Taxable and Nontaxable Compensation

Gross Income and Wages IRC §61 Starting point for determining a taxpayer’s federal tax bill Includes compensation for services, including fees, commissions, fringe benefits, and similar items All remuneration for employment, including cash value of all remuneration, including benefits, paid in any medium other than cash Wages and benefits are generally included in income and subject to income and employment tax withholding, deposit, and reporting requirements unless the IRC says otherwise.

Taxable Compensation Subject to federal income tax and the employer must withhold the tax from the employee’s pay and remit the withholding to the Internal Revenue Service (IRS). Subject to employment taxes Social security and Medicare taxes under the Federal Insurance Contributions Act (FICA) Federal unemployment tax under the Federal Unemployment Tax Act (FUTA)

Fair Market Value (FMV) Definition: What it would cost an individual to purchase the benefit on the open market in an ‘arm’s length transaction’ Formula: (EPA + AEL) = y FMV - y = IFBA EPA = employee paid amount with after tax dollars AEL = amount excluded by law IFBA = includable fringe benefit amount

Nontaxable Fringe Benefits IRC §132 exempts certain fringe benefits from inclusion in income No-additional-cost services Qualified employee discounts Working condition fringes De minimis fringes Qualified transportation benefits On-premises athletic facilities Qualified retirement planning services Qualified moving expense reimbursements Not subject to federal income tax withholding or social security, Medicare, or FUTA taxes

No-additional-cost Services Free service is one that is regularly offered for sale to customers, not employees, in the normal course of the employer’s line of business in which the employee works. Employer bears no substantial additional cost, including lost revenue and additional labor, in providing the service to the employee. The term ‘employee’ includes current and former employees who left because of retirement or disability and their widow(er)s, spouses, and dependent children. Available on equal terms to each member of a group of employees who classification does not discriminate in favor of highly compensated employees

Qualified Employee Discounts Discount on goods cannot exceed the gross profit percentage when the goods are sold to customers. (Total Sales – Cost of Goods Sold) / Total Sales = Gross Profit Percentage Discount of services cannot exceed 20%, excess is taxable income. Discount must be offered for sale to customers in the employer’s line of business in which the employee works. The term ‘employee’ includes current and former employees who left because of retirement or disability and their widow(er)s, spouses, and dependent children. Available on equal terms to each member of a group of employees who classification does not discriminate in favor of highly compensated employees.

Working Condition Fringe Employee’s use of the property or services must be related to the employer’s trade or business Employee would be able to take a business deduction on his/her personal tax return if the employee paid for the benefit. The term ‘employee’ includes current employee, partner, director, or independent contractor performing services for the employer. Employer must maintain the required records to substantiate the business deductions.

Working Condition Fringe Employer may offer without including FMV in employee’s income Business use of a company car or airplane Chauffeur or bodyguard provided for security protection Dues and membership fees for professional organizations Employee’s subscriptions to business periodicals Job-related education Goods used for product testing by employees Use of demonstration automobile by a full-time car salesperson Outplacement services Employee use of business cell phone

De minimis Fringe Value of the benefit is so small that accounting for it would be unreasonable or impracticable. Employer must take into account the frequency with which the benefit is provided to all its employees The term ‘employee’ means anyone to whom the benefit is provided No specific dollar maximum or minimum assigned by the IRS.

De minimis Fringe Employer may offer without including FMV in employee’s income Occasional parties / picnics for all employees Traditional holiday gifts with a small value and no cash or cash equivalents Flowers, fruit or similar items provided under special circumstances Coffee and doughnuts provided to employees Occasional meals, supper money, or cab fare for employees who must work late Operation by the employer of an eating facility on or near the employer’s premises if the facility does not operate at a lost

De minimis Fringe Not excluded from taxable income Season tickets to sporting or theatrical events Commuting use of an employer-provided car or other vehicle for more than 1 day a month Membership in a private country club or athletic facility, regardless of the frequency with which the employee uses the facility Use of the employer-owned or leased facilities for a weekend Apartment, hunting lodge, boat, condo Gift cards and certificates Have ‘readily ascertainable’ value that can easily be accounted for

Qualified Transportation Fringes Employer may offer without including FMV in employee’s income Transportation between home and work in a commuter highway vehicle provided by the employer Vehicle seats at least 6 adults other than the driver 80% of the vehicle’s mileage can be expected to be for commuting ½ of the vehicle’s seating capacity, excluding the driver, is used by employees Excluded benefit is limited to $260 per month, excess is taxable income Transit passes, vouchers, tokens, or fare cards Parking provided on or near the employer’s premises or at a park and ride facility

