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Page Last Reviewed or Updated: 04-Mar-2014

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The Free File Alliance

Free file alliance 2. Free file alliance   Employees' Pay Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Tests for Deducting PayTest 1—Reasonableness Test 2—For Services Performed Kinds of PayAwards Bonuses Education Expenses Fringe Benefits Loans or Advances Property Reimbursements for Business Expenses Sick and Vacation Pay Introduction You can generally deduct the amount you pay your employees for the services they perform. Free file alliance The pay may be in cash, property, or services. Free file alliance It may include wages, salaries, bonuses, commissions, or other non-cash compensation such as vacation allowances and fringe benefits. Free file alliance For information about deducting employment taxes, see chapter 5. Free file alliance You can claim employment credits, such as the following, if you hire individuals who meet certain requirements. Free file alliance Empowerment zone employment credit (Form 8844). Free file alliance Indian employment credit (Form 8845). Free file alliance Work opportunity credit (Form 5884). Free file alliance Credit for employer differential wage payments (Form 8932). Free file alliance Reduce your deduction for employee wages by the amount of employment credits you claim. Free file alliance For more information about these credits, see the form on which the credit is claimed. Free file alliance Topics - This chapter discusses: Tests for deducting pay Kinds of pay Useful Items - You may want to see: Publication 15 (Circular E), Employer's Tax Guide 15-A Employer's Supplemental Tax Guide 15-B Employer's Tax Guide to Fringe Benefits See chapter 12 for information about getting publications and forms. Free file alliance Tests for Deducting Pay To be deductible, your employees' pay must be an ordinary and necessary business expense and you must pay or incur it. Free file alliance These and other requirements that apply to all business expenses are explained in chapter 1. Free file alliance In addition, the pay must meet both of the following tests. Free file alliance Test 1. Free file alliance It must be reasonable. Free file alliance Test 2. Free file alliance It must be for services performed. Free file alliance The form or method of figuring the pay does not affect its deductibility. Free file alliance For example, bonuses and commissions based on sales or earnings, and paid under an agreement made before the services were performed, are both deductible. Free file alliance Test 1—Reasonableness You must be able to prove that the pay is reasonable. Free file alliance Whether the pay is reasonable depends on the circumstances that existed when you contracted for the services, not those that exist when reasonableness is questioned. Free file alliance If the pay is excessive, the excess pay is disallowed as a deduction. Free file alliance Factors to consider. Free file alliance   Determine the reasonableness of pay by the facts and circumstances. Free file alliance Generally, reasonable pay is the amount that a similar business would pay for the same or similar services. Free file alliance   To determine if pay is reasonable, also consider the following items and any other pertinent facts. Free file alliance The duties performed by the employee. Free file alliance The volume of business handled. Free file alliance The character and amount of responsibility. Free file alliance The complexities of your business. Free file alliance The amount of time required. Free file alliance The cost of living in the locality. Free file alliance The ability and achievements of the individual employee performing the service. Free file alliance The pay compared with the gross and net income of the business, as well as with distributions to shareholders if the business is a corporation. Free file alliance Your policy regarding pay for all your employees. Free file alliance The history of pay for each employee. Free file alliance Test 2—For Services Performed You must be able to prove the payment was made for services actually performed. Free file alliance Employee-shareholder salaries. Free file alliance   If a corporation pays an employee who is also a shareholder a salary that is unreasonably high considering the services actually performed, the excessive part of the salary may be treated as a constructive dividend to the employee-shareholder. Free file alliance The excessive part of the salary would not be allowed as a salary deduction by the corporation. Free file alliance For more information on corporate distributions to shareholders, see Publication 542, Corporations. Free file alliance Kinds of Pay Some of the ways you may provide pay to your employees in addition to regular wages or salaries are discussed next. Free file alliance For specialized and detailed information on employees' pay and the employment tax treatment of employees' pay, see Publications 15, 15-A, and 15-B. Free file alliance Awards You can generally deduct amounts you pay to your employees as awards, whether paid in cash or property. Free file alliance If you give property to an employee as an employee achievement award, your deduction may be limited. Free file alliance Achievement awards. Free file alliance   An achievement award is an item of tangible personal property that meets all the following requirements. Free file alliance It is given to an employee for length of service or safety achievement. Free file alliance It is awarded as part of a meaningful presentation. Free file alliance It is awarded under conditions and circumstances that do not create a significant likelihood of disguised pay. Free file alliance Length-of-service award. Free file alliance    An award will qualify as a length-of-service award only if either of the following applies. Free file alliance The employee receives the award after his or her first 5 years of employment. Free file alliance The employee did not receive another length-of-service award (other than one of very small value) during the same year or in any of the prior 4 years. Free file alliance Safety achievement award. Free file alliance    An award for safety achievement will qualify as an achievement award unless one of the following