Employee Compensation

1
EmployeeCompensation

• Chapter 4

2
Compensation

• Salaries and wages
• Bonuses
• Vacation pay
• Tips
• Fringe Benefits

3
Payroll Taxes for Employees

• FICA rate is 7.65 (6.2 for Social Security
  1.45 for Medicare)
• Social security portion is only charged on the
  first 87,000 for 2003
• Employer withholds the FICA tax from employee and
  employer matches employee FICA and then forwards
  total to government
• Employer can deduct employers share of tax
• No deduction by anyone for employees share of tax

4
Payroll Taxes

• Employers is also required to pay other types of
  payroll taxes such as federal and state
  unemployment taxes
• FUTA rate is 6.2 on first 7,000
• State unemployment taxes vary
• These taxes are all deductible by the employer
  paying them

5
Self-Employed

• Employers do not pay payroll taxes for
  independent contractors
• Independent contractors (and other self employed
  individuals) pay their own Social Security and
  Medicare taxes
• This is called self-employment tax

6
Employee vs.Independent Contractor

• Independent contractors pay their own Social
  Security and Medicare taxes (self-employment tax)
• Worker considered an employee if the employer has
  the right to control and direct the individual
  who provides services with regard to the end
  result and the means by which the result is
  accomplished
• Rev. Rul. 87-41 provides 20-factor test

7
Timing of Compensation

• Salaries and bonuses are usually deductible by
  the employer when accrued
• Exceptions
• Compensation not paid within 2-1/2 months of
  year-end is not deductible until paid
• Accrual of compensation to cash-basis related
  party not deductible until paid

8
Accrued Compensation to Related Parties

• Related parties include
• Family members (brothers, sisters, spouse,
  ancestors, and lineal descendants, but not
  in-laws)
• A taxpayer and a corporation in which the
  taxpayer owns directly or indirectly more than
  50 of the stock (indirect ownership includes
  stock owned by family members), and
• Other relationships such as partners/partnerships
  and beneficiaries/trusts

9
Reasonable Compensation

• If a shareholder-employees salary is considered
  excessive, the excess can be reclassified as a
  nondeductible dividend
• If excessive salary is paid to a related party of
  a shareholder, the excess will be nondeductible

10
Excessive Compensation

• A publicly held corporation is denied a deduction
  for compensation paid to CEO and 4 highest paid
  officers if the compensation for any individual
  exceeds 1 million per year
• Compensation for this limit does not include
• Compensation based on individual performance
  goals (if approved in advance by outside
  directors)
• Compensation paid on a commission basis
• Employer contributions to a qualified retirement
  plan
• Tax-free employee benefits

11
S Corporations Low Salaries

• There is an incentive for an S corporation to pay
  an unreasonably low salary to a controlling
  shareholder-employee to minimize payroll taxes
  because S corporation profits are not subject to
  payroll taxes

12
Employing Children

• Children must be paid compensation that is
  reasonable for the services actually performed
• Wages paid to an employers child under age 18
  are not subject to employment taxes (if not a
  corporation)
• Standard deduction for a single individual is
  4,750 in 2003

13
Foreign Earned Income

• Exclusion is 80,000 per year
• Exclusion calculated separately for each spouse
• Qualifying earned income includes most income
  earned from working in a foreign country
  including salary, bonuses, allowances and noncash
  benefits
• U.S. government employees not eligible
• Taxpayer must work outside the U.S. for 330 days
  during a period of 12 consecutive months

14
Foreign Tax Credit

• Employees who do not qualify for the exclusion
  may instead claim a tax credit for the foreign
  taxes paid (and include all of the income in
  taxable income)
• Foreign tax credit cannot exceeds the amount of
  U.S. tax that would have been paid on the foreign
  income

15
Fringe Benefits

• Tax-free fringe benefits are deductible by the
  employer but not taxable as income to the
  employee
• Due to this favorable treatment, they are very
  limited in dollar amount
• If an employer pays an amount in excess of the
  limit (or pays something that is not a qualified
  tax-free benefit) then it is treated as taxable
  compensation (income to the employee and
  deductible by the employer)

