irs publication 15a

7/30/2019 IRS Publication 15a

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Department of the Treasury ContentsInternal Revenue Service

Whats New . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Reminders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2Publication 15-A

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4Cat. No. 21453T

1. Who Are Employees? . . . . . . . . . . . . . . . . . . . . . 4

2. Employee or Independent Contractor? . . . . . . . 7Employers3. Employees of Exempt Organizations . . . . . . . . . 9

Supplemental 4. Religious Exemptions and Special Rulesfor Ministers . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

5. Wages and Other Compensation . . . . . . . . . . . . 11Tax Guide6. Sick Pay Reporting . . . . . . . . . . . . . . . . . . . . . . . 14

(Supplement to7. Special Rules for Paying Taxes . . . . . . . . . . . . . 20

Publication 158. Pensions and Annuities . . . . . . . . . . . . . . . . . . . 22

(Circular E),9. Alternative Methods for Figuring

Withholding . . . . . . . . . . . . . . . . . . . . . . . . . . . 23Employers Tax Guide)Formula Tables for Percentage Method

Withholding (for Automated PayrollSystems) . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

For use in 2012 Wage Bracket Percentage Method Tables(for Automated Payroll Systems) . . . . . . . . . 30

Combined Income Tax, Employee SocialSecurity Tax, and Employee MedicareTax Withholding Tables . . . . . . . . . . . . . . . . 47

10. Tables for Withholding on Distributionsof Indian Gaming Profits to Tribal Members . . 68

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

Quick and Easy Access to IRS Tax Helpand Tax Products . . . . . . . . . . . . . . . . . . . . . . . 71

Whats New

Future developments. The IRS has created a page onIRS.gov for information about Publication 15-A, atwww.irs.gov/pub15a. Information about any future devel-opments affecting Publication 15-A (such as legislationenacted after we release it) will be posted on that page.

Social security and Medicare tax for 2012. The em-ployee tax rate for social security is 4.2% on wages paidand tips received before March 1, 2012. The employee taxrate for social security increases to 6.2% on wages paidand tips received after February 29, 2012. The employertax rate for social security remains unchanged at 6.2%.The social security wage base limit is $110,100. The Medi-care tax rate is 1.45% each for the employee and em-

Get forms and other information ployer, unchanged from 2011. There is no wage base limitfaster and easier by: for Medicare tax.

Internet IRS.gov Employers should implement the 4.2% employee socialsecurity tax rate as soon as possible, but not later than

Jan 31, 2012
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January 31, 2012. After implementing the 4.2% rate, em- all federal tax deposits. Generally, electronic fund transfersployers should make an offsetting adjustment in a subse- are made using the Electronic Federal Tax Payment Sys-quent pay period to correct any overwithholding of social tem (EFTPS). If you do not want to use EFTPS, you cansecurity tax as soon as possible, but not later than March arrange for your tax professional, financial institution, pay-31, 2012. roll service, or other trusted third party to make deposits on

your behalf. Also, you may arrange for your financial insti-Social security and Medicare taxes apply to the wagestution to initiate a same-day wire payment on your behalf.of household workers you pay $1,800 or more in cash or anEFTPS is a free service provided by the Department ofequivalent form of compensation. Social security andTreasury. Services provided by your tax professional, fi-Medicare taxes apply to election workers who are paid

$1,500 or more in cash or an equivalent form of compensa- nancial institution, payroll service, or other third party maytion. have a fee.

For more information on making federal tax deposits,At the time this publication was prepared for re-see How To Depositin Publication 15 (Circular E). To getlease, the rate for the employees share of socialmore information about EFTPS or to enroll in EFTPS, visitsecurity tax was 4.2% and scheduled to increaseCAUTION

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www.eftps.govor call 1-800-555-4477. Additional informa-to 6.2% for wages paid after February 29, 2012. However,tion about EFTPS is also available in Publication 966, TheCongress was discussing an extension of the 4.2% em-Secure Way to Pay Your Federal Taxes.ployee tax rate for social security beyond February 29,

2012. Check for updates atwww.irs.gov/pub15a.Aggregate Form 941 filers. Agents must completeSchedule R (Form 941), Allocation Schedule for Aggre-VOW to Hire Heroes Act of 2011. On November 21,gate Form 941 Filers, when filing an aggregate Form 941,2011, the President signed into law the VOW to HireEmployers QUARTERLY Federal Tax Return. AggregateHeroes Act of 2011. This new law provides an expanded

Forms 941 can only be filed by agents approved by the IRSwork opportunity tax credit to businesses that hire eligible under section 3504 of the Internal Revenue Code. Tounemployed veterans and, for the first time, also makesrequest approval to act as an agent for an employer, thepart of the credit available to tax-exempt organizations.agent files Form 2678, Employer/Payer Appointment ofBusinesses claim the credit as part of the general business

credit and tax-exempt organizations claim it against their Agent, with the IRS.payroll tax liability. The credit is available for eligible unem-

Aggregate Form 940 filers. Agents must completeployed veterans who begin work on or after November 22,Schedule R (Form 940), Allocation Schedule for Aggre-2011, and before January 1, 2013. More information about

the credit against a tax-exempt organizations payroll tax gate Form 940 Filers, when filing an aggregate Form 940,liability will be available early in 2012 at Employers Annual Federal Unemployment (FUTA) Taxwww.irs.gov/form5884c. Return. Aggregate Forms 940 may only be filed by agents

acting on behalf of home care service recipients whoFUTA tax rate. The FUTA tax rate is 6.0% for 2012. receive home care services through a program adminis-

tered by a federal, state, or local government. To requestExpiration of Attributed Tip Income Program (ATIP). approval to act as an agent on behalf of home care serviceThe Attributed Tip Income Program (ATIP) is scheduled to

recipients, the agent files Form 2678 with the IRS.expire on December 31, 2011.

Employers can choose to file Form 941 instead ofWithholding allowance. The 2012 amount for one with-

Form 944. If you previously were notified to file Form 944,holding allowance on an annual basis is $3,800.

