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T7-04-01A-Ch4A-Comp-Fringes-2008 Employee Compensation. Part I- Compensation, Fringe Benefits

T7-04-01A-Ch4A-Comp-Fringes-2008.ppt Employee Compensation. Part I- Compensation, Fringe Benefits. Chapter 4A. Employee Compensation Pg. 132

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T7-04-01A-Ch4A-Comp-Fringes-2008 Employee Compensation. Part I- Compensation, Fringe Benefits

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  1. T7-04-01A-Ch4A-Comp-Fringes-2008.pptEmployee Compensation. Part I-Compensation, Fringe Benefits Chapter4A

  2. Employee CompensationPg. 132 • All forms of compensation (including salaries, wages, bonuses, tips, and fringe benefits) are taxable as ordinary income to employees unless specifically excluded by a provision in the Code • Employers can deduct all reasonable compensation expenses

  3. Payroll Taxes for Employees. Pg. 132 • FICA rate is 7.65% (6.2% for Social Security + 1.45% for Medicare) • Social security portion is only charged on the first $97,500 for 2006

  4. Payroll Taxes for Employees. Pg.132 Employer withholds the FICA tax from employee; employer matches employee FICA and then forwards total to government Employer deducts employer’s share of tax • No deduction for employee’s share of tax

  5. Other Payroll Taxes. Pg. 132 • Employers are 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

  6. Employee vs. Independent Contractor. 133 • Independent contractors (and other self-employed individuals) pay their own Social Security and Medicare taxes • This is called the self-employment tax • Workers considered employees (instead of an independent contractor) if the employer has the right to control and direct the end result and the means by which the result is accomplished • Rev. Rul. 87-41 provides 20-factor test

  7. Timing of Compensation. 135 • Salaries and bonuses are usually deductible by the employer when accrued • Exceptions • Compensation accrued but not paid within 2½ months of year-end is not deductible until paid • Compensation accrued to cash-basis related party not deductible until paid

  8. HW-18. Amy, a cash-basis taxpayer, received a salary of $100,000 in year 1, year 2, and year 3. Amy also was awarded a bonus of $30,000 that was accrued by Amy's employer, Vargus Corp. (an accrual-basis, calendar year C corp.), in December of year 1 but was not paid until March 31 of year 2. In December of year 2, Vargus accrued an additional $32,000 bonus that was paid to Amy in January of year 3. a. How much income does Amy recognize in year 1, year 2, and year 3? b. How much can Vargus Corp. take as a compensation deduction in year 1, year 2, and year 3?

  9. HWA-17-Timing of Compensation Because Amy is a cash basis taxpayer she includes the salary and bonus in income in the year she receives it. Year a. Amy b. Vargus Corp. 1 $100,000 $100,000 2 $130,000 $162,000 3 $132,000 $100,000 Vargus Corporation must pay the accrued bonus within 2½ months after year-end to deduct it in the year accrued. If paid later than 2½ months after year-end, it is deducted in the year paid.

  10. 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

  11. Reasonable Compensation. 135 • Reasonable compensation – amount similar business would pay for the services under similar circumstances • If a shareholder-employee’s salary is considered unreasonable, the excess can be reclassified by IRS as a nondeductible dividend

  12. Reasonable Compensation. 135 • If unreasonable compensation is paid to a party related to a shareholder, the excess can be reclassified as a nondeductible dividend to the shareholder

  13. Excessive Compensation • Deductible compensation paid to CEO and 4 highest-paid officers of publicly-held corporations is limited to $1 million per year

  14. Excessive Compensation • This $1 million compensation 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

  15. Excessive Compensation HW17. [1 of 3] Charlie (35 % marginal tax bracket) is the president and sole owner of Charlie Corp. (a C corp. in the 34 % tax bracket). His current year salary is $700,000 per year. What are the income and FICA tax consequences if the IRS determines that $200,000 of his salary is unreasonable compensation?

  16. S Corporations & Low Salaries Pg. 136 There is an incentive for an S corporation to pay an unreasonably low salary to a controlling shareholder-employee to minimize payroll taxes as S corporation profits are not subject to payroll taxes IRS can reclassify some of an S corporation’s distribution as salary, requiring payment of additional employment taxes. Relate this to previous slide.

  17. Employing Children. 136. • Compensation paid to children is deductible if reasonable for the services actually performed • Wages paid to an employer’s child under age 18 are not subject to employment taxes (if not paid by a corporation) • Standard deduction for a single individual is $5,150 in 2006; this amount can be paid to a child without tax consequences

  18. Fringe Benefits. 137. • Tax-free fringe benefits are not taxable as income to the employee but are deductible by the employer • Most tax-free benefits are limited in dollar amount • If an employer pays an amount in excess of the limit (or pays for something that is not a qualified tax-free benefit), it is treated as taxable compensation (income to the employee and deductible by the employer)

  19. Group Term Life Insurance. 139. • Premiums on the first $50,000 of employer-paid group term life insurance coverage may be excluded from employee's income • Excess over $50,000 is included in income with amount determined from a table based on employee's age at year end rather than cost

  20. Group Term Life Insurance • If the insurance plan is discriminatory, key employees must report gross income equal to the greaterof • Employer’s actual premiums paid or • Benefit determined from the table (without $50,000 exclusion)

  21. HW-19. Group Term Life Insurance Tom is 68 years old. His employer pays the premiums for group term life insurance of $110,000. The company’s cost of Tom’s coverage is $3,000. a. If the plan is nondiscriminatory and Tom is not a key employee, how much gross income does Tom have? b. How does your answer to (a) change if Tom is a key employee? c. If the plan is discriminatory, but Tom is not a key employee, what is Tom’s gross income? d. How does your answer to (c) change if Tom is a key employee?