Qualified Transportation Fringes Bicycle commuting reimbursement – Suspended for 2018 -2025

On-premises athletic facilities Facility is located on the employer’s premises Facility is operated by the employer through its employees or other entity Substantially all use of the facilities is by employees, their spouses, and their dependent children The term ‘employee’ includes current and former employees who left because of retirement or disability and their widow(er)s, spouses, and dependent children. Facility is not a resort or other residential facility

Employer-provided vehicle usage Business related purposes Excluded from income as a working condition fringe benefit Valuation methods for taxation on personal use General valuation method Special valuation method Commuting valuation method Annual lease valuation method Company fleet valuation method Vehicle cents-per-mile method

Employer-provided vehicle usage Commuting valuation method $1.50 per one-way commute $3.00 per round trip commute Vehicle cents-per-mile method Business standard mileage rate = $0.545 per mile Employee pays for fuel, reduce rate by $0.055 per mile

Employer-provided vehicle usage Annual lease valuation method Determine FMV of the care on the first day the vehicle is available to the employee Locate the FMV in IRS Annual Lease Value Table Calculate the percentage of personal miles driven during the year Personal miles driven / total miles driven Calculate the FMV of the employee’s personal use that is to be included in income Annual lease value x percentage of personal miles driven

Annual Lease Value Calculation Employee drives an employer-provided vehicle for both business and personal driving. The employee drove 17,000 miles during the year, 12,300 business miles and 4,700 personal miles. FMV of the car is $24,500. Calculate the taxable annual lease value.

Employer-provided aircraft usage Valuation methods for taxation of personal use General valuation method Non-commercial flight valuation method Free or discounted commercial flights 25% of airline’s highest unrestricted coach fare for that specific flight

Life Insurance Group-term life insurance Whole-life insurance Employee group-term life insurance Dependent group-term life insurance Whole-life insurance Split-dollar life insurance Non-equity split-dollar life insurance arrangements Equity split-dollar life insurance arrangements

Group-Term Life Insurance (GTL) Value of coverage up to $50,000 is excluded from employee’s income Entire amount excluded if: Employer is beneficiary Charitable organization is beneficiary Employee terminates employment during the year due to permanent disability W-2 Reporting: Box 12, Code C

Group-Term Life Insurance (GTL) Non-discriminatory testing At least 70% of all employees benefit from the plan At least 85% of employees participating in the plan are not key employees All participants belong to a non-discriminatory IRS classification The plan is part of a qualified cafeteria plan Former employees Employer is required to include uncollected social security and Medicare taxes on the Form W-2 in Box 12, Code M and N respectively Uncollected additional Medicare tax for former employees whose wages exceed $200,000 are not reported in Box 12, Code N

GTL Calculation Employee was born April 23, 1958. The employer’s GTL plan provides her coverage equal to 2 times her annual salary. The employee’s salary on January 1st was $65,000. The employer’s plan has a maximum coverage of $125,000. The employee contributes $25 per month in after-tax dollars towards the insurance premiums. Monthly GTL taxable income? $65,000 x 2 = $130,000 $125,000 - $50,000 = $75,000 $75,000 / 1000 = $75 (employee will be 59 on Dec 31st) .42 x 75 = $32.25 $32.25 - $25 = $7.25 per month taxable income

GTL Calculation Determine total amount of employee’s coverage Employee’s coverage less $50,000 = excess coverage Divide excess coverage amount by 1,000 Determine employee’s age as of Dec 31 of calendar year Use IRS table – Uniform Premiums to calculate FMV of 1 month of excess insurance benefit per $1,000 Deduct any after-tax contribution by employee from value of insurance

Whole Life Insurance Proceeds paid to designated beneficiary are included in income and subject to federal income tax withholding If paid with after tax dollars - proceeds are nontaxable If coverage is part of a plan intended to benefit employees, the proceeds are not subject to social security, Medicare, or FUTA tax Calculating taxable income Sum of: The increase in the policy’s cash surrender value for the year, if the employee has a vested right to the cash value The reasonable net premium cost of the current life insurance protection, the death benefit payable minus the cash surrender value at the end of the year

Moving Expenses This Fringe Benefit is suspended for tax years 2018-2025 All reimbursement is considered Taxable

