the right to select, approve, or discharge
any helper. A
company representative makes frequent inspections of the construction site. When a house is finished, Wallace is paid a certain
percentage of its
costs. He is not responsible for faults, defects of construction, or wasteful operation. At the end of each week, he presents
the company with a
statement of the amount that he has spent, including the payroll. The company gives him a check for that amount from which
he pays the assistants,
although he is not personally liable for their wages. Wallace Black and his assistants are employees of the Sawdust Co.
Example 4.
Bill Plum contracted with Elm Corporation to complete the roofing on a housing complex. A signed contract established a flat
amount for the
services rendered by Bill Plum. Bill is a licensed roofer and carries workers' compensation and liability insurance under
the business name, Plum
Roofing. He hires his own roofers who are treated as employees for federal employment tax purposes. If there is a problem
with the roofing work, Plum
Roofing is responsible for paying for any repairs. Bill Plum, doing business as Plum Roofing, is an independent contractor.
Example 5.
Vera Elm, an electrician, submitted a job estimate to a housing complex for electrical work at $16 per hour for 400 hours.
She is to receive $1,280
every 2 weeks for the next 10 weeks. This is not considered payment by the hour. Even if she works more or less than 400 hours
to complete the work,
Vera Elm will receive $6,400. She also performs additional electrical installations under contracts with other companies,
that she obtained through
advertisements. Vera is an independent contractor.
For more information about employment taxes in the building and construction industry, visit the IRS website at
www.irs.gov and type “Construction” in the search box.
Example.
Rose Trucking contracts to deliver material for Forest, Inc., at $140 per ton. Rose Trucking is not paid for any articles
that are not delivered.
At times, Jan Rose, who operates as Rose Trucking, may also lease another truck and engage a driver to complete the contract.
All operating expenses,
including insurance coverage, are paid by Jan Rose. All equipment is owned or rented by Jan and she is responsible for all
maintenance. None of the
drivers are provided by Forest, Inc., Jan Rose, operating as Rose Trucking, is an independent contractor.
Example.
Steve Smith, a computer programmer, is laid off when Megabyte, Inc., downsizes. Megabyte agrees to pay Steve a flat amount
to complete a one-time
project to create a certain product. It is not clear how long that it will take to complete the project, and Steve is not
guaranteed any minimum
payment for the hours spent on the program. Megabyte provides Steve with no instructions beyond the specifications for the
product itself. Steve and
Megabyte have a written contract, which provides that Steve is considered to be an independent contractor, is required to
pay federal and state taxes,
and receives no benefits from Megabyte. Megabyte will file a Form 1099-MISC. Steve does the work on a new high-end computer
that cost him $7,000.
Steve works at home and is not expected or allowed to attend meetings of the software development group. Steve is an independent
contractor.
Example 1.
Donna Lee is a salesperson employed on a full-time basis by Bob Blue, an auto dealer. She works six days a week and is on
duty in Bob's showroom on
certain assigned days and times. She appraises trade-ins, but her appraisals are subject to the sales manager's approval.
Lists of prospective
customers belong to the dealer. She is required to develop leads and report results to the sales manager. Because of her experience,
she requires only
minimal assistance in closing and financing sales and in other phases of her work. She is paid a commission and is eligible
for prizes and bonuses
offered by Bob. Bob also pays the cost of health insurance and group-term life insurance for Donna. Donna is an employee of
Bob Blue.
Example 2.
Sam Sparks performs auto repair services in the repair department of an auto sales company. He works regular hours and is
paid on a percentage
basis. He has no investment in the repair department. The sales company supplies all facilities, repair parts, and supplies;
issues instructions on
the amounts to be charged, parts to be used, and the time for completion of each job; and checks all estimates and repair
orders. Sam is an employee
of the sales company.
Example 3.
An auto sales agency furnishes space for Helen Bach to perform auto repair services. She provides her own tools, equipment,
and supplies. She seeks
out business from insurance adjusters and other individuals and does all of the body and paint work that comes to the agency.
She hires and discharges
her own helpers, determines her own and her helpers' working hours, quotes prices for repair work, makes all necessary adjustments,
assumes all losses
from uncollectible accounts, and receives, as compensation for her services, a large percentage of the gross collections from
the auto repair shop.
Helen is an independent contractor and the helpers are her employees.
Example.
Donna Yuma is a sole practitioner who rents office space and pays for the following items: telephone, computer, on-line legal
research linkup, fax
machine, and photocopier. Donna buys office supplies and pays bar dues and membership dues for three other professional organizations.
Donna has a
part-time receptionist who also does the bookkeeping. She pays the receptionist, withholds and pays federal and state employment
taxes, and files a
Form W-2 each year. For the past 2 years, Donna has had only three clients, corporations with which there have been long-standing
relationships. Donna
charges the corporations an hourly rate for her services, sending monthly bills detailing the work performed for the prior
month. The bills include
charges for long distance calls, on-line research time, fax charges, photocopies, postage, and travel, costs for which the
corporations have agreed to
reimburse her. Donna is an independent contractor.
Example.
Tom Spruce rents a cab from Taft Cab Co. for $150 per day. He pays the costs of maintaining and operating the cab. Tom Spruce
keeps all fares that
he receives from customers. Although he receives the benefit of Taft's two-way radio communication equipment, dispatcher,
and advertising, these items
benefit both Taft and Tom Spruce. Tom Spruce is an independent contractor.
To determine whether salespersons are employees under the usual common-law rules, you must evaluate each individual case. If a
salesperson who works for you does not meet the tests for a common-law employee, discussed earlier, you do not have to withhold
federal income tax
from his or her pay (see Statutory Employees in section 1). However, even if a salesperson is not an employee under the usual common-law
rules, his or her pay may still be subject to social security, Medicare, and FUTA taxes.
To determine whether a salesperson is an employee for social security, Medicare, and FUTA tax purposes, the salesperson must
meet all eight
elements of the statutory employee test. A salesperson is a statutory employee for social security, Medicare, and FUTA tax
purposes if he or
she:
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Works full time for one person or company except, possibly, for sideline sales activities on behalf of some other person,
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Sells on behalf of, and turns his or her orders over to, the person or company for which he or she works,
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Sells to wholesalers, retailers, contractors, or operators of hotels, restaurants, or similar establishments,
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Sells merchandise for resale, or supplies for use in the customer's business,
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Agrees to do substantially all of this work personally,
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Has no substantial investment in the facilities used to do the work, other than in facilities for transportation,
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Maintains a continuing relationship with the person or company for which he or she works, and
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Is not an employee under common-law rules.
3. Employees of Exempt Organizations
Many nonprofit organizations are exempt from federal income tax. Although they do not have to pay federal income tax themselves,
they must still
withhold federal income tax from the pay of their employees. However, there are special social security, Medicare, and federal
unemployment (FUTA) tax
rules that apply to the wages that they pay their employees.
Section 501(c)(3) organizations.
Nonprofit organizations that are exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code
include any community chest,
fund, or foundation organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary
or educational
purposes, fostering national or international amateur sports competition, or for the prevention of cruelty to children or
animals. These organizations
are usually corporations and are exempt from federal income tax under section 501(a).
Social security and Medicare taxes.
Wages paid to employees of section 501(c)(3) organizations are subject to social security and Medicare taxes unless
one of the following situations
applies.
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The organization pays an employee less than $100 in a calendar year.
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The organization is a church or church-controlled organization opposed for religious reasons to the payment of social security
and Medicare
taxes and has filed Form 8274, Certification by Churches and Qualified Church-Controlled Organizations Electing Exemption
From Employer Social
Security and Medicare Taxes, to elect exemption from social security and Medicare taxes. The organization must have filed
for exemption before the
first date on which a quarterly employment tax return (Form 941) would otherwise be due.
An employee of a church or church-controlled organization that is exempt from social security and Medicare taxes must
pay self-employment tax if
the employee is paid $108.28 or more in a year. However, an employee who is a member of a qualified religious sect can apply
for an exemption from the
self-employment tax by filing Form 4029, Application for Exemption From Social Security and Medicare Taxes and Waiver of Benefits.
See Members of
recognized religious sects opposed to insurance in section 4.
Federal unemployment tax.
An organization that is exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code is also
exempt from the federal
unemployment (FUTA) tax. This exemption cannot be waived.