Employers ANNUAL Federal Tax Return, but want to filequarterly Forms 941 to report your social security, Medi-Change of address. Beginning in 2012, employers mustcare and withheld federal income taxes, you must firstuse new Form 8822-B, Change of AddressBusiness, forcontact the IRS to request to file Forms 941, rather thanany address change.Form 944. See Rev. Proc. 2009-51, 2009-45 I.R.B 625, forthe procedures for employers who previously were notifiedto file Form 944 to request to file Forms 941 instead. In

Reminders addition, Rev. Proc. 2009-51 provides the procedures foremployers to request to file Form 944. Rev. Proc. 2009-51is available at www.irs.gov/irb/2009-45_IRB/ar12.html.COBRA premium assistance credit. The credit for CO-Also see the Instructions for Form 944.BRA premium assistance payments applies to premiums

paid for employees involuntarily terminated between Sep-Additional employment tax information. Visit the IRStember 1, 2008, and May 31, 2010, and to premiums paidwebsite at www.irs.gov/businessesand click on thefor up to 15 months. For more information, see COBRAEmployment Taxeslink.premium assistance credit in Publication 15 (Circular E),

Employers Tax Guide.Telephone help. You can call the IRS Business and Spe-cialty Tax Line with your employment tax questions atFederal tax deposits must be made by electronic funds1-800-829-4933.transfer. You must use electronic funds transfer to make

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Help for people with disabilities. Telephone help is Spend less time and worry on taxes and more timerunning your business. Use e-fileand the Electronic Fed-available using TTY/TDD equipment. You can calleral Tax Payment System (EFTPS) to your benefit.1-800-829-4059 with your tax question or to order forms

and publications. You may also use this number for prob- For e-file, visit www.irs.gov/efilefor additional infor-

lem resolution assistance. mation.

Furnishing Form W-2 to employees electronically. For EFTPS, visit www.eftps.govor call EFTPS Cus-tomer Service at 1-800-555-4477.You may set up a system to furnish Form W-2, Wage and

Tax Statement, electronically. Each employee participat-ing must consent (either electronically or by paper docu- Electronic submission of Forms W-4, W-4P, W-4S andment) to receive his or her Form W-2 electronically, and W-4V. You may set up a system to electronically receiveyou must notify the employee of all hardware and software any or all of the following forms (and their Spanish ver-requirements to receive the form. You may not send a sions, if available) from an employee or payee.Form W-2 electronically to any employee who does not

Form W-4, Employees Withholding Allowance Cer-consent or who has revoked consent previously provided.tificate.To furnish Forms W-2 electronically, you must meet the

following disclosure requirements and provide a clear Form W-4P, Withholding Certificate for Pension orand conspicuous statement of each requirement to your Annuity Payments.employees.

Form W-4S, Request for Federal Income Tax With- The employee must be informed that he or she will holding From Sick Pay.

receive a paper Form W-2 if consent is not given to Form W-4V, Voluntary Withholding Request.

receive it electronically.

The employee must be informed of the scope and For each form that you establish an electronic submis-duration of the consent. sion system for, you must meet each of the following five

requirements. The employee must be informed of any procedure

for obtaining a paper copy of his or her Form W-2 1. The electronic system must ensure that the informa-and whether or not the request for a paper statement tion received by the payer is the information sent byis treated as a withdrawal of his or her consent to the payee. The system must document all occasionsreceiving his or her Form W-2 electronically. of user access that result in a submission. In addi-

tion, the design and operation of the electronic sys- The employee must be notified about how to with-

tem, including access procedures, must make itdraw a consent and the effective date and mannerreasonably certain that the person accessing theby which the employer will confirm the withdrawnsystem and submitting the form is the person identi-consent. The employee must also be notified thatfied on the form.the withdrawn consent does not apply to the previ-

ously issued Forms W-2. 2. The electronic system must provide exactly the sameinformation as the paper form.

The employee must be informed about any condi-tions under which electronic Forms W-2 will no 3. The electronic submission must be signed with anlonger be furnished (for example, termination of em- electronic signature by the payee whose name is onployment). the form. The electronic signature must be the final

entry in the submission. The employee must be informed of any procedures

for updating his or her contact information that en- 4. Upon request, you must furnish a hard copy of anyables the employer to provide electronic Forms W-2. completed electronic form to the IRS and a state-

ment that, to the best of the payers knowledge, the The employer must notify the employee of any

electronic form was submitted by the named payee.changes to the employers contact information.

The hard copy of the electronic form must provideexactly the same information as, but need not be a

You must furnish electronic Forms W-2 by the same due

facsimile of, the paper form. For Form W-4, the sig-date as the paper Forms W-2. For more information on nature must be under penalty of perjury, and mustfurnishing Form W-2 to employees electronically, see Reg-

contain the same language that appears on the pa-ulations section 31.6051-1(j).

per version of the form. The electronic system mustinform the employee that he or she must make a

Electronic filing and payment. Now, more than everdeclaration contained in the perjury statement and

before, businesses can enjoy the benefits of filing andthat the declaration is made by signing the Form

paying their federal taxes electronically. Whether you relyW-4.

on a tax professional or handle your own taxes, the IRSoffers you convenient programs to make filing and pay- 5. You must also meet all recordkeeping requirementsment easier. that apply to the paper forms.

Publication 15-A (2012) Page 3
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For more information, see: We respond to many letters by telephone. Therefore, itwould be helpful if you would include your daytime phone

Regulations sections 31.3402(f)(5)-1(c) (for Formnumber, including the area code, in your correspondence.

W-4), andYou can email us at [email protected]. Please put Pub-

Announcement 99-6 (for Forms W-4P, W-4S, and lication 15-A on the subject line. Although we cannotW-4V). You can find Announcement 99-6 on page respond individually to each email, we do appreciate your24 of Internal Revenue Bulletin 1999-4 at feedback and will consider your comments as we revisewww.irs.gov/pub/irs-irbs/irb99-04.pdf. our tax products.

