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1040nr Free1040nr free 2. 1040nr free 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. 1040nr free The pay may be in cash, property, or services. 1040nr free It may include wages, salaries, bonuses, commissions, or other non-cash compensation such as vacation allowances and fringe benefits. 1040nr free For information about deducting employment taxes, see chapter 5. 1040nr free You can claim employment credits, such as the following, if you hire individuals who meet certain requirements. 1040nr free Empowerment zone employment credit (Form 8844). 1040nr free Indian employment credit (Form 8845). 1040nr free Work opportunity credit (Form 5884). 1040nr free Credit for employer differential wage payments (Form 8932). 1040nr free Reduce your deduction for employee wages by the amount of employment credits you claim. 1040nr free For more information about these credits, see the form on which the credit is claimed. 1040nr free 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. 1040nr free 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. 1040nr free These and other requirements that apply to all business expenses are explained in chapter 1. 1040nr free In addition, the pay must meet both of the following tests. 1040nr free Test 1. 1040nr free It must be reasonable. 1040nr free Test 2. 1040nr free It must be for services performed. 1040nr free The form or method of figuring the pay does not affect its deductibility. 1040nr free For example, bonuses and commissions based on sales or earnings, and paid under an agreement made before the services were performed, are both deductible. 1040nr free Test 1—Reasonableness You must be able to prove that the pay is reasonable. 1040nr free 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. 1040nr free If the pay is excessive, the excess pay is disallowed as a deduction. 1040nr free Factors to consider. 1040nr free Determine the reasonableness of pay by the facts and circumstances. 1040nr free Generally, reasonable pay is the amount that a similar business would pay for the same or similar services. 1040nr free To determine if pay is reasonable, also consider the following items and any other pertinent facts. 1040nr free The duties performed by the employee. 1040nr free The volume of business handled. 1040nr free The character and amount of responsibility. 1040nr free The complexities of your business. 1040nr free The amount of time required. 1040nr free The cost of living in the locality. 1040nr free The ability and achievements of the individual employee performing the service. 1040nr free 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. 1040nr free Your policy regarding pay for all your employees. 1040nr free The history of pay for each employee. 1040nr free Test 2—For Services Performed You must be able to prove the payment was made for services actually performed. 1040nr free Employee-shareholder salaries. 1040nr free 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. 1040nr free The excessive part of the salary would not be allowed as a salary deduction by the corporation. 1040nr free For more information on corporate distributions to shareholders, see Publication 542, Corporations. 1040nr free Kinds of Pay Some of the ways you may provide pay to your employees in addition to regular wages or salaries are discussed next. 1040nr free For specialized and detailed information on employees' pay and the employment tax treatment of employees' pay, see Publications 15, 15-A, and 15-B. 1040nr free Awards You can generally deduct amounts you pay to your employees as awards, whether paid in cash or property. 1040nr free If you give property to an employee as an employee achievement award, your deduction may be limited. 1040nr free Achievement awards. 1040nr free An achievement award is an item of tangible personal property that meets all the following requirements. 1040nr free It is given to an employee for length of service or safety achievement. 1040nr free It is awarded as part of a meaningful presentation. 1040nr free It is awarded under conditions and circumstances that do not create a significant likelihood of disguised pay. 1040nr free Length-of-service award. 1040nr free An award will qualify as a length-of-service award only if either of the following applies. 1040nr free The employee receives the award after his or her first 5 years of employment. 1040nr free 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. 1040nr free Safety achievement award. 1040nr free An award for safety achievement will qualify as an achievement award unless one of the following applies. 1040nr free It is given to a manager, administrator, clerical employee, or other professional employee. 1040nr free 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). 1040nr free Deduction limit. 1040nr free Your deduction for the cost of employee achievement awards given to any one employee during the tax year is limited to the following. 1040nr free $400 for awards that are not qualified plan awards. 1040nr free $1,600 for all awards, whether or not qualified plan awards. 1040nr free 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. 1040nr free A highly compensated employee is an employee who meets either of the following tests. 1040nr free The employee was a 5% owner at any time during the year or the preceding year. 1040nr free The employee received more than $115,000 in pay for the preceding year. 1040nr free 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. 1040nr free 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. 1040nr free To figure this average cost, ignore awards of nominal value. 1040nr free Deduct achievement awards as a nonwage business expense on your return or business schedule. 1040nr free You may not owe employment taxes on the value of some achievement awards you provide to an employee. 1040nr free See Publication 15-B. 1040nr free 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. 1040nr free However, the total bonuses, salaries, and other pay must be reasonable for the services performed. 1040nr free If the bonus is paid in property, see Property , later. 1040nr free Gifts of nominal value. 1040nr free 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. 1040nr free Your deduction for de minimis gifts of food or drink are not subject to the 50% deduction limit that generally applies to meals. 1040nr free For more information on this deduction limit, see Meals and lodging , later. 1040nr free 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. 1040nr free Deduct them on the “Employee benefit programs” or other appropriate line of your tax return. 1040nr free For information on educational assistance programs, see Educational Assistance in section 2 of Publication 15-B. 1040nr free Fringe Benefits A fringe benefit is a form of pay for the performance of services. 1040nr free You can generally deduct the cost of fringe benefits. 