Note.
An organization wholly owned by a state or its political subdivision should contact the appropriate state official for information
about reporting
and getting social security and Medicare coverage for its employees.
Other than section 501(c)(3) organizations.
Nonprofit organizations that are not section 501(c)(3) organizations may also be exempt from federal income tax under
section 501(a) or section
521. However, these organizations are not exempt from withholding federal income, social security, or Medicare tax from their
employees' pay, or from
paying FUTA tax. Two special rules for social security, Medicare, and FUTA taxes apply.
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If an employee is paid less than $100 during a calendar year, his or her wages are not subject to social security and Medicare
taxes.
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If an employee is paid less than $50 in a calendar quarter, his or her wages are not subject to FUTA tax for the quarter.
The above rules do not apply to employees who work for pension plans and other similar organizations described in section
401(a).
Special rules apply to the treatment of ministers for social security purposes. An exemption from social security is available
for ministers and
certain other religious workers and members of certain recognized religious sects. For more information on getting an exemption,
see Publication 517,
Social Security and Other Information for Members of the Clergy and Religious Workers.
Ministers.
Ministers are individuals who are duly ordained, commissioned, or licensed by a religious body constituting a church
or church denomination. They
are given the authority to conduct religious worship, perform sacerdotal functions, and administer ordinances and sacraments
according to the
prescribed tenets and practices of that religious organization.
A minister who performs services for you subject to your will and control is your employee. The common-law rules discussed
in sections 1 and 2
should be applied to determine whether a minister is your employee or is self-employed. The earnings of a minister are not
subject to federal income,
social security, and Medicare tax withholding. However, the earnings as reported on the minister's Form 1040 are subject to
self-employment tax and
federal income tax. You do not withhold these taxes from wages earned by a minister, but you may agree with the minister to
voluntarily withhold tax
to cover the minister's liability for self-employment tax and federal income tax.
Form W-2.
If your employee is an ordained minister, report all taxable compensation as wages in box 1 on Form W-2. Include in
this amount expense allowances
or reimbursements paid under a nonaccountable plan, discussed in section 5 of Publication 15 (Circular E). Do not include
a parsonage allowance
(excludable housing allowance) in this amount. You may report a parsonage or rental allowance (housing allowance), utilities
allowance, and the rental
value of housing provided in a separate statement or in box 14 on Form W-2. Do not show on Form W-2 or Form 941 any amount
as social security or
Medicare wages, or any withholding for social security or Medicare taxes. If you withheld tax from the minister under a voluntary
agreement, this
amount should be shown in box 2 on Form W-2 as federal income tax withheld. For more information on ministers, see Publication
517.
Exemptions for ministers and others.
Certain ordained ministers, Christian Science practitioners, and members of religious orders who have not taken a
vow of poverty, who are subject
to self-employment tax, may apply to exempt their earnings from the tax on religious grounds. The application must be based
on conscientious
opposition to public insurance because of personal religious considerations. The exemption applies only to qualified services
performed for the
religious organization. See Rev. Proc. 91-20, 1991-1 C.B. 524, for guidelines to determine whether an organization is a religious
order or whether an
individual is a member of a religious order.
To apply for the exemption, the employee should file Form 4361, Application for Exemption From Self-Employment Tax
for Use by Ministers, Members of
Religious Orders and Christian Science Practitioners. See Publication 517 for more information about claiming an exemption
from self-employment tax
using Form 4361.
Members of recognized religious sects opposed to insurance.
If you belong to a recognized religious sect or to a division of such sect that is opposed to insurance, you may qualify
for an exemption from the
self-employment tax. To qualify, you must be conscientiously opposed to accepting the benefits of any public or private insurance
that makes payments
because of death, disability, old age, or retirement, or makes payments toward the cost of, or provides services for, medical
care (including social
security and Medicare benefits). If you buy a retirement annuity from an insurance company, you will not be eligible for this
exemption. Religious
opposition based on the teachings of the sect is the only legal basis for the exemption. In addition, your religious sect
(or division) must have
existed since December 31, 1950.
Self-employed.
If you are self-employed and a member of a recognized religious sect opposed to insurance, you can apply for exemption
by filing Form 4029,
Application for Exemption From Social Security and Medicare Taxes and Waiver of Benefits, and waive all social security benefits.
Employees.
The social security and Medicare tax exemption available to the self-employed who are members of a recognized religious
sect opposed to insurance
is also available to their employees who are members of such a sect. This applies to partnerships only if each partner is
a member of the sect. This
exemption for employees applies only if both the employee and the employer are members of such a sect, and the employer has
an exemption. To get the
exemption, the employee must file Form 4029.
An employee of a church or church-controlled organization that is exempt from social security and Medicare taxes can
also apply for an exemption on
Form 4029.
5. Wages and Other Compensation
Publication 15 (Circular E) , provides a general discussion of taxable wages. Publication 15-B discusses fringe benefits.
The following topics
supplement those discussions.
Relocating for Temporary Work Assignments
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.
Employee Achievement Awards
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.
Limits.
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.
Scholarship and Fellowship Payments
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.
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.
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, FUTA taxes, and federal income tax withholding.
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.
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
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.
Golden Parachute Payments
A golden parachute payment is a contract entered into by a corporation and key personnel under which 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.
Beginning with payments under contracts entered into, significantly amended, or renewed after June 14, 1984, no deduction
is allowed to the
corporation for any excess parachute payment. A payment is generally considered to be 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. 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.
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).
Reporting golden parachute payments.
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.
Exempt payments.
Most small business corporations are exempt from the golden parachute rules. See Regulations section 1.280G-1 for
more information.
Interest-Free and Below-Market-Interest-Rate Loans
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 accessing 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.
Nonqualified Deferred Compensation Plans
Section 885 of the American Jobs Creation Act of 2004 added section 409A to the Internal Revenue Code. 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 or are
restricted to the provision of benefits in connection with a decline in the financial health of the plan sponsor. Employers
must withhold federal
income tax (but not the additional 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 new provisions do not affect the application or reporting of
social security, Medicare,
or FUTA taxes.
Section 409A applies to amounts deferred in tax years beginning after December 31, 2004, and may also apply to amounts deferred
in tax years
beginning before January 1, 2005, for example, if the plan under which the deferral is made is materially modified after October
3, 2004. The
reporting requirements apply to amounts deferred after December 31, 2004. Public guidance on section 409A, including transition
rules, was published
on December 20, 2004, as Notice 2005-1. (The employer and payer reporting and wage withholding requirements provided by Notice
2005-1 have been
suspended for calendar year 2005 by Notice 2005-94.) The new provisions do not prevent the inclusion of amounts in income
or wages under other
provisions of the Internal Revenue Code or common law tax principles, such as when amounts are actually or constructively
received or irrevocably
contributed to a separate fund.
Social security, Medicare, and FUTA taxes.
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.
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)-2T for the definition of a salary reduction agreement.
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, 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, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans), 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.
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.
Special rules apply to the reporting of sick pay payments to employees. How these payments are reported depends on whether
the payments are made by
the employer or a third party, such as an insurance company.
Sick pay is usually subject to social security, Medicare, and FUTA taxes. For exceptions, see Social Security, Medicare, and FUTA Taxes on
Sick Pay later. Sick pay may also be subject to either mandatory or voluntary federal income tax withholding, depending on who pays
it.
Sick pay generally means any amount paid under a plan because of an employee's temporary absence from work due to injury,
sickness, or disability.
It may be paid by either the employer or a third party, such as an insurance company. Sick pay includes both short- and long-term
benefits. It is
often expressed as a percentage of the employee's regular wages.
Payments That Are Not Sick Pay
Sick pay does not include the following payments.
-
Disability retirement payments. Disability retirement payments are not sick pay and are not discussed in this section. Those
payments are subject to the rules for federal income tax withholding from pensions and annuities. See section 8.
-
Workers' compensation. Payments because of a work-related injury or sickness that are made under a workers' compensation law are
not sick pay and are not subject to employment taxes. But see Payments in the nature of workers' compensation—public employees
below.
