Taxation of Employee Compensation: Federal
Author: Alice Gilman
- Employees' salary and fringe benefits are subject to federal income tax (FIT) and Social Security and Medicare (FICA) taxes. Employers pay federal unemployment insurance (FUTA) tax on the same amounts. However, while certain cash and noncash fringe benefits may be offered to employees on a tax-free basis, an otherwise tax-free fringe benefit becomes taxable compensation if an employer does not comply with the IRS's rules regarding that particular fringe benefit. See Nontaxable Fringe Benefits; Withholding on Employer-Provided Benefits; Other Common Fringe Benefits With Special Tax Rules.
- Employees who drive company vehicles on business and who substantiate their business use under the accountable plan rules receive a tax-free working condition fringe benefit. Under most circumstances, an employee's personal use of company vehicles is subject to FIT and FICA tax withholding and to FUTA tax. See Personal Use of Employer-Provided Vehicles; Withholding on Employer-Provided Benefits.
- So long as an employee substantiates certain business expenses under the accountable plan rules, the employer may reimburse the employee for those expenses on a tax-free basis. See Nontaxable Fringe Benefits; Club Membership Rules; Taxability of Other Employer Payments.
- An employee's pay and bonuses, including back pay and retroactive wage increases, are always subject to FIT and FICA tax withholding and to FUTA tax. However, incentive payments a salesperson receives are excluded from taxation. In addition, certain employee awards and prizes are not taxable income to the recipient employees. And employees who receive incentive stock options and options under qualified employee plans are not taxed on the income they receive when they exercise their options and buy company stock. See Taxability of Other Employer Payments.
- Special withholding and reporting rules apply to many types of fringe benefits. See Withholding on Employer-Provided Benefits.
The following states have additional requirements for this topic under applicable state law.