  22. HW-19. Group Term Life Insurance a. Tom has $914.40 of income. $110,000 - $50,000 excluded = $60,000 taxable coverage. (60 increments x $1.27 table rate x 12 months - $914.40) b. Same answer as part a. c. Same answer as part a. d. $3,000. Tom is a key employee and the plan is discriminatory so he must include in income the greater of the actual premiums ($3,000) or the $1,676.40 computed from the table without excluding the first $50,000 (110 increments x $1.27 table rate x 12 months = $1,676.40).

  23. Heath and Accident Insurance Employees are not taxed on value of insurance premiums paid for by their employers for health and accident plans for employees and their families • Self-insured discriminatory plans may result in taxable income to highly-compensated employees

  24. Dependent Care Benefits • An employer can provide up to $5,000 ($2,500 if MFS) for the care of an employee's dependents during working hours through an on-site or off-site facility • Highly-compensated employees cannot exclude benefits if they are discriminatory

  25. Cafeteria Plans. 141. • A qualified cafeteria plan allows an employer to offer employees the option of choosing cash or nontaxable fringe benefits [An exception to the doctrine of constructive receipt] • If the employee chooses cash, the cash is taxable • If nontaxable fringe benefits are chosen, they are excludable

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

  27. Cafeteria Plans • Some of the nontaxable benefits that can be offered include (1) coverage for medical and dental care, (2) group-term life insurance up to $50,000, and (3) dependent care assistance • Any amounts set aside in a flexible spending plan must be used before the end of the year or they are lost

  28. HW-20.Tax-Free Fringe Benefits Priscilla, an employee of Choice Corp., receives an annual salary of $70,000. Choice has a cafeteria plan that allows all employees to choose an amount equal to 8 percent of their annual salary from a menu of nontaxable fringe benefits or to take cash. Priscilla selects $50,000 of group term life insurance that costs the company $900 and also selects health insurance that costs the company $2,000; she takes the remaining $2,700 in cash. How much compensation income does Priscilla recognize from Choice Corporation?

  29. HWA-20.Tax-Free Fringe Benefits Solution: Priscilla includes $72,700 in income ($70,000 salary + $2,700 cash benefits). The group term life insurance and health insurance are tax-free benefits.

  30. Meals and Lodging Pg 141 • Value of meals and lodging provided by an employer to an employee are excluded if 1. Provided for the employer's convenience and 2. Provided on the employer's business premises and 3. Employee required to occupy the lodging to perform employment duties • If an employee is given achoicebetween additional compensation or meals and lodging, the value of any meals and lodging selected is taxable

  31. HW-22. Lodging vs. Cash Allowance Clark works all year at the front-desk of the DewDrop Inn and earns a salary of $30,000. He is offered the option of a $400-per-month living allowance or rent-free use of a room at the DewDrop Inn. Clark chooses to live at the inn in a room that normally rents for $400 per month. How much gross income does Clark have from the DewDrop Inn?

  32. HWA-22. Lodging vs. Cash Allowance Clark must include $34,800 in income [$30,000 salary + ($400 x 12 months)]. Lodging must be required as a condition of employment to be excluded.

  33. No-Additional-Cost Services Pg. 142 • 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 • Example: Free or discounted seats on an airplane when the employee does not displace a paying customer

  34. No-Additional-Cost Services. 142. • 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

  35. Employee Discounts. 143. • Property or services provided employee at below FMV results in income to employee unless within the qualified employee discount limits • Only property and services offered to customers in the ordinary course of the employer's business qualifies • Full discount excluded if discount does not exceed gross profit percentage times price charged to customers • For services, discount can’t exceed 20%

  36. HW-23. Employee Discount Kevin is an employee of One-Hour Dry Cleaners, Inc. All employees of One-Hour are eligible for a 40 percent discount on their dry cleaning. During the year, Kevin paid $300 for cleaning that would normally have cost $500. Does Kevin have any taxable income as a result of this discount?

  37. HWA-23. Employee Discount Yes. $100 is taxable. The excludable discount for services cannot exceed 20 percent (20% x $500 = $100 maximum tax-free discount). Kevin's discount was $200 - $100 maximum tax-free discount = $100 excess discount that is taxable

  38. Employee Awards. 143. • 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 much as $1,600

  39. 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

  40. De Minimis Fringe Benefits. 143. • An amount is considered de minimis when the value is so small that accounting for it is unreasonable or impractical • Examples: coffee & doughnuts, company picnics, limited use of copy machine, etc.

  41. Transportation & Parking. 136. • Transit passes and special carpool commuting expenses (combined value of up to $105 per month) • Free or discounted parking (up to $205 per month in 2006)

  42. Athletic Facilities • Employees (and their families) who use employer-provided athletic facilities that are located on the employer’s business premises can exclude the value of the benefit from gross income • Facilities include tennis courts, gymnasiums, and swimming pools

  43. Working ConditionFringe Benefits. Pg 144 • Working condition fringe benefits can be excluded from the employee’s gross income if the employee would have been entitled to a tax deduction if he had actually paid the expense • Discriminatory benefits can still be excluded

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