-
Payments in the nature of workers' compen-
sation—public employees. State and local government employees, such as police officers and firefighters, sometimes receive payments due
to injury in 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 a statute in the nature of a workers' compensation law are not sick pay and
are not subject to
employment taxes. For more information, get Treasury Decision 9233 by accessing
www.irs.gov and typing “TD 9233” in the search box
-
Medical expense payments. Payments under a definite plan or system for medical and hospitalization expenses, or for insurance
covering these expenses, are not sick pay and are not subject to employment taxes.
-
Payments unrelated to absence from work. Accident or health insurance payments unrelated to absence from work are not sick pay
and are not subject to employment taxes. These include payments for:
-
Permanent loss of a member or function of the body,
-
Permanent loss of the use of a member or function of the body, or
-
Permanent disfigurement of the body.
Example. Donald was injured in a car accident and lost an eye. Under a policy paid for by Donald's employer, Delta Insurance Co. paid
Donald $5,000 as compensation for the loss of his eye. Because the payment was determined by the type of injury and was unrelated
to Donald's absence
from work, it is not sick pay and is not subject to federal employment taxes.
A sick pay plan is a plan or system established by an employer under which sick pay is available to employees generally or
to a class or classes of
employees. This does not include a situation in which benefits are provided on a discretionary or occasional basis with merely
an intention to aid
particular employees in time of need.
You have a sick pay plan or system if the plan is in writing or is otherwise made known to employees, such as by a bulletin
board notice or your
long and established practice. Some indications that you have a sick pay plan or system include references to the plan or
system in the contract of
employment, employer contributions to a plan, or segregated accounts for the payment of benefits.
Definition of employer.
The employer for whom the employee normally works, a term used in the following discussion, is either the employer
for whom the employee was
working at the time that the employee became sick or disabled or the last employer for whom the employee worked before becoming
sick or disabled, if
that employer made contributions to the sick pay plan on behalf of the sick or disabled employee.
Note: Contributions to a sick pay plan through a cafeteria plan (by direct employer contributions or salary reduction) are employer
contributions unless
they are after-tax employee contributions (that is, included in taxable wages).
Third-Party Payers of Sick Pay
Employer's agent.
An employer's agent is a third party that bears no insurance risk and is reimbursed on a cost-plus-fee basis for payment
of sick pay and similar
amounts. A third party may be your agent even if the third party is responsible for determining which employees are eligible
to receive payments. For
example, if a third party provides administrative services only, the third party is your agent. If the third party is paid
an insurance premium and is
not reimbursed on a cost-plus-fee basis, the third party is not your agent. Whether an insurance company or other third party
is your agent depends on
the terms of their agreement with you.
A third party that makes payments of sick pay as your agent is not considered the employer and generally has no responsibility
for employment
taxes. This responsibility remains with you. However, under an exception to this rule, the parties may enter into an agreement
that makes the
third-party agent responsible for employment taxes. In this situation, the third-party agent should use its own name and EIN
(rather than your name
and EIN) for the responsibilities that it has assumed.
Third party not employer's agent.
A third party that makes payments of sick pay other than as an agent of the employer is liable for federal income
tax withholding (if requested by
the employee) and the employee part of the social security and Medicare taxes.
The third party is also liable for the employer part of the social security and Medicare taxes and the FUTA tax, unless
the third party transfers
this liability to the employer for whom the employee normally works. This liability is transferred if the third party takes
the following steps:
-
Withholds the employee social security and Medicare taxes from the sick pay payments,
-
Makes timely deposits of the employee social security and Medicare taxes, and
-
Notifies the employer for whom the employee normally works of the payments on which employee taxes were withheld and deposited.
The third
party must notify the employer within the time required for the third party's deposit of the employee part of the social security
and Medicare taxes.
For instance, if the third party is a monthly schedule depositor, it must notify the employer by the 15th day of the month
following the month in
which the sick pay payment is made because that is the day by which the deposit is required to be made. The third party should
notify the employer as
soon as information on payments is available so that an employer required to make electronic deposits can make them timely.
For multi-employer plans,
see the special rule discussed next.
Multi-employer plan timing rule.
A special rule applies to sick pay payments made to employees by a third-party insurer under an insurance contract
with a multi-employer plan
established under a collectively bargained agreement. If the third-party insurer making the payments complies with steps 1
and 2 above and gives the
plan (rather than the employer) the required timely notice described in step 3 above, then the plan (not the third-party insurer)
must pay the
employer part of the social security and Medicare taxes and the FUTA tax. Similarly, if within six business days of the plan's
receipt of
notification, the plan gives notice to the employer for whom the employee normally works, the employer (not the plan) must
pay the employer part of
the social security and Medicare taxes and the FUTA tax.
Reliance on information supplied by the employer.
A third party that pays sick pay should request information from the employer to determine amounts that are not subject
to employment taxes. Unless
the third party has reason not to believe the information, it may rely on that information for the following items.
-
The total wages paid to the employee during the calendar year.
-
The last month in which the employee worked for the employer.
-
The employee contributions to the sick pay plan made with aftertax dollars.
The third party should not rely on statements regarding these items made by the employee.
Social Security, Medicare, and FUTA Taxes on Sick Pay
Employer.
If you pay sick pay to your employee, you must generally withhold employee social security and Medicare taxes from
the sick pay. You must timely
deposit employee and employer social security and Medicare taxes and FUTA tax. There are no special deposit rules for sick
pay. See section 11 of
Publication 15 (Circular E) for more information on the deposit rules.
Amounts not subject to social security, Medicare, or FUTA taxes.
The following payments, whether made by the employer or a third party, are not subject to social security, Medicare,
or FUTA taxes (different rules
apply to federal income tax withholding).
-
Payments after an employee's death or disability retirement. Social security, Medicare, and FUTA taxes do not apply to amounts
paid under a definite plan or system, as defined under Sick Pay Plan earlier, on or after the termination of the employment relationship
because of death or disability retirement. However, even if there is a definite plan or system, amounts paid to a former employee
are subject to
social security, Medicare, and FUTA taxes if they would have been paid even if the employment relationship had not terminated
because of death or
disability retirement. For example, a payment to a disabled former employee for unused vacation time would have been made
whether or not the employee
retired on disability. Therefore, the payment is wages and is subject to social security, Medicare, and FUTA taxes.
-
Payments after calendar year of employee's death. Sick pay paid to the employee's estate or survivor after the calendar year of
the employee's death is not subject to social security, Medicare, or FUTA taxes. (Also, see Amounts not subject to income tax
withholding under Income Tax Withholding on Sick Pay later.)
Example. Sandra became entitled to sick pay on November 25, 2005, and died on December 31, 2005. On January 13, 2006, Sandra's sick
pay
for the period from December 24 through December 31, 2005, was paid to her survivor. The payment is not subject to social
security, Medicare, or FUTA
taxes.
-
Payments to an employee entitled to disability insurance benefits. Payments to an employee when the employee is entitled to
disability insurance benefits under section 223(a) of the Social Security Act are not subject to social security and Medicare
taxes. This rule applies
only if the employee became entitled to the Social Security Act benefits before the calendar year in which the payments are
made, and the employee
performs no services for the employer during the period for which the payments are made. However, these payments are subject to FUTA tax.
-
Payments that exceed the applicable wage base. Social security and FUTA taxes do not apply to payments of sick pay that, when
combined with the regular wages and sick pay previously paid to the employee during the year, exceed the applicable wage base.
Because there is no
Medicare tax wage base, this exception does not apply to Medicare tax. The social security tax wage base for 2006 is $94,200.
The FUTA tax wage base
is $7,000.
Example. If an employee receives $85,000 in wages from an employer in 2006 and then receives $15,000 of sick pay, only the first $9,200
of the sick pay is subject to social security tax. All of the sick pay is subject to Medicare tax. None of the sick pay is
subject to FUTA tax. See
Example of Figuring and Reporting Sick Pay later.
-
Payments after 6 months absence from work. Social security, Medicare, and FUTA taxes do not apply to sick pay paid more than 6
calendar months after the last calendar month in which the employee worked.
Example 1. Ralph's last day of work before he became entitled to receive sick pay was December 13, 2005. He was paid sick pay for 9
months before his return to work on September 12, 2006. Sick pay paid to Ralph after June 30, 2006, is not subject to social
security, Medicare, or
FUTA taxes.
Example 2. The facts are the same as in Example 1, except that Ralph worked 1 day during the 9-month period, on February 13, 2006.