Photographs of missing children. The Internal Reve-nue Service is a proud partner with the National Center for 1. Who Are Employees?Missing and Exploited Children. Photographs of missingchildren selected by the Center may appear in this publica-

Before you can know how to treat payments that you maketion on pages that would otherwise be blank. You can helpto workers for services, you must first know the businessbring these children home by looking at the photographsrelationship that exists between you and the person per-and calling 1-800-THE-LOST (1-800-843-5678) if you rec-forming the services. The person performing the servicesognize a child.may be:

An independent contractor,

Introduction A common-law employee,This publication supplements Publication 15 (Circular E). It A statutory employee, orcontains specialized and detailed employment tax informa-

A statutory nonemployee.tion supplementing the basic information provided in Publi-cation 15 (Circular E). This publication also contains tables

This discussion explains these four categories. A laterfor withholding on distributions of Indian gaming profits todiscussion, Employee or Independent Contractor in sec-tribal members. Publication 15-B, Employers Tax Guide totion 2, points out the differences between an independentFringe Benefits, contains information about the employ-contractor and an employee and gives examples fromment tax treatment of various types of noncash compensa-various types of occupations.tion.

If an individual who works for you is not an employeeunder the common-law rules (see section 2), you generally

Ordering publications and forms. See Quick and Easydo not have to withhold federal income tax from that indi-

Access to IRS Tax Help and Tax Products, located at theviduals pay. However, in some cases you may be required

end of this publication, for information on how to obtainto withhold under the backup withholding requirements on

forms and publications.these payments. See Publication 15 (Circular E) for infor-

mation on backup withholding.Useful ItemsYou may want to see: Independent Contractors

Publication People such as doctors, veterinarians, and auctioneerswho follow an independent trade, business, or professiont 15-B Employers Tax Guide to Fringe Benefitsin which they offer their services to the public, are generally

t 505 Tax Withholding and Estimated Tax not employees. However, whether such people are em-ployees or independent contractors depends on the factst 515 Withholding of Tax on Nonresident Aliens andin each case. The general rule is that an individual is anForeign Entitiesindependent contractor if you, the person for whom the

t 583 Starting a Business and Keeping Records services are performed, have the right to control or directonly the result of the work and not the means and methodst 1635 Understanding Your EIN

of accomplishing the result.Comments and suggestions. We welcome your com-

Common-Law Employeesments about this publication and your suggestions forfuture editions.

Under common-law rules, anyone who performs servicesYou can write to us at the following address:

for you is your employee if you have the right to controlwhat will be done and how it will be done. This is so even

Internal Revenue Service when you give the employee freedom of action. WhatBusiness Forms and Publications Branch matters is that you have the right to control the details ofSE:W:CAR:MP:T:B how the services are performed. For a discussion of facts1111 Constitution Ave. NW, IR-6526 that indicate whether an individual providing services is anWashington, DC 20224 independent contractor or employee, see section 2.

http://www.irs.gov/pub/irs-irbs/irb99-04.pdfmailto:*[email protected]


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If you have an employer-employee relationship, it 2. A full-time life insurance sales agent whose principalmakes no difference how it is labeled. The substance of business activity is selling life insurance or annuitythe relationship, not the label, governs the workers status. contracts, or both, primarily for one life insuranceIt does not matter whether the individual is employed full company.time or part time.

3. An individual who works at home on materials orFor employment tax purposes, no distinction is made

goods that you supply and that must be returned tobetween classes of employees. Superintendents, manag-

you or to a person you name, if you also furnishers, and other supervisory personnel are all employees. An

specifications for the work to be done.officer of a corporation is generally an employee; how-ever, an officer who performs no services or only minor 4. A full-time traveling or city salesperson who works on

services, and neither receives nor is entitled to receive any your behalf and turns in orders to you from wholesal-pay, is not considered an employee. A director of a ers, retailers, contractors, or operators of hotels, res-corporation is not an employee with respect to services taurants, or other similar establishments. The goodsperformed as a director. sold must be merchandise for resale or supplies for

You generally have to withhold and pay income, social use in the buyers business operation. The work per-security, and Medicare taxes on wages that you pay to formed for you must be the salespersons principalcommon-law employees. However, the wages of certain business activity. See Salespersonin section 2.employees may be exempt from one or more of thesetaxes. See Employees of Exempt Organizations(section

Social security and Medicare taxes. Withhold social se-3) and Religious Exemptions and Special Rules for Minis-curity and Medicare taxes from the wages of statutoryters(section 4).employees if all three of the following conditions apply.

Leased employees. Under certain circumstances, a firm The service contract states or implies that substan-

furnishing workers to other firms is the employer of those tially all the services are to be performed personallyworkers for employment tax purposes. For example, a by them.temporary staffing service may provide the services of

They do not have a substantial investment in thesecretaries, nurses, and other similarly trained workers toequipment and property used to perform the serv-its clients on a temporary basis.ices (other than an investment in facilities for trans-The staffing service enters into contracts with the clientsportation, such as a car or truck).under which the clients specify the services to be provided

and a fee is paid to the staffing service for each individual The services are performed on a continuing basis forfurnished. The staffing service has the right to control and the same payer.direct the workers services for the client, including the rightto discharge or reassign the worker. The staffing service

Federal unemployment (FUTA) tax. For FUTA tax, thehires the workers, controls the payment of their wages,unemployment tax paid under the Federal Unemploymentprovides them with unemployment insurance and otherTax Act, the term employee means the same as it doesbenefits, and is the employer for employment tax pur-for social security and Medicare taxes, except that it doesposes. For information on employee leasing as it relates tonot include statutory employees defined above in catego-pension plan qualification requirements, see Leased em-ries 2 and 3. Any individual who is a statutory employeeployee in Publication 560, Retirement Plans for Smallunder category 1 or 4, earlier, is also an employee forBusiness.FUTA tax purposes and subject to FUTA tax.