Educational Assistance Job-related education Considered working condition fringe Non job-related education American Taxpayer Relief Act of 2012 Extended the income exclusion under IRC §127 up to $5,250 per year Undergraduate and graduate education assistance provided by employer Assistance provided over limit is subject to federal income tax withholding, social security, Medicare, and FUTA taxes

Business Travel Reimbursements Accountable plan Excluded from income Key: Business connection and substantiated expenses Advances allowed 30 days prior to travel Expenses must be substantiated within 60 days of travel Nonaccountable plan Included in income Amounts not substantiated becomes taxable income Amounts paid exceeding expenses becomes taxable income W-2 Reporting: Box 12, Code L

Business Travel Reimbursements Per diem Paid per diem allowance per day of travel Deemed substantiated if amount does not exceed IRS established federal per diem rates Lodging per diem does not include taxes which can be claimed as miscellaneous expense Incidentals are reimbursed separately High-low per diem substantiation methods Employer may use the high-low rate instead of the individual federal rate of the locality of travel as long as the allowance is for lodging, meal, and incidental expenses and within CONUS

Employer-provided Meals / Lodging Value of the meals are excluded from employee’s income Furnished on employer’s business premises Furnished for the convenience of the employer Employer-provided lodging Value of the lodging is excluded from employee’s income Furnished on the employer’s business premises Employee is required to accept the lodging as a condition of employment

Adoption Assistance Small Business Job Protection Act of 1996 IRC §23 Allows individuals to take an income credit for qualified adoption expenses IRC §137 Excludes from employee’s income employer-provided adoption assistance that is furnished under an adoption assistance program in connection with the employee’s adoption of an eligible child Dollar Limitation: $13,810 per child over all taxable years related to the particular adoption Income Limitation: phased out when adjusted gross income reaches $247,140 W-2 reporting: Box 12, Code T

Advances and Overpayments Included in income for the payroll period when received Subject to federal income tax withholding, social security, Medicare, and FUTA taxes Repayment Options Repayment made in small calendar year Repayment made in a subsequent calendar year Repayment made in a subsequent calendar year as gross up

Awards and Prizes Qualified plan awards – excluded from income Length of service: starting at 5 years, in 5 year increments Safety Awards: less than 10% of employees receiving the award are not managers, administrators, professional employees, or clerical employees Nonqualified plan awards – included in income Length of service: before 5 years, increments closer than every 5 years Safety Awards: 10% or more of employees receiving the award are managers, administrators, professional employees, or clerical employees Civic and charitable awards – excluded from income Employee did not seek out the award and turns it over to charity / govt. Not a condition on performing future services

Back pay awards Employee wins a lawsuit or settlement against the employer Actual wages are subject to federal income tax withholding, social security, Medicare, and FUTA taxes Compensatory, Consequential, Liquidated, and Punitive damages Not subject to tax withholding Reported on Form 1099-MISC, Box 3 Payments to attorney’s Reported on Form 1099-MISC Notify SSA of back pay. SSA will require document to move the current year W-2 into the appropriate tax year when actually earned

Dependent Care Assistance Programs Maximum exclusion: $5,000 or the employee’s earned income for the year, whichever is less Payments above the maximum exclusion are subject to federal income tax withholding, social security, Medicare, and FUTA taxes. Must pay for or provide services that are necessary so that the employee receiving the benefit can work Child must be under the age of 13 or other dependent who cannot care for herself or himself Expenses are treated as incurred when the care is provided, not when payments are made to the employee or 3rd party W-2 Reporting: Benefit value = Box 10; Taxable amounts = Boxes 1,3,5

Employer-paid Taxes (Grossing Up) When the employer pays the employee’s taxes, the amount paid is an employer-provided benefit Taxes paid on the employee’s behalf is taxable income to the employee IRS has approved a procedure known as “grossing up” to calculate the gross payment the employee must receive when the employer pays the employee’s taxes. Gross up formulas use tax withholding percentages Different formulas account for social security cap and additional Medicare tax withholdings

Equipment Allowance Allowance paid to employees who use their own tools or heavy equipment on the job Not subject to federal income tax withholding, social security, Medicare, or FUTA Taxes Allowance payments are kept separate from the employee’s wages Allowance paid to employees regardless of whether they use the employer’s tools or their own Subject to federal income tax withholding, social security, Medicare, or FUTA Taxes Tool and equipment plans are nonaccountable plans = taxable income to employee