Because the 6-month period begins again in March, only the sick pay paid to Ralph after August 31, 2005, is exempt from social
security, Medicare, and
FUTA taxes.
-
Payments attributable to employee contributions. Social security, Medicare, and FUTA taxes do not apply to payments, or parts of
payments, attributable to employee contributions to a sick pay plan made with aftertax dollars. (Contributions to a sick pay
plan made on behalf of
employees with employees' pre-tax dollars under a cafeteria plan are employer contributions.)
Group policy. If both the employer and the employee contributed to the sick pay plan under a group insurance policy, figure the taxable
sick pay by multiplying it by the percentage of the policy's cost that was contributed by the employer for the 3 policy years
before the calendar year
in which the sick pay is paid. If the policy has been in effect fewer than 3 years, use the cost for the policy years in effect
or, if in effect less
than 1 year, a reasonable estimate of the cost for the first policy year.
Example. Alan is employed by Edgewood Corporation. Because of an illness, he was absent from work for 3 months during 2006. Key
Insurance Company paid Alan $2,000 sick pay for each month of his absence under a policy paid for by contributions from both
Edgewood and its
employees. All of the employees' contributions were paid with aftertax dollars. For the 3 policy years before 2006, Edgewood
paid 70% of the policy's
cost and its employees paid 30%. Because 70% of the sick pay paid under the policy is due to Edgewood's contributions, $1,400
($2,000 × 70%) of
each payment made to Alan is taxable sick pay. The remaining $600 of each payment that is due to employee contributions is
not taxable sick pay and is
not subject to employment taxes. Also, see Example of Figuring and Reporting Sick Pay later.
Income Tax Withholding on Sick Pay
The requirements for federal income tax withholding on sick pay and the methods for figuring it differ depending on whether
the sick pay is paid
by:
Employer or employer's agent.
Sick pay paid by you or your agent is subject to mandatory federal income tax withholding. An employer or agent paying sick pay
generally determines the federal income tax to be withheld based on the employee's Form W-4. The employee cannot choose how
much will be withheld by
giving you or your agent a Form W-4S, Request for Federal Tax Withholding From Sick Pay. Sick pay paid by an agent is treated
as supplemental wages.
If the agent does not pay regular wages to the employee, the agent may choose to withhold federal income tax at a flat 25%
rate, rather than at the
wage withholding rate. See section 7 in Publication 15 (Circular E) for the flat rate (35%) when supplemental wage payments
to an individual exceed
$1,000,000 during the year.
Third party not an agent.
Sick pay paid by a third party that is not your agent is not subject to mandatory federal income tax withholding. However, an employee
may elect to have federal income tax withheld by submitting Form W-4S to the third party.
If Form W-4S has been submitted, the third party should withhold federal income tax on all payments of sick pay made
8 or more days after receiving
the form. The third party may, at its option, withhold federal income tax before 8 days have passed.
The employee may request on Form W-4S to have a specific whole dollar amount withheld. However, if the requested withholding
would reduce any net
payment below $10, the third party should not withhold any federal income tax from that payment. The minimum amount of withholding
that the employee
can specify is $4 per day, $20 per week, or $88 per month based on the payroll period.
Withhold from all payments at the same rate. For example, if $25 is withheld from a regular full payment of $100,
then $20 (25%) should be withheld
from a partial payment of $80.
Amounts not subject to income tax withholding.
The following amounts, whether paid by you or a third party, are not wages subject to federal income tax withholding.
-
Payments after the employee's death. Sick pay paid to the employee's estate or survivor at any time after the employee's death is
not subject to federal income tax withholding, regardless of who pays it.
-
Payments attributable to employee contributions. Payments, or parts of payments, attributable to employee contributions made to a
sick pay plan with after-tax dollars are not subject to federal income tax withholding. For more information, see the corresponding
discussion in
Amounts not subject to social security, Medicare, or FUTA taxes earlier.
This section discusses who is liable for depositing social security, Medicare, FUTA, and withheld federal income taxes on
sick pay. These taxes
must be deposited under the same rules that apply to deposits of taxes on regular wage payments. See Publication 15 (Circular
E) for information on
the deposit rules.
This section also explains how sick pay should be reported on Forms W-2, W-3, 940 (or Form 940-EZ for 2005), and 941.
Sick Pay Paid by Employer or Agent
If you or your agent (defined earlier) make sick pay payments, you deposit taxes and file Forms W-2, W-3, 940 (or Form 940-EZ
for 2005), and 941
under the same rules that apply to regular wage payments.
However, the agreement between the parties may require your agent to carry out responsibilities that would otherwise have
been borne by you. In
this situation, your agent should use its own name and EIN (rather than yours) for the responsibilities that it has assumed.
Reporting sick pay on Form W-2.
You may either combine the sick pay with other wages and prepare a single Form W-2 for each employee, or you may prepare
separate Forms W-2 for
each employee, one reporting sick pay and the other reporting regular wages. A Form W-2 must be prepared even if all of the
sick pay is nontaxable
(see Box 12 below in the list of information that must be included on Form W-2). All Forms W-2 must be given to the employees
by January 31.
The Form W-2 filed for the sick pay must include the employer's name, address, and EIN; the employee's name, address,
and SSN; and the following
information.
| Box 1 - Sick pay the employee must include in income. |
| Box 2 - Any federal income tax withheld from the sick pay. |
| Box 3 - Sick pay subject to employee social security tax. |
| Box 4 - Employee social security tax withheld from the sick pay. |
| Box 5 - Sick pay subject to employee Medicare tax. |
| Box 6 - Employee Medicare tax withheld from the sick pay. |
| Box 12 - Any sick pay that was paid by a third party and was not subject to federal income tax because the employee
contributed to the sick pay plan (enter code J).
|
| Box 13 - Check the “Third-party sick pay” box only if the amounts were paid by a third party.
|
Sick Pay Paid by Third Party
The rules for a third party that is not your agent depend on whether liability has been transferred as discussed under Third-Party Payers of
Sick Pay earlier.
To figure the due dates and amounts of its deposits of employment taxes, a third party should combine:
Liability not transferred to the employer.
If the third party does not satisfy the requirements for transferring liability for FUTA tax and the employer's part of the social
security and Medicare taxes, the third party reports the sick pay on its own Form 940 (or Form 940-EZ for 2005) and 941. In
this situation, the
employer has no tax responsibilities for sick pay.
The third party must deposit social security, Medicare, FUTA, and withheld federal income taxes using its own name
and EIN. The third party must
give each employee to whom it paid sick pay a Form W-2 by January 31 of the following year. The Form W-2 must include the
third party's name, address,
and EIN instead of the employer information. Otherwise, the third party must complete Form W-2 as shown in Reporting sick pay on Form W-2
earlier.
Liability transferred to the employer.
Generally, if a third party satisfies the requirements for transferring liability for the employer part of the social security and
Medicare taxes and for the FUTA tax, the following rules apply.
Deposits.
The third party must make deposits of withheld employee social security and Medicare taxes and withheld federal income
tax using its own name and
EIN. You must make deposits of the employer part of the social security and Medicare taxes and the FUTA tax using your name and EIN. In
applying the deposit rules, your liability for these taxes begins when you receive the third party's notice of sick pay payments.
Form 941.
The third party and you must each file Form 941. Line 7b of each Form 941 must contain a special adjusting entry for
social security and Medicare
taxes. These entries are required because the total tax liability for social security and Medicare taxes (employee and employer
parts) is split
between you and the third party.
-
Employer. You must include third-party sick pay on lines 2, 5a, and 5c of Form 941. (There should be no entry on line 3 because
the third party withheld federal income tax, if any.) After completing line 6, subtract on line 7b the employee social security
and Medicare taxes
withheld and deposited by the third party.
-
Third party. The third party must include on Form 941 the employee part of the social security and Medicare taxes (and federal
income tax, if any) it withheld. The third party does not include on line 2 any sick pay paid as a third party but does include
on line 3 any federal
income tax withheld. On line 5a, column 1, the third party enters the total amount it paid subject to social security taxes.
This amount includes both
wages paid to its own employees and sick pay paid as a third party. The third party completes line 5c, column 1, in a similar
manner. On line 7b, the
third party subtracts the employer part of the social security and Medicare taxes that you must pay.