16
Group Term Life Insurance

• Premiums on the first 50,000 of employer-paid
  group term life insurance coverage may be
  excluded from an employee's gross income
• Excess over 50,000 is included in income based
  on the employee's age as year end

17
Group Term Life InsuranceTaxable Amount per
Month per 1,000
Employees Age Monthly Amount
Under 25 .05
25 to 29 .06
30 to 34 .08
35 to 39 .09
40 to 44 .10
45 to 49 .15
50 to 54 .23
55 to 59 .43
60 to 64 .66
65 to 69 1.27
70 and above 2.06
18
Group Term Life Insurance

• When it is a discriminatory plan, key employees
  must report gross income equal to the greater of
• Employers actual premiums paid or
• Benefit determined from the table (without a
  50,000 exclusion)

19
Heath and Accident Insurance

• Employees are not taxed on value of insurance
  premiums paid for by their employers for health,
  accident, and disability insurance plans

20
Dependent Care Benefits

• Up to 5,000 (2,500 if MFS) of care for
  employee's dependents during working hours can be
  provided through an on-site or off-site facility

21
Cafeteria Plans

• A qualified cafeteria plan allows an employer to
  offer employees the option of choosing cash or
  nontaxable fringe benefits
• If the employee chooses cash, the cash is taxable
• If nontaxable fringe benefits are chosen, they
  are excludable

22
Cafeteria Plans

• Benefits can be funded with employer
  contributions or by employees voluntarily
  electing to reduce their salaries (thus allowing
  employees to obtain fringe benefits with
  before-tax dollars)
• These plans are sometimes called flexible
  spending arrangements (FSA)

23
Cafeteria Plans

• Some of the nontaxable benefits that can be
  provided are coverage for medical and dental
  care, group-term life insurance up to 50,000,
  and dependent care assistance
• Any amounts set aside in a flexible spending plan
  must be use before the end of the year or they
  are lost

24
Meals and Lodging

• Value of meals and lodging provided by an
  employer to an employee excluded if
• Provided for the employer's convenience and
• Provided on the employer's business premises and
• Employee required to occupy the lodging to
  perform employment duties
• If an employee is given a choice between
  additional compensation or meals and lodging, the
  value of any meals and lodging selected is taxable

25
No-Additional-Cost Services

• When an employer provides services for its
  employees and incurs no substantial additional
  cost (excess capacity services), employees can
  exclude the value of the services from gross
  income
• Free or discounted seats on an airplane excluded
  if the employee does not displace paying customers

26
No-Additional-Cost-Services

• This exclusion applies only to services received,
  not property
• Only employees who work in the line of business
  that renders similar services are allowed to
  exclude the benefits (baggage handlers who work
  for an airline can fly free)
• In addition to current employees, the exclusion
  is available to former employees, as well as
  spouse and dependents

27
Employee Discounts

• Sale of property at below FMV results in income
  to employee unless a qualified employee
• Only property and services offered to customers
  in the ordinary course of the employer's business
  qualifies
• Full discount excluded as long as employee pays
  at least employers cost
• For services, discount cant exceed 20

28
Employee Awards

• Employee awards generally are treated as taxable
  compensation
• Exceptions for length of service or safety awards
• Qualifying employee awards must be made with
  tangible property (no cash)
• Average cost of qualified plan awards limited to
  400, but individual awards can be as large as
  1,600

29
De Minimis Fringe Benefits

• Employees who receive de minimis (very small in
  value) property or services from their employers
  can exclude the value from gross income
• An amount is considered de minimis when the
  value is so small that accounting for it is
  unreasonable or impracticable

30
De Minimis Fringe Benefits

• Examples include
• Coffee and doughnuts
• Limited personal use of copy machines or
  computers
• Use of business phone for local personal calls
• Non-cash holiday gifts like turkeys
• Nominal birthday gifts other than cash
• Occasional company picnics or cocktail parties
• Flowers sent to an employee because of illness or
  a celebration

31
Transportation Parking

• Transit passes and special carpool commuting
  expenses (combined value of up to 100 per month)
• Free or discounted parking (up to 190 per month)

32
Athletic Facilities

• Employees who use employer-provided athletic
  facilities that are located on the employers
  business premises can exclude the value of the
  benefit from gross income
• Facilities include tennis courts, gymnasiums, and
  swimming pools