Additional information. For more information about theIncome tax. Do not withhold federal income tax from thetreatment of special types of employment, the treatment ofwages of statutory employees.special types of payments, and similar subjects, see Publi-

cation 15 (Circular E) or Publication 51 (Circular A), Agri-Reporting payments to statutory employees. Furnishcultural Employers Tax Guide.Form W-2 to a statutory employee, and check Statutoryemployee in box 13. Show your payments to the em-Statutory Employeesployee as other compensation in box 1. Also, show social

security wages in box 3, social security tax withheld in boxIf workers are independent contractors under the common 4, Medicare wages in box 5, and Medicare tax withheld inlaw rules, such workers may nevertheless be treated asbox 6. The statutory employee can deduct his or her tradeemployees by statute, (also known as statutory employ-or business expenses from the payments shown on Formees) for certain employment tax purposes. This wouldW-2. He or she reports earnings as a statutory employeehappen if they fall within any one of the following fouron line 1 of Schedule C (Form 1040), Profit or Loss Fromcategories and meet the three conditions described nextBusiness, or Schedule C-EZ (Form 1040), Net Profit Fromunder Social security and Medicare taxes.Business. A statutory employees business expenses aredeductible on Schedule C (Form 1040) or C-EZ (Form1. A driver who distributes beverages (other than milk)1040) and are not subject to the reduction by 2% of his oror meat, vegetable, fruit, or bakery products; or whoher adjusted gross income that applies to common-lawpicks up and delivers laundry or dry cleaning, if theemployees.driver is your agent or is paid on commission.



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Statutory Nonemployees Misclassification of Employees

There are three categories of statutory nonemployees:Consequences of treating an employee as an indepen-

direct sellers, licensed real estate agents, and certaindent contractor. If you classify an employee as an inde-

companion sitters. Direct sellers and licensed real estatependent contractor and you have no reasonable basis for

agents are treated as self-employed for all federal tax doing so, you are liable for employment taxes for thatpurposes, including income and employment taxes, if: worker (the relief provision, discussed next, will not apply).

See section 2 in Publication 15 (Circular E) for more Substantially all payments for their services as directinformation.sellers or real estate agents are directly related to

sales or other output, rather than to the number of Relief provision. If you have a reasonable basis for nothours worked, and treating a worker as an employee, you may be relieved

from having to pay employment taxes for that worker. To Their services are performed under a written con-get this relief, you must file all required federal informationtract providing that they will not be treated as em-returns on a basis consistent with your treatment of theployees for federal tax purposes.worker. You (or your predecessor) must not have treatedany worker holding a substantially similar position as an

Direct sellers. Direct sellers include persons falling within employee for any periods beginning after 1977.any of the following three groups.

Technical service specialists. This relief provision1. Persons engaged in selling (or soliciting the sale of) does not apply for a technical services specialist you pro-

vide to another business under an arrangement betweenconsumer products in the home or place of businessyou and the other business. A technical service specialistother than in a permanent retail establishment.is an engineer, designer, drafter, computer programmer,

2. Persons engaged in selling (or soliciting the sale of) systems analyst, or other similarly skilled worker engagedconsumer products to any buyer on a buy-sell basis, in a similar line of work.a deposit-commission basis, or any similar basis pre- This limit on the application of the rule does not affectscribed by regulations, for resale in the home or at a the determination of whether such workers are employeesplace of business other than in a permanent retail under the common-law rules. The common-law rules con-establishment. trol whether the specialist is treated as an employee or an

independent contractor. However, if you directly contract3. Persons engaged in the trade or business of deliver-with a technical service specialist to provide services foring or distributing newspapers or shopping news (in-your business and not for another business, you may stillcluding any services directly related to such deliverybe entitled to the relief provision.or distribution).

Test proctors and room supervisors. The consistentDirect selling includes activities of individuals who at-treatment requirement does not apply to services per-tempt to increase direct sales activities of their direct sell-

formed after December 31, 2006, by an individual as a testers and who earn income based on the productivity of their proctor or room supervisor assisting in the administrationdirect sellers. Such activities include providing motivationof college entrance or placement examinations if the indi-and encouragement; imparting skills, knowledge, or expe-vidual:rience; and recruiting.

Is performing the services for a section 501(c) or-ganization exempt from tax under section 501(a) ofLicensed real estate agents. This category includes indi-the code, andviduals engaged in appraisal activities for real estate sales

if they earn income based on sales or other output. Is not otherwise treated as an employee of the or-ganization for employment taxes.

Companion sitters. Companion sitters are individualswho furnish personal attendance, companionship, or Voluntary Classification Settlement Program (VCSP).household care services to children or to individuals who Employers who are currently treating their workers (or a

are elderly or disabled. A person engaged in the trade or class or group of workers) as independent contractors orbusiness of putting the sitters in touch with individuals who other nonemployees and want to voluntarily reclassify theirwish to employ them (that is, a companion sitting place- workers as employees for future tax periods may be eligi-ment service) will not be treated as the employer of the ble to participate in the VCSP if certain requirements aresitters if that person does not receive or pay the salary or met. The employer cannot currently be under examinationwages of the sitters and is compensated by the sitters or by the IRS, Department of Labor, or a state governmentthe persons who employ them on a fee basis. Companion agency, concerning the classification of workers. To apply,sitters who are not employees of a companion sitting use Form 8952, Application for Voluntary Classificationplacement service are generally treated as self-employed Settlement Program (VCSP). For more information, visitfor all federal tax purposes. the IRS website at www.irs.gov/form8952.

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Financial control. Facts that show whether the businesshas a right to control the business aspects of the workers2. Employee or Independent

job include:

Contractor? The extent to which the worker has unreimbursedbusiness expenses. Independent contractors are more

An employer must generally withhold federal incomelikely to have unreimbursed expenses than are employ-

taxes, withhold and pay social security and Medicare ees. Fixed ongoing costs that are incurred regardless oftaxes, and pay unemployment tax on wages paid to an whether work is currently being performed are especiallyemployee. An employer does not generally have to with- important. However, employees may also incur un-hold or pay any federal taxes on payments to independent

reimbursed expenses in connection with the services thatcontractors. they perform for their employer.

The extent of the workers investment. An indepen-Common-Law Rulesdent contractor often has a significant investment in thefacilities or tools he or she uses in performing services forTo determine whether an individual is an employee or ansomeone else. However, a significant investment is notindependent contractor under the common law, the rela-necessary for independent contractor status.tionship of the worker and the business must be examined.