Form 940 (or Form 940-EZ).
You, not the third party, must prepare Form 940 (or Form 940-EZ for 2005) for sick pay.
Third-party sick pay recap Forms W-2 and W-3.
The third party must prepare a “ Third-Party Sick Pay Recap” Form W-2 and a “ Third-Party Sick Pay Recap” Form W-3. These forms, previously
called “ Dummy” forms, do not reflect sick pay paid to individual employees, but instead show the combined amount of sick pay paid to all
employees of all clients of the third party. The recap forms provide a means of reconciling the wages shown on the third party's
Form 941. However,
see Optional rule for Form W-2 later. Do not file the recap Form W-2 and W-3 electronically or on magnetic media.
The third party fills out the third-party sick pay recap Form W-2 as follows.
| Box b - Third party's EIN. |
| Box c - Third party's name and address. |
| Box e - “Third-Party Sick Pay Recap” in place of the employee's name.
|
| Box 1 - Total sick pay paid to all employees. |
| Box 2 - Any federal income tax withheld from the sick pay. |
| Box 3 - Sick pay subject to employee social security tax. |
| Box 4 - Employee social security tax withheld from sick pay. |
| Box 5 - Sick pay subject to employee Medicare tax. |
| Box 6 - Employee Medicare tax withheld from the sick pay. |
The third party attaches the third-party sick pay recap Form W-2 to a separate recap Form W-3, on which only boxes
b, e, f, g, 1, 2, 3, 4, 5, 6,
and 13 are completed. Enter “ Third-Party Sick Pay Recap” in box 13. (Only the employer makes an entry in box 14 of Form W-3.)
Optional rule for Form W-2.
You and the third party may choose to enter into a legally binding agreement designating the third party to be your
agent for purposes of preparing
Forms W-2 reporting sick pay. The agreement must specify what part, if any, of the payments under the sick pay plan is excludable
from the employees'
gross incomes because it is attributable to their contributions to the plan. If you enter into an agreement, the third party
prepares the actual Forms
W-2, not the “ Third-Party Sick Pay Recap” Form W-2 as discussed earlier, for each employee who receives sick pay from the third party. If the
optional rule is used:
-
The third party does not provide you with the sick pay statement described below and
-
You (not the third party) prepare “Third-Party Sick Pay Recap” Forms W-2 and W-3. These recap forms are needed to reconcile the sick
pay shown on your Form 941.
Sick pay statement.
The third party must furnish you with a sick pay statement by January 15 of the year following the year in which the
sick pay was paid. The
statement must show the following information about each employee who was paid sick pay.
-
The employee's name.
-
The employee's SSN (if social security, Medicare, or income tax was withheld).
-
The sick pay paid to the employee.
-
Any federal income tax withheld.
-
Any employee social security tax withheld.
-
Any employee Medicare tax withheld.
Example of Figuring and Reporting Sick Pay
Dave, an employee of Edgewood Corporation, was seriously injured in a car accident on January 1, 2005. Dave's last day of
work was December 31,
2004. The accident was not job related.
Key, an insurance company that was not an agent of the employer, paid Dave $2,000 each month for 10 months, beginning in January
2005. Dave
submitted a Form W-4S to Key, requesting $210 be withheld from each payment for federal income tax. Dave received no payments
from Edgewood, his
employer, from January 2005 through October 2005. Dave returned to work in November 2005.
For the policy year in which the car accident occurred, Dave paid a part of the premiums for his coverage, and Edgewood paid
the remaining part.
The plan was, therefore, a “contributory plan.” During the 3 policy years before the calendar year of the accident, Edgewood paid 70% of the
total of the net premiums for its employees' insurance coverage, and its employees paid 30%.
Social security and Medicare taxes.
For social security and Medicare tax purposes, taxable sick pay was $8,400 ($2,000 per month × 70% = $1,400 taxable
portion per payment;
$1,400 × 6 months = $8,400 total taxable sick pay). Only the six $2,000 checks received by Dave from January through June
are included in the
calculation. The check received by Dave in July (the seventh check) was received more than 6 months after the month in which
Dave last worked.
Of each $2,000 payment Dave received, 30% ($600) is not subject to social security and Medicare taxes because the
plan is contributory and Dave's
aftertax contribution is considered to be 30% of the premiums during the 3 policy years before the calendar year of the accident.
FUTA tax.
Of the $8,400 taxable sick pay (figured the same as for social security and Medicare taxes), only $7,000 is subject
to the FUTA tax because the
FUTA contribution base is $7,000.
Federal income tax withholding.
Of each $2,000 payment, $1,400 ($2,000 × 70%) is subject to voluntary federal income tax withholding. In accordance
with Dave's Form W-4S,
$210 was withheld from each payment ($2,100 for the 10 payments made during 2005).
Liability transferred.
For the first 6 months following the last month in which Dave worked, Key was liable for social security, Medicare,
and FUTA taxes on any payments
that constituted taxable wages. However, Key could have shifted the liability for the employer part of the social security
and Medicare taxes (and for
the FUTA tax) during the first 6 months by withholding Dave's part of the social security and Medicare taxes, timely depositing
the taxes, and
notifying Edgewood of the payments.
If Key shifted liability for the employer part of the social security and Medicare taxes to Edgewood and provided
Edgewood with a sick pay
statement, Key would not prepare a Form W-2 for Dave. However, Key would prepare “ Third-Party Sick Pay Recap” Forms W-2 and W-3. Key and Edgewood
must each prepare Form 941. Edgewood must also report the sick pay and withholding for Dave on Forms W-2, W-3, and 940.
As an alternative, the parties could have followed the optional rule described under Optional rule for Form W-2 earlier. Under this
rule, Key would prepare Form W-2 even though liability for the employer part of the social security and Medicare taxes had
been shifted to Edgewood.
Also, Key would not prepare a sick pay statement, and Edgewood, not Key, would prepare the recap Forms W-2 and W-3 reflecting
the sick pay shown on
Edgewood's Form 941.
Liability not transferred.
If Key did not shift liability for the employer part of the social security and Medicare taxes to Edgewood, Key would
prepare Forms W-2 and W-3 as
well as Forms 941 and 940. In this situation, Edgewood would not report the sick pay.
Payments received after 6 months.
The payments received by Dave in July through October are not subject to social security, Medicare, or FUTA taxes,
because they were received more
than 6 months after the last month in which Dave worked (December 2004). However, Key must continue to withhold federal income
tax from each payment
because Dave furnished Key with a Form W-4S. Also, Key must prepare Forms W-2 and W-3, unless it has furnished Edgewood with
a sick pay statement. If
the sick pay statement was furnished, then Edgewood must prepare Forms W-2 and W-3.
7. Special Rules for Paying Taxes
If two or more related corporations employ the same individual at the same time and pay this individual through a common paymaster,
which is one of
the corporations, the corporations are considered to be a single employer. They have to pay, in total, no more in social security
and Medicare taxes
than a single employer would.
Each corporation must pay its own part of the employment taxes and may deduct only its own part of the wages. The deductions
will not be allowed
unless the corporation reimburses the common paymaster for the wage and tax payments. See Regulations section 31.3121(s)-1
for more information.
You must submit an application for authorization to act as an agent to the IRS Service Center where you will be filing returns.
A Form 2678,
Employer Appointment of Agent, properly completed by each employer, must be submitted with this application. See Rev. Proc.
70-6, 1970-1 C.B. 420,
Rev. Proc. 84-33, 1984-1 C.B. 502, and the separate Instructions for Forms W-2 and W-3 for procedures and reporting requirements.
Form 2678 does not
apply to FUTA taxes reportable on Form 940.
Magnetic tape filing of Forms 940 and 941.
Reporting agents may not use magnetic tape for filing Forms 940 and 941. Instead, see Electronic filing of Forms 940 and 941 below.
Electronic filing of Forms 940 and 941.