33
Working Condition Fringe Benefits

• Working condition fringe benefits can be excluded
  from the employees gross income if the employee
  would have been entitled to a tax deduction if he
  had actually paid the expense
• Examples include
• Professional membership dues
• Subscriptions to professional journals
• Use of a company car for business

34
Employee Use ofCompany-Owned Cars

• The value of an employees personal use of a
  company car is a taxable fringe benefit
• In determining the amount of income to be taxed
  to the employee for personal use, there are 3
  methods
• Lease value (from table)
• Cents per mile rate (36 in 2003)
• Commuting method (valued at 1.50 per one-way
  trip)

35
Relocation Expenses

• Qualified direct moving expenses include the
  reasonable cost of moving household belongings
  and family members from the old home to the new
  home by the shortest and most direct route
• No dollar limit
• Indirect expenses such as house-hunting or
  temporary living expenses do not qualify

36
Relocation Expenses

• Moving expenses are deductible if they are
  related to assuming duties at a new place of
  business and both the distance and time
  requirements are met
• Distance test - distance from old residence to
  new job must be at least 50 miles greater than
  the distance from old residence to old job
• Even though a taxpayer is required to relocate,
  no deduction is allowed if the distance test is
  not met

37
Relocation Expenses

• Time Test - taxpayer must work as an employee at
  the new location for 39 weeks during the 12
  months following arrival or as a self-employed
  person for 78 weeks during the 24 months
  following arrival
• Exceptions in event of death, disability,
  involuntary separation, or transfers for the
  employers benefit
• Qualified moving expenses that are not reimbursed
  are deductible for AGI by employee

38
Education Assistance Plans

• Up to 5,250 a year of employer-provided
  educational assistance benefits can be excluded
• Courses do not need to be job-related.
• Excludable benefits are payments for tuition,
  fees, books, supplies, and equipment

39
Job-Related Education

• No dollar limit if education expenses qualify as
  related to the current job of the employee
• Qualified educational expenses include tuition,
  fees, books, and transportation from job to class
  
• Expenses that meet the minimum education
  requirements for the taxpayers job or qualify
  taxpayer for a new profession do not qualify for
  exclusion

40
Substantiating Expenses

• Accountable Plan - an employee provides an
  adequate accounting to the employer and refunds
  to the employer any excess advanced funds
• Adequate Accounting - provides details concerning
  the time, date, place, business purposes, and the
  amount of the expense
• If an employee makes an adequate accounting, and
  the reimbursement exceeds the deductible
  expenses, the employee must include the excess in
  income

41
Substantiating Expenses

• If the employer maintains a nonaccountable plan
  that does not require the employee to
  substantiate expenses or to refund excess
  advanced funds, the employer must report all of
  the reimbursed expenses on employees W-2
• Employees who receive advances in a
  nonaccountable plan must report details of both
  the reimbursement and the expenses
• Employees deductions are subject to 2 AGI floor
  for miscellaneous itemized deductions

42
Employee Stock Options

• Nonqualified stock options (NQSO) are rights
  granted by the employer allowing the employee to
  purchase employer stock at a certain price
  (generally below the market price)
• Employee recognizes income on the date the
  options are exercised on difference between the
  FMV of the stock and exercise price
• Employer gets matching compensation deduction

43
Incentive Stock Options

• Incentive stock options (ISO) receive more
  favorable treatment for employee
• ISOs do not trigger any income recognition at the
  date of grant or exercise
• Income is recognized only upon the sale of the
  stock - usually all long-term capital gain
• But bargain element is an individual AMT
  adjustment
• Employer receives no compensation deduction

44
Phantom Stock and SARs

• Phantom stock plan - deferred compensation is
  hypothetically invested in shares of companys
  stock
• At the end of deferral period (such as at
  retirement), the employer pays the employee the
  FMV of the phantom shares
• Stock appreciation right (SAR) plan - employees
  are given the right to receive a cash payment
  equal to the appreciation in value of employers
  stock for a certain period of time
• Employees recognize income only when they
  exercise their SARs

45
Qualified Deferred Compensation

• Funded plans that receive favorable tax treatment
• Employer contributions are deducted as they are
  paid into the trust
• Earnings on these contributions accumulate
  tax-free until withdrawn
• Benefits are taxable to the employee only when
  actually received