In any employee-independent contractor determination, all The extent to which the worker makes his or herinformation that provides evidence of the degree of control services available to the relevant market. An indepen-and the degree of independence must be considered. dent contractor is generally free to seek out business

opportunities. Independent contractors often advertise,Facts that provide evidence of the degree of control andmaintain a visible business location, and are available toindependence fall into three categories: behavioral control,work in the relevant market.financial control, and the type of relationship of the parties.

These facts are discussed next. How the business pays the worker. An employee isgenerally guaranteed a regular wage amount for an hourly,

Behavioral control. Facts that show whether the busi- weekly, or other period of time. This usually indicates that aness has a right to direct and control how the worker does worker is an employee, even when the wage or salary isthe task for which the worker is hired include the type and supplemented by a commission. An independent contrac-degree of: tor is often paid a flat fee or on a time and materials basis

for the job. However, it is common in some professions,Instructions that the business gives to the worker.such as law, to pay independent contractors hourly.An employee is generally subject to the business instruc-

tions about when, where, and how to work. All of the The extent to which the worker can realize a profit orfollowing are examples of types of instructions about how loss. An independent contractor can make a profit or loss.to do work.

Type of relationship. Facts that show the parties type of When and where to do the work. relationship include:

What tools or equipment to use. Written contracts describing the relationship theparties intended to create.

What workers to hire or to assist with the work.

Whether or not the business provides the worker Where to purchase supplies and services.

with employee-type benefits, such as insurance, What work must be performed by a specified a pension plan, vacation pay, or sick pay.

individual. The permanency of the relationship. If you en-

What order or sequence to follow. gage a worker with the expectation that the relation-ship will continue indefinitely, rather than for a

The amount of instruction needed varies among differ- specific project or period, this is generally consid-ent jobs. Even if no instructions are given, sufficient behav- ered evidence that your intent was to create an em-ioral control may exist if the employer has the right to ployer-employee relationship.control how the work results are achieved. A business may

The extent to which services performed by thelack the knowledge to instruct some highly specializedworker are a key aspect of the regular businessprofessionals; in other cases, the task may require little orof the company. If a worker provides services thatno instruction. The key consideration is whether the busi-are a key aspect of your regular business activity, itness has retained the right to control the details of ais more likely that you will have the right to direct andworkers performance or instead has given up that right.control his or her activities. For example, if a law firm

Training that the business gives to the worker. An hires an attorney, it is likely that it will present theemployee may be trained to perform services in a particu- attorneys work as its own and would have the rightlar manner. Independent contractors ordinarily use their to control or direct that work. This would indicate anown methods. employer-employee relationship.



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IRS help. If you want the IRS to determine whether or not contract established a flat amount for the services ren-a worker is an employee, file Form SS-8, Determination of dered by Bill Plum. Bill is a licensed roofer and carriesWorker Status for Purposes of Federal Employment Taxes workers compensation and liability insurance under theand Income Tax Withholding, with the IRS. business name, Plum Roofing. He hires his own roofers

who are treated as employees for federal employment taxpurposes. If there is a problem with the roofing work, PlumIndustry ExamplesRoofing is responsible for paying for any repairs. Bill Plum,doing business as Plum Roofing, is an independent con-The following examples may help you properly classifytractor.your workers.

Example 5. Vera Elm, an electrician, submitted a jobBuilding and Construction Industry estimate to a housing complex for electrical work at $16per hour for 400 hours. She is to receive $1,280 every 2weeks for the next 10 weeks. This is not considered pay-Example 1. Jerry Jones has an agreement with Wilmament by the hour. Even if she works more or less than 400White to supervise the remodeling of her house. She didhours to complete the work, Vera Elm will receive $6,400.not advance funds to help him carry on the work. SheShe also performs additional electrical installations undermakes direct payments to the suppliers for all necessarycontracts with other companies, that she obtained throughmaterials. She carries liability and workers compensation

insurance covering Jerry and others that he engaged to advertisements. Vera is an independent contractor.assist him. She pays them an hourly rate and exercisesalmost constant supervision over the work. Jerry is not free

Trucking Industryto transfer his assistants to other jobs. He may not work onother jobs while working for Wilma. He assumes no re-

Example. Rose Trucking contracts to deliver materialsponsibility to complete the work and will incur no contrac-for Forest, Inc., at $140 per ton. Rose Trucking is not paidtual liability if he fails to do so. He and his assistantsfor any articles that are not delivered. At times, Jan Rose,perform personal services for hourly wages. Jerry Joneswho operates as Rose Trucking, may also lease anotherand his assistants are employees of Wilma White.truck and engage a driver to complete the contract. All

Example 2. Milton Manning, an experienced tile setter, operating expenses, including insurance coverage, areorally agreed with a corporation to perform full-time serv- paid by Jan Rose. All equipment is owned or rented by Janices at construction sites. He uses his own tools and and she is responsible for all maintenance. None of theperforms services in the order designated by the corpora- drivers are provided by Forest, Inc. Jan Rose, operating astion and according to its specifications. The corporation Rose Trucking, is an independent contractor.supplies all materials, makes frequent inspections of hiswork, pays him on a piecework basis, and carries workers

Computer Industrycompensation insurance on him. He does not have a place

of business or hold himself out to perform similar servicesfor others. Either party can end the services at any time. Example. Steve Smith, a computer programmer, is laidMilton Manning is an employee of the corporation. off when Megabyte, Inc., downsizes. Megabyte agrees to

pay Steve a flat amount to complete a one-time project toExample 3. Wallace Black agreed with the Sawdust create a certain product. It is not clear how long that it will

Co. to supply the construction labor for a group of houses. take to complete the project, and Steve is not guaranteedThe company agreed to pay all construction costs. How- any minimum payment for the hours spent on the program.ever, he supplies all the tools and equipment. He performs Megabyte provides Steve with no instructions beyond thepersonal services as a carpenter and mechanic for an specifications for the product itself. Steve and Megabytehourly wage. He also acts as superintendent and foreman have a written contract, which provides that Steve is con-and engages other individuals to assist him. The company sidered to be an independent contractor, is required to payhas the right to select, approve, or discharge any helper. A federal and state taxes, and receives no benefits fromcompany representative makes frequent inspections of the Megabyte. Megabyte will file Form 1099-MISC, Miscella-construction site. When a house is finished, Wallace is neous Income, to report the amount paid to Steve. Stevepaid a certain percentage of its costs. He is not responsible works at home and is not expected or allowed to attendfor faults, defects of construction, or wasteful operation. At meetings of the software development group. Steve is anthe end of each week, he presents the company with a independent contractor.statement of the amount that he has spent, including thepayroll. The company gives him a check for that amount