applies. Free file alliance It is given to a manager, administrator, clerical employee, or other professional employee. Free file alliance During the tax year, more than 10% of your employees, excluding those listed in (1), have already received a safety achievement award (other than one of very small value). Free file alliance Deduction limit. Free file alliance   Your deduction for the cost of employee achievement awards given to any one employee during the tax year is limited to the following. Free file alliance $400 for awards that are not qualified plan awards. Free file alliance $1,600 for all awards, whether or not qualified plan awards. Free file alliance   A qualified plan award is an achievement award given as part of an established written plan or program that does not favor highly compensated employees as to eligibility or benefits. Free file alliance   A highly compensated employee is an employee who meets either of the following tests. Free file alliance The employee was a 5% owner at any time during the year or the preceding year. Free file alliance The employee received more than $115,000 in pay for the preceding year. Free file alliance You can choose to ignore test (2) if the employee was not also in the top 20% of employees ranked by pay for the preceding year. Free file alliance   An award is not a qualified plan award if the average cost of all the employee achievement awards given during the tax year (that would be qualified plan awards except for this limit) is more than $400. Free file alliance To figure this average cost, ignore awards of nominal value. Free file alliance Deduct achievement awards as a nonwage business expense on your return or business schedule. Free file alliance You may not owe employment taxes on the value of some achievement awards you provide to an employee. Free file alliance See Publication 15-B. Free file alliance Bonuses You can generally deduct a bonus paid to an employee if you intended the bonus as additional pay for services, not as a gift, and the services were performed. Free file alliance However, the total bonuses, salaries, and other pay must be reasonable for the services performed. Free file alliance If the bonus is paid in property, see Property , later. Free file alliance Gifts of nominal value. Free file alliance    If, to promote employee goodwill, you distribute food or merchandise of nominal value to your employees at holidays, you can deduct the cost of these items as a nonwage business expense. Free file alliance Your deduction for de minimis gifts of food or drink are not subject to the 50% deduction limit that generally applies to meals. Free file alliance For more information on this deduction limit, see Meals and lodging , later. Free file alliance Education Expenses If you pay or reimburse education expenses for an employee, you can deduct the payments if they are part of a qualified educational assistance program. Free file alliance Deduct them on the “Employee benefit programs” or other appropriate line of your tax return. Free file alliance For information on educational assistance programs, see Educational Assistance in section 2 of Publication 15-B. Free file alliance Fringe Benefits A fringe benefit is a form of pay for the performance of services. Free file alliance You can generally deduct the cost of fringe benefits. Free file alliance You may be able to exclude all or part of the value of some fringe benefits from your employees' pay. Free file alliance You also may not owe employment taxes on the value of the fringe benefits. Free file alliance See Table 2-1, Special Rules for Various Types of Fringe Benefits, in Publication 15-B for details. Free file alliance Your deduction for the cost of fringe benefits for activities generally considered entertainment, amusement, or recreation, or for a facility used in connection with such an activity (for example, a company aircraft) for certain officers, directors, and more-than-10% shareholders is limited. Free file alliance Certain fringe benefits are discussed next. Free file alliance See Publication 15-B for more details on these and other fringe benefits. Free file alliance Meals and lodging. Free file alliance   You can usually deduct the cost of furnishing meals and lodging to your employees. Free file alliance Deduct the cost in whatever category the expense falls. Free file alliance For example, if you operate a restaurant, deduct the cost of the meals you furnish to employees as part of the cost of goods sold. Free file alliance If you operate a nursing home, motel, or rental property, deduct the cost of furnishing lodging to an employee as expenses for utilities, linen service, salaries, depreciation, etc. Free file alliance Deduction limit on meals. Free file alliance   You can generally deduct only 50% of the cost of furnishing meals to your employees. Free file alliance However, you can deduct the full cost of the following meals. Free file alliance Meals whose value you include in an employee's wages. Free file alliance Meals that qualify as a de minimis fringe benefit as discussed in section 2 of Publication 15-B. Free file alliance This generally includes meals you furnish to employees at your place of business if more than half of these employees are provided the meals for your convenience. Free file alliance Meals you furnish to your employees at the work site when you operate a restaurant or catering service. Free file alliance Meals you furnish to your employees as part of the expense of providing recreational or social activities, such as a company picnic. Free file alliance Meals you are required by federal law to furnish to crew members of certain commercial vessels (or would be required to furnish if the vessels were operated at sea). Free file alliance This does not include meals you furnish on vessels primarily providing luxury water transportation. Free file alliance Meals you furnish on an oil or gas platform or drilling rig located offshore or in Alaska. Free file alliance This includes meals you furnish at a support camp that is near and integral to an oil or gas drilling rig located in Alaska. Free file alliance Employee benefit programs. Free file alliance   Employee benefit programs include the following. Free file alliance Accident and health plans. Free file alliance Adoption