Reporting agents may file Forms 940 and 941 electronically. Get Publication 3112, IRS e-file Application and Participation,
for details. File Form
8633, Application to Participate in the IRS e-file Program, and Form 8655, Reporting Agent Authorization. See Rev. Proc. 2005-60
for information on
electronic filing of Forms 940 and 941. You can find Rev. Proc. 2005-60 on page 449 of Internal Revenue Bulletin 2005-35 at
www.irs.gov/pub/irs-irbs/irb05-35.pdf. See Rev. Proc. 2003-69 for the
requirements on completing and submitting Form 8655. You can find Rev. Proc. 2003-69 on page 403 of Internal Revenue Bulletin
2003-34 at
www.irs.gov/pub/irs-irbs/irb03-34.pdf. Visit the IRS website at
www.irs.gov/efile or call 1-866-255-0654 for more information.
Payment of Employment Taxes by Disregarded Entities
Employment taxes for employees of a qualified subchapter S subsidiary or other entity disregarded as an entity separate from
its owner may be
reported and paid under one of the following methods
-
By its owner (as if the employees of the disregarded entity are employed directly by the owner) using the owner's name and
taxpayer
identification number.
-
By each entity recognized as a separate entity under state law using the entity's own name and taxpayer identification number.
If the second method is chosen, the owner retains responsibility for the federal employment tax obligations of the disregarded
entity. For more
information, see Notice 99-6, 1999-3 C.B. 321. You can find Notice 99-6 on page 12 of Internal Revenue Bulletin 1999-3 at
www.irs.gov/pub/irs-irbs/irb99-03.pdf.
Employee's Portion of Taxes Paid by Employer
If you pay your employee's social security and Medicare taxes without deducting them from the employee's pay, you must include
the amount of the
payments in the employee's wages for federal income tax withholding and social security, Medicare, and FUTA taxes. This increase
in the employee's
wage payment for your payment of the employee's social security and Medicare taxes is also subject to employee social security
and Medicare taxes.
This again increases the amount of the additional taxes you must pay.
Note: This discussion (see both above and below) does not apply to household and agricultural employers. If you pay a household
or agricultural
employee's social security and Medicare taxes, these payments must be included in the employee's wages. However, this wage
increase due to the tax
payments made for the employee is not subject to social security or Medicare taxes as discussed in this section.
To figure the employee's increased wages in this situation, divide the stated pay (the amount that you pay without taking
into account your payment
of employee social security and Medicare taxes) by a factor for that year. This factor is determined by subtracting from 1
the combined employee
social security and Medicare tax rate for the year that the wages are paid. For 2006, the factor is .9235 (1 - .0765). If
the stated pay is more
than $86,993.70 (2006 wage base $94,200 × .9235), follow the procedure described under Stated pay of more than $86,993.70 in 2006
below.
Stated pay of $86,993.70 or less in 2006.
For an employee with stated pay of $86,993.70 or less in 2006, figure the correct wages (wages plus employer-paid
employee taxes) and withholding
to report by dividing the stated pay by .9235. This will give you the wages to report in box 1 and the social security and
Medicare wages to report in
boxes 3 and 5 of Form W-2.
To figure the correct social security tax to enter in box 4 and Medicare tax to enter in box 6, multiply the amounts
in boxes 3 and 5 by the
withholding rates (6.2% and 1.45%) for those taxes, and enter the results in boxes 4 and 6.
Example.
Donald Devon hires Lydia Lone for only one week during 2005. He pays her $300 for that week. Donald agrees to pay Lydia's
part of the social
security and Medicare taxes. To figure her reportable wages, he divides $300 by .9235. The result, $324.85, is the amount
that he reports as wages in
boxes 1, 3, and 5 of Form W-2. To figure the amount to report as social security tax, Donald multiplies $324.85 by the social
security tax rate of
6.2% (.062). The result, $20.14, is entered in box 4 of Form W-2. To figure the amount to report as Medicare tax, Donald multiplies
$324.85 by the
Medicare tax rate of 1.45% (.0145). The result, $4.71, is entered in box 6 of Form W-2. Although he did not actually withhold
the amounts from Lydia,
he will report these amounts as taxes withheld on Form 941 and is responsible for matching the amounts with the employer share
of these taxes.
For FUTA tax and federal income tax withholding, Lydia's weekly wages are $324.85.
Stated pay of more than $86,993.70 in 2006.
For an employee with stated pay of more than $86,993.70 in 2006, the correct social security wage amount is $86,993.70
(the first $94,200 of wages
× .9235). The stated pay in excess of $86,993.70 is not subject to social security tax because the tax only applies to the
first $94,200 of
wages (stated pay plus employer-paid employee taxes). Enter $94,200 in box 3 of Form W-2. The social security tax to enter
in box 4 is $5,840.40
(94,200 x .062).
To figure the correct Medicare wages to enter in box 5 of Form W-2, subtract $86,993.70 from the stated pay. Divide
the result by .9855 (1 -
.0145) and add $94,200. For example, if stated pay is $100,000, the correct Medicare wages are figured as follows.
| $100,000 - $86,993.70 = $13,006.30 |
| $13,006.30 ÷ .9855 = $13,197.67 |
| $13,197.67 + $94,200 = $107,397.67 |
The Medicare wages are $107,397.67. Enter this amount in box 5 of Form W-2. The Medicare tax to enter in box 6 is
$1,557.27 ($107,397.67 ×
.0145).
Although these employment tax amounts are not actually withheld from the employee's pay, report them as withheld on
Form 941, and pay this amount
as the employer's share of the social security and Medicare taxes. If the wages for federal income tax purposes in the preceding
example are the same
as for social security and Medicare purposes, the correct wage amount for income tax withholding is $107,397.67 ($100,000
+ $5,840.40 + $1,557.27),
which is included in box 1 of Form W-2.
Tax deposits and Form 941.
If you pay your employee's portion of his or her social security and Medicare taxes rather than deducting them from
his or her pay, you are liable
for timely depositing the increased taxes associated with the wage increase. Also, report the increased wages on the appropriate
lines of Form 941 for
the quarter during which the wages were paid.
International Social Security Agreements
The United States has social security agreements with many countries to eliminate dual taxation and coverage under two social
security systems.
Under these agreements, sometimes known as totalization agreements, employees generally must pay social security taxes only
to the country where they
work. Employees and employers who are subject only to foreign social security taxes under these agreements are exempt from
U.S. social security taxes,
including the Medicare portion.
The United States has social security agreements with the following countries: Australia, Austria, Belgium, Canada, Chile,
Finland, France,
Germany, Greece, Ireland, Italy, Japan, South Korea, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland,
and the United
Kingdom. Additional agreements are expected in the future. For more information, see Publication 519, U.S. Tax Guide for Aliens,
or contact:
Social Security Administration
Office of International Programs
P.O. Box 17741
Baltimore, MD 21235-7741
You can get more information from the SSA at
www.socialsecurity.gov/international.
8. Pensions and Annuities
Generally, federal income tax withholding applies to the taxable part of payments made from pension, profit-sharing, stock
bonus, annuity, and
certain deferred compensation plans; from individual retirement arrangements (IRAs); and from commercial annuities. The method
and rate of withholding
depends on (a) the kind of payment, (b) whether the payments are delivered outside the United States or its possessions,
and (c) whether the payee is
a nonresident alien individual, a nonresident alien beneficiary, or a foreign estate. Qualified distributions from Roth
IRAs are nontaxable and,
therefore, not subject to withholding. See Payments to Foreign Persons and Payments Outside the United States later for special
withholding rules that apply to payments outside the United States and payments to foreign persons.
The recipient of pension or annuity payments can choose not to have federal income tax withheld from the payments by using
line 1 of Form W-4P. For
an estate, the election to have no federal income tax withheld can be made by the executor or personal representative of the
decedent. The estate's
EIN should be entered in the area reserved for “Your social security number” on Form W-4P.
A recipient cannot choose not to have federal income tax withheld for eligible rollover distributions. See Eligible Rollover
Distribution—20% Withholding later.
Federal Income Tax Withholding
Withholding from periodic payments of a pension or annuity is figured in the same manner as withholding from wages. Periodic
payments are made in
installments at regular intervals over a period of more than 1 year. They may be paid annually, quarterly, monthly, etc.
If the recipient wants income tax withheld, he or she must designate the number of withholding allowances on line 2 of Form
W-4P and can designate
an additional amount to be withheld on line 3. If the recipient does not want any federal income tax withheld from his or
her periodic payments, he
or she can check the box on line 1 of Form W-4P and submit the form to you. If the recipient does not submit Form W-4P, you
must withhold on periodic
payments as if the recipient were married claiming three withholding allowances. Generally, this means that tax will be withheld
if the pension or
annuity is at least $1,480 a month.