Automobile Industryfrom which he pays the assistants, although he is notpersonally liable for their wages. Wallace Black and his

Example 1. Donna Lee is a salesperson employed on aassistants are employees of the Sawdust Co.full-time basis by Bob Blue, an auto dealer. She works six

Example 4. Bill Plum contracted with Elm Corporation days a week and is on duty in Bobs showroom on certainto complete the roofing on a housing complex. A signed assigned days and times. She appraises trade-ins, but her



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appraisals are subject to the sales managers approval. receives from customers. Although he receives the benefitLists of prospective customers belong to the dealer. She is of Tafts two-way radio communication equipment, dis-required to develop leads and report results to the sales patcher, and advertising, these items benefit both Taft andmanager. Because of her experience, she requires only Tom Spruce. Tom Spruce is an independent contractor.minimal assistance in closing and financing sales and inother phases of her work. She is paid a commission and is

Salespersoneligible for prizes and bonuses offered by Bob. Bob alsopays the cost of health insurance and group-term life

To determine whether salespersons are employees underinsurance for Donna. Donna is an employee of Bob Blue.

the usual common-law rules, you must evaluate each

individual case. If a salesperson who works for you doesExample 2. Sam Sparks performs auto repair services not meet the tests for a common-law employee, discussedin the repair department of an auto sales company. He

earlier in this section, you do not have to withhold federalworks regular hours and is paid on a percentage basis. Heincome tax from his or her pay (see Statutory Employeesinhas no investment in the repair department. The salessection 1). However, even if a salesperson is not an em-company supplies all facilities, repair parts, and supplies;ployee under the usual common-law rules, his or her payissues instructions on the amounts to be charged, parts tomay still be subject to social security, Medicare, and FUTAbe used, and the time for completion of each job; andtaxes.checks all estimates and repair orders. Sam is an em-

To determine whether a salesperson is an employee forployee of the sales company.social security, Medicare, and FUTA tax purposes, thesalesperson must meet all eight elements of the statutoryExample 3. An auto sales agency furnishes space foremployee test. A salesperson is a statutory employee forHelen Bach to perform auto repair services. She providessocial security, Medicare, and FUTA tax purposes if he orher own tools, equipment, and supplies. She seeks out

she:business from insurance adjusters and other individualsand does all of the body and paint work that comes to the1. Works full time for one person or company except,

agency. She hires and discharges her own helpers, deter-possibly, for sideline sales activities on behalf of

mines her own and her helpers working hours, quotessome other person,

prices for repair work, makes all necessary adjustments,assumes all losses from uncollectible accounts, and re- 2. Sells on behalf of, and turns his or her orders over to,ceives, as compensation for her services, a large percent- the person or company for which he or she works,age of the gross collections from the auto repair shop.

3. Sells to wholesalers, retailers, contractors, or opera-Helen is an independent contractor and the helpers are her

tors of hotels, restaurants, or similar establishments,employees.4. Sells merchandise for resale, or supplies for use in

the customers business,Attorney

5. Agrees to do substantially all of this work personally,

Example. Donna Yuma is a sole practitioner who rents 6. Has no substantial investment in the facilities used tooffice space and pays for the following items: telephone, do the work, other than in facilities for transportation,computer, on-line legal research linkup, fax machine, and

7. Maintains a continuing relationship with the person orphotocopier. Donna buys office supplies and pays barcompany for which he or she works, anddues and membership dues for three other professional

organizations. Donna has a part-time receptionist who also 8. Is not an employee under common-law rules.does the bookkeeping. She pays the receptionist, with-holds and pays federal and state employment taxes, andfiles a Form W-2 each year. For the past 2 years, Donnahas had only three clients, corporations with which there 3. Employees of Exempthave been long-standing relationships. Donna charges the

Organizationscorporations an hourly rate for her services, sendingmonthly bills detailing the work performed for the prior

Many nonprofit organizations are exempt from federal in-month. The bills include charges for long distance calls,come tax. Although they do not have to pay federal incomeon-line research time, fax charges, photocopies, postage,tax themselves, they must still withhold federal income taxand travel, costs for which the corporations have agreed tofrom the pay of their employees. However, there are spe-reimburse her. Donna is an independent contractor.cial social security, Medicare, and federal unemployment(FUTA) tax rules that apply to the wages that they pay their

Taxicab Driver employees.

Section 501(c)(3) organizations. Nonprofit organiza-Example. Tom Spruce rents a cab from Taft Cab Co.tions that are exempt from federal income tax under sec-for $150 per day. He pays the costs of maintaining andtion 501(c)(3) of the Internal Revenue Code include anyoperating the cab. Tom Spruce keeps all fares that he



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community chest, fund, or foundation organized and oper- 2. If an employee is paid less than $50 in a calendarquarter, his or her wages are not subject to FUTA taxated exclusively for religious, charitable, scientific, testingfor the quarter.for public safety, literary or educational purposes, fostering

national or international amateur sports competition, or forThe above rules do not apply to employees who work for

the prevention of cruelty to children or animals. Thesepension plans and other similar organizations described in

organizations are usually corporations and are exemptsection 401(a).

from federal income tax under section 501(a).