1040nr free You may be able to exclude all or part of the value of some fringe benefits from your employees' pay. 1040nr free You also may not owe employment taxes on the value of the fringe benefits. 1040nr free See Table 2-1, Special Rules for Various Types of Fringe Benefits, in Publication 15-B for details. 1040nr free 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. 1040nr free Certain fringe benefits are discussed next. 1040nr free See Publication 15-B for more details on these and other fringe benefits. 1040nr free Meals and lodging. 1040nr free You can usually deduct the cost of furnishing meals and lodging to your employees. 1040nr free Deduct the cost in whatever category the expense falls. 1040nr free 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. 1040nr free 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. 1040nr free Deduction limit on meals. 1040nr free You can generally deduct only 50% of the cost of furnishing meals to your employees. 1040nr free However, you can deduct the full cost of the following meals. 1040nr free Meals whose value you include in an employee's wages. 1040nr free Meals that qualify as a de minimis fringe benefit as discussed in section 2 of Publication 15-B. 1040nr free 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. 1040nr free Meals you furnish to your employees at the work site when you operate a restaurant or catering service. 1040nr free Meals you furnish to your employees as part of the expense of providing recreational or social activities, such as a company picnic. 1040nr free 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). 1040nr free This does not include meals you furnish on vessels primarily providing luxury water transportation. 1040nr free Meals you furnish on an oil or gas platform or drilling rig located offshore or in Alaska. 1040nr free This includes meals you furnish at a support camp that is near and integral to an oil or gas drilling rig located in Alaska. 1040nr free Employee benefit programs. 1040nr free Employee benefit programs include the following. 1040nr free Accident and health plans. 1040nr free Adoption assistance. 1040nr free Cafeteria plans. 1040nr free Dependent care assistance. 1040nr free Education assistance. 1040nr free Life insurance coverage. 1040nr free Welfare benefit funds. 1040nr free You can generally deduct amounts you spend on employee benefit programs on the applicable line of your tax return. 1040nr free 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. 1040nr free ). 1040nr free Life insurance coverage. 1040nr free 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. 1040nr free See Regulations section 1. 1040nr free 264-1 for more information. 1040nr free Welfare benefit funds. 1040nr free 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. 1040nr free Welfare benefits are any benefits other than deferred compensation or transfers of restricted property. 1040nr free Your deduction for contributions to a welfare benefit fund is limited to the fund's qualified cost for the tax year. 1040nr free If your contributions to the fund are more than its qualified cost, carry the excess over to the next tax year. 1040nr free Generally, the fund's “qualified cost” is the total of the following amounts, reduced by the after-tax income of the fund. 1040nr free The cost you would have been able to deduct using the cash method of accounting if you had paid for the benefits directly. 1040nr free The contributions added to a reserve account that are needed to fund claims incurred but not paid as of the end of the year. 1040nr free These claims can be for supplemental unemployment benefits, severance pay, or disability, medical, or life insurance benefits. 1040nr free For more information, see sections 419(c) and 419A of the Internal Revenue Code and the related regulations. 1040nr free 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. 1040nr free However, if the employee performs no services, treat the amount you advanced as a loan. 1040nr free If the employee does not repay the loan, treat it as income to the employee. 1040nr free Below-market interest rate loans. 1040nr free 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. 1040nr free See Below-Market Loans in chapter 4. 1040nr free Property If you transfer property (including your company's stock) to an employee as payment for services, you can generally deduct it as wages. 1040nr free 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. 1040nr free You can claim the deduction only for the tax year in which your employee includes the property's value in income. 1040nr free 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. 1040nr free 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. 1040nr free Your gain or loss is the difference between the fair market value of the property and its adjusted basis on the date of transfer. 1040nr free These rules also apply to property transferred to an independent contractor for services, generally reported on Form 1099-MISC, Miscellaneous Income. 1040nr free Restricted property. 1040nr free 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. 1040nr free However, if the recipient pays for the property, you must report any gain at the time of the transfer up to the amount paid. 1040nr free “Substantially vested” means the property is not subject to a substantial risk of forfeiture. 1040nr free This means that the recipient is not likely to have to give up his or her rights in the property in the future. 1040nr free Reimbursements for Business Expenses You can generally deduct the amount you pay or reimburse employees for business expenses incurred for your business. 1040nr free However, your deduction may be limited. 1040nr free If you make the payment under an accountable plan, deduct it in the category of the expense paid. 1040nr free For example, if you pay an employee for travel expenses incurred on your behalf, deduct this payment as a travel expense. 1040nr free If you make the payment under a nonaccountable plan, deduct it as wages and include it in the employee's Form W-2. 1040nr free See Reimbursement of Travel, Meals, and Entertainment in chapter 11 for more information about deducting reimbursements and an explanation of accountable and nonaccountable plans. 1040nr free Sick and Vacation Pay Sick pay. 1040nr free You can deduct amounts you pay to your employees for sickness and injury, including lump-sum amounts, as wages. 1040nr free However, your deduction is limited to amounts not compensated by insurance or other means. 1040nr free Vacation pay. 1040nr free Vacation pay is an employee benefit. 1040nr free It includes amounts paid for unused vacation leave. 1040nr free You can deduct vacation pay only in the tax year in which the employee actually receives it. 1040nr free This rule applies regardless of whether you use the cash or accrual method of accounting. 1040nr free Prev Up Next Home More Online Publications
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