If you receive a Form W-4P that does not contain the recipient's correct taxpayer identification number (TIN), you must withhold
as if the
recipient were single claiming zero withholding allowances even if the recipient chooses not to have income tax withheld.
There are some kinds of periodic payments for which the recipient cannot use Form W-4P because they are already defined as
wages subject to federal
income tax withholding. These include retirement pay for service in the U.S. Armed Forces and payments from certain nonqualified
deferred compensation
plans and compensation plans of exempt organizations described in section 457.
The recipient's Form W-4P stays in effect until he or she changes or revokes it. You must notify recipients each year of their
right to choose not
to have federal income tax withheld or to change their previous choice.
Nonperiodic Payments—10% Withholding
You must withhold at a flat 10% rate from nonperiodic payments (but see Eligible Rollover Distribution—20% Withholding later)
unless the recipient chooses not to have income tax withheld. Distributions from an IRA that are payable on demand are treated
as nonperiodic
payments. A recipient can choose not to have income tax withheld (if permitted) from a nonperiodic payment by submitting Form
W-4P (containing his or
her correct TIN) and checking the box on line 1. Generally, this choice not to have federal income tax withheld will apply
to any later payment from
the same plan. A recipient cannot use line 2 for nonperiodic payments. But he or she may use line 3 to specify an additional
amount that he or she
wants withheld.
If a recipient submits a Form W-4P that does not contain his or her correct TIN, you cannot honor his or her request not to
have income tax
withheld and you must withhold 10% of the payment for federal income tax.
Eligible Rollover Distribution—20% Withholding
Distributions from qualified pension or annuity plans (for example, 401(k) pension plans, IRAs, and section 457(b) plans
maintained by a
governmental employer) or tax-sheltered annuities that are eligible to be rolled over tax free to an IRA or qualified plan
are subject to a flat 20%
withholding rate. The 20% withholding rate is required and a recipient cannot choose not to have federal income tax withheld
from eligible rollover
distributions. However, you should not withhold federal income tax if the entire distribution is transferred by the plan administrator
in a direct
rollover to a traditional IRA, qualified pension plan, governmental section 457(b) plan (if allowed by the plan), or tax-sheltered
annuity.
Note: Distributions that are (a) required by law, (b) one of a specified series of equal payments, or (c) qualifying “hardship” distributions are
not “eligible rollover distributions” and are not subject to the mandatory 20% federal income tax withholding. See Publication 505, Tax
Withholding and Estimated Tax, for details. See also Nonperiodic Payments—10% Withholding above.
Payments to Foreign Persons and Payments Outside the United States
Unless the recipient is a nonresident alien, withholding (in the manner described above) is required on any periodic or nonperiodic
payments that
are delivered outside the United States or its possessions. A recipient cannot choose not to have federal income tax withheld.
In the absence of a treaty exemption, nonresident aliens, nonresident alien beneficiaries, and foreign estates generally
are subject to a 30%
withholding tax under section 1441 on the taxable portion of a periodic or nonperiodic pension or annuity payment that is
from U.S. sources. However,
most tax treaties provide that private pensions and annuities are exempt from withholding and tax. Also, payments from certain
pension plans are
exempt from withholding even if no tax treaty applies. See Publication 515, Withholding of Tax on Nonresident Aliens and Foreign
Entities, and
Publication 519, U.S. Tax Guide for Aliens, for details. A foreign person should submit Form W-8BEN, Certificate of Foreign
Status of Beneficial Owner
for United States Tax Withholding, to you before receiving any payments. The Form W-8BEN must contain the foreign person's
TIN.
Statement of Income Tax Withheld
By January 31 of the next year, you must furnish a statement on Form 1099-R, Distributions From Pensions, Annuities, Retirement
or Profit-Sharing
Plans, IRAs, Insurance Contracts, etc., showing the total amount of the recipient's pension or annuity payments and the total
federal income tax you
withheld during the prior year. Report income tax withheld on Form 945, Annual Return of Withheld Federal Income Tax, not
on Form 941.
If the recipient is a foreign person who has provided you with Form W-8BEN, you instead must furnish a statement to the recipient
on Form 1042-S,
Foreign Person's U.S. Source Income Subject to Withholding, by March 15 for the prior year. Report federal income tax withheld
on Form 1042, Annual
Withholding Tax Return for U.S. Source Income of Foreign Persons.
9. Alternative Methods for Figuring Withholding
You may use various methods of figuring federal income tax withholding. The methods described below may be used instead of
the common payroll
methods provided in Publication 15 (Circular E). Use the method that best suits your payroll system and employees.
For wages paid after December 31, 2005, employers must use a new procedure to figure the amount of federal income tax withholding
on the wages of
nonresident alien employees. This procedure is discussed in Publication 15 (Circular E). Before you use any of the alternative
methods to figure the
federal income tax withholding on the wages of nonresident alien employees, see Publication 15 (Circular E). Do not use the Combined
Income Tax, Employee Social Security Tax, and Employee Medicare Tax Withholding Table on pages 36-55 for figuring withholding
on nonresident
alien employees.
Annualized wages.
Using your employee's annual wages, figure the withholding using the Percentage Method, Table 7-Annual Payroll Period,
in Publication 15
(Circular E). Divide the amount from the table by the number of payroll periods, and the result will be the amount of withholding
for each payroll
period.
Average estimated wages.
You may withhold the tax for a payroll period based on estimated average wages, with necessary adjustments, for any
quarter. For details, see
Regulations section 31.3402(h)(1)-1.
Cumulative wages.
An employee may ask you, in writing, to withhold tax on cumulative wages. If you agree to do so, and you have paid
the employee for the same kind
of payroll period (weekly, biweekly, etc.) since the beginning of the year, you may figure the tax as follows.
Add the wages you have paid the employee for the current calendar year to the current payroll period amount. Divide
this amount by the number of
payroll periods so far this year including the current period. Figure the withholding on this amount, and multiply the withholding
by the number of
payroll periods used above. Use the percentage method shown in Publication 15 (Circular E). Subtract the total withholding
calculated from the total
tax withheld during the calendar year. The excess is the amount to withhold for the current payroll period. (See Rev. Proc.
78-8, 1978-1 C.B. 562, for
an example of the cumulative method.)
Part-year employment.
A part-year employee who figures income tax on a calendar-year basis may ask you to withhold tax by the part-year
employment method. The request
must be in writing and must contain the following information:
-
The last day of any employment during the calendar year with any prior employer.
-
A statement that the employee uses the calendar year accounting period.
-
A statement that the employee reasonably anticipates that he or she will be employed by all employers for a total of no more
than 245 days
in all terms of continuous employment (defined below) during the current calendar year.
Complete the following steps to figure withholding tax by the part-year method.
-
Add the wages to be paid to the employee for the current payroll period to any wages that you have already paid to the employee
in the
current term of continuous employment.
-
Add the number of payroll periods used in step 1 to the number of payroll periods between the employee's last employment and
current
employment. To find the number of periods between the last employment and current employment, divide the number of calendar
days between the
employee's last day of earlier employment (or the previous December 31, if later) and the first day of current employment
by the number of calendar
days in the current payroll period.
-
Divide the step 1 amount by the total number of payroll periods from step 2.
-
Find the tax in the withholding tax tables on the step 3 amount. Be sure to use the correct payroll period table and to take
into account
the employee's withholding allowances.
-
Multiply the total number of payroll periods from step 2 by the step 4 amount.
-
Subtract from the step 5 amount the total tax already withheld during the current term of continuous employment. Any excess
is the amount to
withhold for the current payroll period.
(See Regulations section 31.3402(h)(4)-1(c)(4) for examples of the part-year method.)
Term of continuous employment.
A term of continuous employment may be a single term or two or more following terms of employment with the same employer.
A continuous term
includes holidays, regular days off, and days off for illness or vacation. A continuous term begins on the first day that
an employee works for you
and earns pay. It ends on the earlier of the employee's last day of work for you or, if the employee performs no services
for you for more than 30
calendar days, the last workday before the 30-day period. If an employment relationship is ended, the term of continuous employment
is ended even if a
new employment relationship is established with the same employer within 30 days.