assistance. Free file alliance Cafeteria plans. Free file alliance Dependent care assistance. Free file alliance Education assistance. Free file alliance Life insurance coverage. Free file alliance Welfare benefit funds. Free file alliance   You can generally deduct amounts you spend on employee benefit programs on the applicable line of your tax return. Free file alliance For example, if you provide dependent care by operating a dependent care facility for your employees, deduct your costs in whatever categories they fall (utilities, salaries, etc. Free file alliance ). Free file alliance Life insurance coverage. Free file alliance   You cannot deduct the cost of life insurance coverage for you, an employee, or any person with a financial interest in your business, if you are directly or indirectly the beneficiary of the policy. Free file alliance See Regulations section 1. Free file alliance 264-1 for more information. Free file alliance Welfare benefit funds. Free file alliance   A welfare benefit fund is a funded plan (or a funded arrangement having the effect of a plan) that provides welfare benefits to your employees, independent contractors, or their beneficiaries. Free file alliance Welfare benefits are any benefits other than deferred compensation or transfers of restricted property. Free file alliance   Your deduction for contributions to a welfare benefit fund is limited to the fund's qualified cost for the tax year. Free file alliance If your contributions to the fund are more than its qualified cost, carry the excess over to the next tax year. Free file alliance   Generally, the fund's “qualified cost” is the total of the following amounts, reduced by the after-tax income of the fund. Free file alliance The cost you would have been able to deduct using the cash method of accounting if you had paid for the benefits directly. Free file alliance The contributions added to a reserve account that are needed to fund claims incurred but not paid as of the end of the year. Free file alliance These claims can be for supplemental unemployment benefits, severance pay, or disability, medical, or life insurance benefits. Free file alliance   For more information, see sections 419(c) and 419A of the Internal Revenue Code and the related regulations. Free file alliance Loans or Advances You generally can deduct as wages an advance you make to an employee for services performed if you do not expect the employee to repay the advance. Free file alliance However, if the employee performs no services, treat the amount you advanced as a loan. Free file alliance If the employee does not repay the loan, treat it as income to the employee. Free file alliance Below-market interest rate loans. Free file alliance   On certain loans you make to an employee or shareholder, you are treated as having received interest income and as having paid compensation or dividends equal to that interest. Free file alliance See Below-Market Loans in chapter 4. Free file alliance Property If you transfer property (including your company's stock) to an employee as payment for services, you can generally deduct it as wages. Free file alliance The amount you can deduct is the property's fair market value on the date of the transfer less any amount the employee paid for the property. Free file alliance You can claim the deduction only for the tax year in which your employee includes the property's value in income. Free file alliance Your employee is deemed to have included the value in income if you report it on Form W-2, Wage and Tax Statement, in a timely manner. Free file alliance You treat the deductible amount as received in exchange for the property, and you must recognize any gain or loss realized on the transfer, unless it is the company's stock transferred as payment for services. Free file alliance Your gain or loss is the difference between the fair market value of the property and its adjusted basis on the date of transfer. Free file alliance These rules also apply to property transferred to an independent contractor for services, generally reported on Form 1099-MISC, Miscellaneous Income. Free file alliance Restricted property. Free file alliance   If the property you transfer for services is subject to restrictions that affect its value, you generally cannot deduct it and do not report gain or loss until it is substantially vested in the recipient. Free file alliance However, if the recipient pays for the property, you must report any gain at the time of the transfer up to the amount paid. Free file alliance    “Substantially vested” means the property is not subject to a substantial risk of forfeiture. Free file alliance This means that the recipient is not likely to have to give up his or her rights in the property in the future. Free file alliance Reimbursements for Business Expenses You can generally deduct the amount you pay or reimburse employees for business expenses incurred for your business. Free file alliance However, your deduction may be limited. Free file alliance If you make the payment under an accountable plan, deduct it in the category of the expense paid. Free file alliance For example, if you pay an employee for travel expenses incurred on your behalf, deduct this payment as a travel expense. Free file alliance If you make the payment under a nonaccountable plan, deduct it as wages and include it in the employee's Form W-2. Free file alliance See Reimbursement of Travel, Meals, and Entertainment in chapter 11 for more information about deducting reimbursements and an explanation of accountable and nonaccountable plans. Free file alliance Sick and Vacation Pay Sick pay. Free file alliance   You can deduct amounts you pay to your employees for sickness and injury, including lump-sum amounts, as wages. Free file alliance However, your deduction is limited to amounts not compensated by insurance or other means. Free file alliance Vacation pay. Free file alliance   Vacation pay is an employee benefit. Free file alliance It includes amounts paid for unused vacation leave. Free file alliance You can deduct vacation pay only in the tax year in which the employee actually receives it. Free file alliance This rule applies regardless of whether you use the cash or accrual method of accounting. Free file alliance Prev  Up  Next   Home   More Online Publications