Social security and Medicare taxes. Wages paid toemployees of section 501(c)(3) organizations are subject 4. Religious Exemptions andto social security and Medicare taxes unless one of thefollowing situations applies. Special Rules for Ministers The organization pays an employee less than $100

Special rules apply to the treatment of ministers for socialin a calendar year.

security purposes. An exemption from social security is The organization is a church or church-controlled available for ministers and certain other religious workers

organization opposed for religious reasons to the and members of certain recognized religious sects. Forpayment of social security and Medicare taxes and more information on getting an exemption, see Publicationhas filed Form 8274, Certification by Churches and 517, Social Security and Other Information for Members ofQualified Church-Controlled Organizations Electing the Clergy and Religious Workers.Exemption From Employer Social Security and

Ministers. Ministers are individuals who are duly or-Medicare Taxes, to elect exemption from social se-dained, commissioned, or licensed by a religious bodycurity and Medicare taxes. The organization mustconstituting a church or church denomination. They arehave filed for exemption before the first date on

given the authority to conduct religious worship, performwhich a quarterly employment tax return (Form 941)sacerdotal functions, and administer ordinances and sac-or annual employment tax return (Form 944) wouldraments according to the prescribed tenets and practicesotherwise be due.of that religious organization.

Ministers are employees if they perform services in theAn employee of a church or church-controlled organiza-exercise of ministry and are subject to your will and control.tion that is exempt from social security and Medicare taxesThe common-law rules discussed in section 1 and sectionmust pay self-employment tax if the employee is paid2 should be applied to determine whether a minister is your$108.28 or more in a year. However, an employee who is aemployee or is self-employed. Whether the minister is anmember of a qualified religious sect can apply for anemployee or self-employed, the earnings of a minister areexemption from the self-employment tax by filing Formnot subject to federal income, social security, and Medi-4029, Application for Exemption From Social Security andcare tax withholding. However, even if the minister is aMedicare Taxes and Waiver of Benefits. See Members ofcommon law employee, the earnings as reported on therecognized religious sects opposed to insurancein

ministers Form 1040 are subject to self-employment taxsection 4. and federal income tax. You do not withhold these taxesFederal unemployment tax. An organization that is from wages earned by a minister, but if the minister is your

exempt from federal income tax under section 501(c)(3) of employee, you may agree with the minister to voluntarilythe Internal Revenue Code is also exempt from FUTA tax. withhold tax to cover the ministers liability forThis exemption cannot be waived. Do not file Form 940 to self-employment tax and federal income tax. For morereport wages paid by these organizations or pay the tax. information, see Publication 517.

Form W-2. If your minister is an employee, report allNote. An organization wholly owned by a state or itstaxable compensation as wages in box 1 on Form W-2.political subdivision should contact the appropriate stateInclude in this amount expense allowances or reimburse-official for information about reporting and getting socialments paid under a nonaccountable plan, discussed insecurity and Medicare coverage for its employees.section 5 of Publication 15 (Circular E). Do not include aparsonage allowance (excludable housing allowance) inOther than section 501(c)(3) organizations. Nonprofit

this amount. You may report a designated parsonage ororganizations that are not section 501(c)(3) organizations rental allowance (housing allowance) and a utilities allow-may also be exempt from federal income tax under sectionance, or the rental value of housing provided in a separate501(a) or section 521. However, these organizations arestatement or in box 14 on Form W-2. Do not show on Formnot exempt from withholding federal income, social secur-W-2, Form 941, or Form 944 any amount as social securityity, or Medicare tax from their employees pay, or fromor Medicare wages, or any withholding for social securitypaying FUTA tax. Two special rules for social security,or Medicare taxes. If you withheld federal income tax fromMedicare, and FUTA taxes apply.the minister under a voluntary agreement, this amount

1. If an employee is paid less than $100 during a calen- should be shown in box 2 on Form W-2 as federal incomedar year, his or her wages are not subject to social tax withheld. For more information on ministers, see Publi-security and Medicare taxes. cation 517.



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Exemptions for ministers and others. Certain ordainedministers, Christian Science practitioners, and members of 5. Wages and Otherreligious orders who have not taken a vow of poverty may

Compensationapply to exempt their earnings from self-employment taxon religious grounds. The application must be based on

Publication 15 (Circular E) provides a general discussionconscientious opposition because of personal considera-of taxable wages. Publication 15-B discusses fringe bene-tions to public insurance that makes payments in the eventfits. The following topics supplement those discussions.of death, disability, old age, or retirement, or that makes

payments toward the cost of, or provides services for,medical care, including social security and Medicare bene- Relocating for Temporary Workfits. The exemption applies only to qualified services per- Assignmentsformed for the religious organization. See RevenueProcedure 91-20, 1991-1 C.B. 524, for guidelines to deter- If an employee is given a temporary work assignmentmine whether an organization is a religious order or away from his or her regular place of work, certain travelwhether an individual is a member of a religious order. expenses reimbursed or paid directly by the employer in

To apply for the exemption, the employee should file accordance with an accountable plan (see section 5 inForm 4361, Application for Exemption From Publication 15 (Circular E)) may be excludable from theSelf-Employment Tax for Use by Ministers, Members of employees wages. Generally, a temporary work assign-Religious Orders and Christian Science Practitioners. See ment in a single location is one that is realistically expectedPublication 517 for more information about claiming an to last (and does in fact last) for 1 year or less. If theexemption from self-employment tax using Form 4361. employees new work assignment is indefinite, any living

expenses reimbursed or paid by the employer (other thanMembers of recognized religious sects opposed toqualified moving expenses) must be included in the em-insurance. If you belong to a recognized religious sect or

ployees wages as compensation. For the travel expensesto a division of such sect that is opposed to insurance, youto be excludable:may qualify for an exemption from the self-employment

tax. To qualify, you must be conscientiously opposed to The new work location must be outside of the city or

accepting the benefits of any public or private insurance general area of the employees regular work place orthat makes payments because of death, disability, old age, post of duty,or retirement, or makes payments toward the cost of, or

The travel expenses must otherwise qualify as de-provides services for, medical care (including social secur-ductible by the employee, andity and Medicare benefits). If you buy a retirement annuity

from an insurance company, you will not be eligible for this The expenses must be for the period during which

exemption. Religious opposition based on the teachings of the employee is at the temporary work location.the sect is the only legal basis for the exemption. In addi-tion, your religious sect (or division) must have existed If you reimburse or pay any personal expenses of ansince December 31, 1950. employee during his or her temporary work assignment,

such as expenses for home leave for family members orSelf-employed. If you are self-employed and a mem-for vacations, these amounts must be included in theber of a recognized religious sect opposed to insurance,employees wages. See chapter 1 of Publication 463,you can apply for exemption by filing Form 4029, Applica-Travel, Entertainment, Gift, and Car Expenses, and sec-tion for Exemption From Social Security and Medicaretion 5 of Publication 15 (Circular E), for more information.Taxes and Waiver of Benefits, and waive all social securityThese rules generally apply to temporary work assign-and Medicare benefits.ments both inside and outside the U.S.