Other methods.
You may use other methods and tables for withholding taxes, as long as the amount of tax withheld is consistently
about the same as it would be
under the percentage method shown in Publication 15 (Circular E). If you develop an alternative method or table, you should
test the full range of
wage and allowance situations to be sure that they meet the tolerances contained in Regulations section 31.3402(h)(4)-1 as
shown in the chart below.
Formula Tables for Percentage Method Withholding (for Automated Payroll Systems)
Two formula tables for percentage method withholding are on pages 24 and 25. The differences in the Alternative Percentage
Method formulas and the
steps for figuring withheld tax for different payroll systems are shown in this example.
MARRIED PERSON (Weekly Payroll Period)
|
If wages exceeding the allowance amount are over $154 but not over $440:
|
| Method: |
Income Tax Withheld: |
|
Percentage (Pub. 15)
|
10% of excess over $154
|
|
Alternative 1 (Page 24)
|
10% of such wages minus $15.40
|
|
Alternative 2 (Page 25)
|
Such wages minus $154, times 10% of remainder
|
For wages paid after December 31, 2005, employers must use a new procedure to figure the amount of federal income tax withholding
on the wages of
nonresident alien employees. This procedure is discussed in Publication 15 (Circular E). Before you use these tables to figure
the federal income tax
withholding on the wages of nonresident alien employees, see Publication 15 (Circular E).
When employers use the percentage method in Publication 15 (Circular E) or the formula tables for percentage method withholding
in this
publication, the tax for the pay period may be rounded to the nearest dollar. If rounding is used, it must be used consistently.
Withheld tax amounts
should be rounded to the nearest whole dollar by (a) dropping amounts under 50 cents and (b) increasing amounts from 50 to
99 cents to the next higher
dollar. This rounding will be considered to meet the tolerances under section 3402(h)(4).
Wage Bracket Percentage Method Tables (for Automated Payroll Systems)
The Wage Bracket Percentage Method Tables show the gross wage brackets that apply to each withholding percentage rate for employees with
up to nine withholding allowances. These tables also show the computation factors for each number of withholding allowances
and the applicable wage
bracket. The computation factors are used to figure the amount of withholding tax by a percentage method.
For wages paid after December 31, 2005, employers must use a new procedure to figure the amount of federal income tax withholding
on the wages of
nonresident alien employees. This procedure is discussed in Publication 15 (Circular E). Before you use these tables to figure
the federal income tax
withholding on the wages of nonresident alien employees, see Publication 15 (Circular E).
Two kinds of Wage Bracket Percentage Method Tables are shown. Each has tables for married and single persons for weekly, biweekly,
semimonthly, and monthly payroll periods.
The difference between the two kinds of tables is the reduction factor to be subtracted from wages before multiplying by the
applicable percentage
withholding rate. In the tables for Computing Income Tax Withholding From Gross Wages on pages 27-30, the reduction factor includes
both the amount for withholding allowances claimed and a rate adjustment factor as shown in the Alternative 2—Tables for Percentage Method
Withholding Computations on page 25. In the tables for Computing Income Tax Withholding From Wages Exceeding Allowance Amount on
pages 31-34, the reduction factor does not include an amount for the number of allowances claimed.
Use the kind of wage bracket table that best suits your payroll system. For example, some payroll systems automatically subtract
from wages the
allowance amount for each employee before finding the amount of tax to withhold. The tables for Computing Income Tax Withholding From Wages
Exceeding Allowance Amount can be used in these systems. The reduction factors in these tables do not include the allowance amount that was
automatically subtracted before applying the table factors in the calculation. For other systems that do not separately subtract
the allowance amount,
use the tables for Computing Income Tax Withholding From Gross Wages.
When employers use the Wage Bracket Percentage Method Tables, the tax for the period may be rounded to the nearest dollar. If rounding
is used, it must be used consistently. Withheld tax amounts should be rounded to the nearest whole dollar by (a) dropping
amounts under 50 cents and
(b) increasing amounts from 50 to 99 cents to the next higher dollar. Such rounding will be deemed to meet the tolerances
under section 3402(h)(4).
Combined Income Tax, Employee Social Security Tax, and Employee Medicare Tax Withholding Tables
If you want to combine amounts to be withheld as income tax, employee social security tax, and employee Medicare tax, you
may use the combined
tables on pages 36-55.
You cannot use the tables on pages 36-55 to figure withholding on the wages of nonresident alien employees. For wages paid
after December 31,
2005, employers must use a new procedure to figure the amount of federal income tax withholding on the wages of nonresident
alien employees. For
information about this new procedure, see Publication 15 (Circular E).
Combined withholding tables for single and married taxpayers are shown for weekly, biweekly, semimonthly, monthly, and daily
or miscellaneous
payroll periods. The payroll period and marital status of the employee determine the table to be used.
If the wages are greater than the highest wage bracket in the applicable table, you will have to use one of the other methods
for figuring income
tax withholding described in this publication or in Publication 15 (Circular E). For wages that do not exceed $94,200 the
combined social security tax
rate and Medicare tax rate is 7.65% each for both the employee and the employer for wages paid in 2006. You can figure the
employee social security
tax by multiplying the wages by 6.2%, and you can figure the employee Medicare tax by multiplying the wages by 1.45%.
The combined tables give the correct total withholding only if wages for social security and Medicare taxes and income tax
withholding are the
same. When you have paid more than the maximum amount of wages subject to social security tax ($94,200 in 2006) in a calendar
year, you may no longer
use the combined tables.
If you use the combined withholding tables, use the following steps to find the amounts to report on your
Form 941, Employer's Quarterly Federal Tax Return.
-
Employee social security tax withheld. Multiply the wages by 6.2%.
-
Employee Medicare tax withheld. Multiply the wages by 1.45%.
-
Income tax withheld. Subtract the amounts from steps 1 and 2 from the total tax withheld.
You can figure the amounts to be shown on Form W-2, Wage and Tax Statement, in the same way.
10. Tables for Withholding on Distributions of Indian Gaming Profits to Tribal Members
If you make certain payments to members of Indian tribes from gaming profits, you must withhold federal income tax. You must
withhold if (a) the
total payment to a member for the year is over $8,450 and (b) the payment is from the net revenues of class II or class III
gaming activities
(classified by the Indian Gaming Regulatory Act) conducted or licensed by the tribes.
A class I gaming activity is not subject to this withholding requirement. Class I activities are social games solely for prizes
of minimal value or
traditional forms of Indian gaming engaged in as part of tribal ceremonies or celebrations.
Class II.
Class II includes (a) bingo and similar games, such as pull tabs, punch boards, tip jars, lotto, and instant bingo,
and (b) card games that are
authorized by the state or that are not explicitly prohibited by the state and played at a location within the state.
Class III.
A class III gaming activity is any gaming that is not class I or class II. Class III includes horse racing, dog racing,
jai alai, casino gaming,
and slot machines.
To figure the amount of tax to withhold each time you make a payment, use the table on page 57 for the period for which you
make payments. For
example, if you make payments weekly, use Table 1; if you make payments monthly, use Table 4. If the total payments to an
individual for the year are
$8,450 or less, no withholding is required.
Example.
A tribal member is paid monthly. The monthly payment is $5,000. Using Table 4, Monthly Distribution Period, figure the withholding
as follows:
Subtract $3,258 from the $5,000 payment for a remainder of $1,742. Multiply this amount by 25%, for a total of $435.50. Add
$351.65, for total
withholding of $787.15.
Depositing and reporting withholding.
Combine the Indian gaming withholding with all other nonpayroll withholding (for example, backup withholding and withholding
on gambling winnings).
Generally, you must deposit the amounts withheld by EFTPS (see Electronic filing and payment on page 2) or at an authorized financial
institution using Form 8109, Federal Tax Deposit Coupon. See Publication 15 (Circular E), Employer's Tax Guide, for a detailed
discussion of the
deposit requirements.
Report Indian gaming withholding on Form 945, Annual Return of Withheld Federal Income Tax. For more information,
see Form 945 and the Instructions
for Form 945. Also, report the payments and withholding to tribal members and to the IRS on Form 1099-MISC, Miscellaneous
Income (see the Instructions
for Forms 1099-MISC).
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