46
Distributions

• Tax must be paid on the earnings and all pre-tax
  (deductible) contributions when the funds are
  withdrawn
• Taxpayers may not take distributions before age
  59½ without a 10 percent penalty for premature
  distributions, in addition to the regular tax

47
Rollover of Distribution

• A taxpayer may roll over all or part of a
  distribution within 60 days without paying any
  tax or penalty on the distribution
• Lump sum distributions are subject to 20
  withholding unless there is a direct trustee to
  trustee transfer

48
Deferred Compensation Plans

• Defined Benefit - employer assumes the risk that
  the plan assets will be sufficient to pay
  benefits
• Defined Contribution - amounts contributed
  according to formula
• Employees benefit is dependent upon employers
  contributions and the actual earnings of the
  individual account

49
401(k) Plans

• Employee can elect to have employer contribute
  part of their salary pre-tax to plan
• Up to 12,000 plus extra 2,000 if age 50
• Flexibility - employee can elect each year to
  have a different amount contributed
• Employer may match some of the contributions

50
Other Plans

• Employee stock ownership plans (ESOPs)
• Simplified employee pension plans (SEPs)
• Savings incentive match plans for employees
  (SIMPLE)
• SIMPLE 401k plans

51
Nonqualified Deferred Compensation

• Advantages no dollar limits and can be offered
  on a discriminatory basis
• In unfunded plans employer receives a deduction
  only upon the actual payment of benefits to the
  employee
• In unfunded plans employee recognizes income upon
  the actual receipt of these benefits
• Employer accrues liability on financial
  statements, but no cash is set aside
• If the employers business fails, the employee is
  merely unsecured creditor

52
Individual Retirement Accounts (IRA)

• Individuals can contribute up to 3,000 (3,500
  if age 50 or older) or earned income if less
• A married taxpayer can contribute for a
  nonworking spouse if sufficient income
• Qualified contributions are deductible for AGI
• Deductions not allowed if the individual is a
  participant in an employer-sponsored retirement
  plans unless AGI is below certain limits

53
IRA Phaseout Limits

• Deductible contribution phased out for AGI over a
  range
• Single 40,000 - 50,000
• Married filing jointly 60,000 - 70,000
• Zero if married filing separately
• If spouse an active participant, phaseout over
  AGI of 150,000 - 160,000

54
Roth IRA

• Taxpayers may make nondeductible contributions to
  a Roth IRA if their AGIs do not exceed certain
  limits
• 95,000 if single
• 150,000 if married filing joint return
• Contributions to Roth and the regular IRA cannot
  exceed a total of 3,000 (3,500 if age 50)

55
Roth IRA

• Primary advantage of the Roth IRA is that
  distributions are totally tax free
• Distributions from Roth IRAs are not subject to
  minimum distribution rules
• Do not have to begin by age 70½
• But must meet the other distribution requirements
  of regular IRAs (generally, they cannot be made
  before the taxpayer turns 59½)

56
Self-Employment Taxes

• Self-employed individuals must pay both the
  employers and the employees share of social
  security taxes for a combined rate of 15.3
• 12.4 (6.2 x 2) for Social Security on income
  up to 87,000
• 2.9 (1.45 x 2) for Medicare no income limit
• Deduction simulated by multiplying net income
  from self-employment by 92.35 (100 - 7.65)
  before calculating SE tax

57
Self-Employment Taxes

• Self-employed individuals are also allowed a
  deduction for AGI for the employers half of
  self-employment taxes
• There is no deduction for the employees half of
  the taxes

58
Fringe Benefits for Self-Employed

• Self-employed individuals (including sole
  proprietors, partners, and greater than 2
  shareholders of S corporations) do not qualify
  for most fringe benefits on a tax-free basis.
• Special deduction for AGI applies to health
  insurance for self-employed individuals

59
Retirement Plans for Self-Employed

• Keogh (H.R. 10) plan is designed for
  self-employed persons with limits on
  contributions similar to corporate retirement
  plans
• Contributions are deductible for AGI
• Extending return due date also extends deadline
  for making contributions to plan

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The End