Golden Parachute Payments IRC definition: compensation paid to an officer, shareholder, or highly compensated employee only after a change in corporate ownership or control that is at least 3 times the employees average compensation during the 5 most recent years. The excess parachute payment is the portion that exceeds the employee’s 5 year average compensation Entire parachute payment is subject to federal income tax withholding, social security, and Medicare taxes. Excess parachute payment is subject to a 20% excise tax the employer must withhold W-2 Reporting for excise tax withheld: Box 12, Code K

Loans to Employees The difference between the interest charged to the employee and the applicable federal interest rate must be included in the income of the employee on any day in which the combined amount of all outstanding loans between the employer and the employee is more than $10,000 Subject to social security, Medicare, and FUTA taxes only Debt forgiveness: entire balance become income subject to federal income tax withhold, social security, Medicare, and FUTA taxes in year forgiven If forgiven periodically, the amount forgiven becomes taxable as forgiven

Military Pay – Differential Pay Heroes Earnings Assistance and Relief Tax Act of 2009 Payments taxes as supplemental wages Definition: Payment made for any period during which the employee is performing service in the uniformed services while on active duty for more than 30 days Represents all wages that the employee would have received from the employer if the employee were performing services for the employer Makes the employee wages “whole” while on active duty

Military Pay – Differential Pay Taxation: Provided while the employee is on temporary assignment with the state National Guard or the Armed Forces Reserve Subject to social security, Medicare, and FUTA taxes Provided while the employee is on active service with the U.S. Armed Forces or on an indefinite assignment with the state National Guard Not subject to social security, Medicare, and FUTA taxes Deferrals continue from any differential pay paid by employer into defined contribution retirement plans under §401(k), §403(b), §457(b) Employees returning from active service can also make retro-active deferrals for the time spent in the service when they made no deferrals

Stocks Employee receives company stock instead of cash as compensation for services rendered FMV of stock when transferred to employee without restriction is taxable income Watch transfers of stock during a divorce Taxable income could be required to be calculated

Stock Options Qualified stock options Nonqualified stock options Incentive stock options (ISO) Employer gives option to buy stock at a set price for a period of time Generally not taxed if complies with stock holding period Employee stock purchase plans (ESPP) Generally not taxes if complies with stock holding period Nonqualified stock options Exercised without conditions Income equal to the excess value of the stock when exercised over the value paid by the employee W-2 Reporting: Box 12, Code V

Tips Provided voluntarily by customers are taxable wages to the employee receiving them Cash tips received directly from customer Tips from customers who leave a tip on an electronic payment method Value of any noncash tips Amounts paid out through tip pools, tip splitting, or tip sharing arrangement Service charges are not tips

Tips Employees must report tip income to employer Qualify when receive at least $20 a month Reportable by the 10th of the next month on Form 4070 Employee’s Report of Tips to Employer Electronic tip reporting allowed by IRS Withholding on tip income Subject to federal income tax withholding, social security, Medicare, and FUTA taxes Uncollected social security and Medicare tax withholding W-2 Reporting: Box 12, Code A and B respectively Employer must pay their portion in full

Tips Employer Reporting Form 4137 Form 8846 Form 8027 Form 8027-T Social Security and Medicare tax on Unreported Tip Income Form 8846 Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips Form 8027 Employer’s Annual Return of Tip Income and Allocated Tips Form 8027-T Transmittal of Employer’s Annual Return of Tip Income and Allocated Tips

Wages paid after Death Employee dies before cashing paycheck Reissue the check to the employee’s personal representative for the same net amount Check state laws before reissuing

Wages paid after Death Wages paid after employees dies and in the same year Payable to employee’s estate or legal representative Not subject to federal income tax withholding Subject to social security, Medicare, and FUTA taxes Annual Statement Reporting: W-2 Reporting: Income paid Boxes 3 and 5 W-2 Reporting: Taxes withheld Boxes 4 and 6 1099-MISC Reporting: Income paid Box 3 Reportable to employee’s estate or legal representative

Wages paid after Death Wages paid after the year of death Payable to employee’s estate or legal representative Not subject to federal income tax withholding, social security, Medicare, or FUTA taxes Annual Statement Reporting: Form 1099-MISC Box 3

DO YOU KNOW??? What is the maximum amount of GTL an employer can provide an employee’s dependents without its value becoming tax to the employee? Name 2 types of deductible moving expenses What is a golden parachute payment? What is the acronym FMV? What is the business standard mileage rate for 2018? What is the moving mileage rate for 2018?