Employees. The social security and Medicare tax ex-emption available to the self-employed who are members

Employee Achievement Awardsof a recognized religious sect opposed to insurance is alsoavailable to their employees who are members of such a

Do not withhold federal income, social security, or Medi-sect. This applies to partnerships only if each partner is a

care taxes on the fair market value of an employeemember of the sect. This exemption for employees applies

achievement award if it is excludable from your employees

only if both the employee and the employer are members gross income. To be excludable from your employeesof such a sect, and the employer has an exemption. To getgross income, the award must be tangible personal prop-

the exemption, the employee must file Form 4029.erty (not cash, gift certificates, or securities) given to an

An employee of a church or church-controlled organiza-employee for length of service or safety achievement,

tion that is exempt from social security and Medicare taxesawarded as part of a meaningful presentation, and

can also apply for an exemption on Form 4029.awarded under circumstances that do not indicate that thepayment is disguised compensation. Excludable em-ployee achievement awards also are not subject to FUTAtax.

Limits. The most that you can exclude for the cost of allemployee achievement awards to the same employee for



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the year is $400. A higher limit of $1,600 applies to quali- The employee would be able to deduct the cost ofthe services as employee business expenses if he orfied plan awards. Qualified plan awards are employeeshe had paid for them.achievement awards under a written plan that does not

discriminate in favor of highly compensated employees.However, if you receive no additional benefit from pro-An award cannot be treated as a qualified plan award if the

viding the services, or if the services are not provided onaverage cost per recipient of all awards under all of yourthe basis of employee need, then the value of the servicesqualified plans is more than $400.is treated as wages and is subject to federal income taxIf during the year an employee receives awards notwithholding and social security and Medicare taxes. Simi-made under a qualified plan and also receives awardslarly, if an employee receives the outplacement services inunder a qualified plan, the exclusion for the total cost of all

exchange for reduced severance pay (or other taxableawards to that employee cannot be more than $1,600. Thecompensation), then the amount the severance pay is$400 and $1,600 limits cannot be added together to ex-reduced is treated as wages for employment tax purposes.clude more than $1,600 for the cost of awards to any one

employee during the year.Withholding for Idle Time

Scholarship and FellowshipPayments made under a voluntary guarantee to employ-

Payments ees for idle time (any time during which an employeeperforms no services) are wages for the purposes of social

Only amounts that you pay as a qualified scholarship to a security, Medicare, FUTA taxes, and federal income taxcandidate for a degree may be excluded from the recipi- withholding.ents gross income. A qualified scholarship is any amountgranted as a scholarship or fellowship that is used for:

Back Pay Tuition and fees required to enroll in, or to attend, an

educational institution, or Treat back pay as wages in the year paid and withhold andpay employment taxes as required. If back pay was

Fees, books, supplies, and equipment that are re-awarded by a court or government agency to enforce a

quired for courses at the educational institution.federal or state statute protecting an employees right toemployment or wages, special rules apply for reporting

The exclusion from income does not apply to the portionthose wages to the Social Security Administration. These

of any amount received that represents payment for teach-rules also apply to litigation actions, and settlement agree-

ing, research, or other services required as a condition ofments or agency directives that are resolved out of court

receiving the scholarship or tuition reduction. Theseand not under a court decree or order. Examples of perti-

amounts are reportable on Form W-2. However, the exclu-nent statutes include, but are not limited to, the National

sion will still apply for any amount received under twoLabor Relations Act, Fair Labor Standards Act, Equal Pay

specific programsthe National Health Service CorpsAct, and Age Discrimination in Employment Act. See Publi-

Scholarship Program and the Armed Forces Health Pro-cation 957, Reporting Back Pay and Special Wage Pay-fessions Scholarship and Financial Assistance Program ments to the Social Security Administration, and Form

despite any service condition attached to those amounts.SSA-131, Employer Report of Special Wage Payments,

Any amounts that you pay for room and board are not for details.excludable from the recipients gross income. A qualifiedscholarship is not subject to social security, Medicare, and

Supplemental UnemploymentFUTA taxes, or federal income tax withholding. For moreBenefitsinformation, see Publication 970, Tax Benefits for Educa-

tion.If you pay, under a plan, supplemental unemploymentbenefits to a former employee, all or part of the payments

Outplacement Services may be taxable and subject to federal income tax withhold-ing, depending on how the plan is funded. Amounts thatIf you provide outplacement services to your employees torepresent a return to the employee of amounts previously

help them find new employment (such as career counsel-subject to tax are not taxable and are not subject toing, resume assistance, or skills assessment), the value ofwithholding. You should withhold federal income tax on the

these benefits may be income to them and subject to alltaxable part of the payments made, under a plan, to an

withholding taxes. However, the value of these servicesemployee who is involuntarily separated because of a

will not be subject to any employment taxes if:reduction in force, discontinuance of a plant or operation,

You derive a substantial business benefit from pro- or other similar condition. It does not matter whether theviding the services (such as improved employee mo- separation is temporary or permanent.rale or business image) separate from the benefit There are special rules that apply in determiningthat you would receive from the mere payment of whether benefits qualify as supplemental unemploymentadditional compensation, and benefits that are excluded from wages for social security,



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Medicare, and FUTA tax purposes. To qualify as supple- the 12-month period prior to and ending on the date of themental unemployment benefits for these purposes, the change in ownership or control of the corporation (thebenefits must meet the following requirements. disqualified individual determination period) was an em-

ployee or independent contractor and was, in regard to that Benefits are paid only to unemployed former em-

corporation, a shareholder, an officer, or highly compen-ployees who are laid off by the employer.

sated individual. Eligibility for benefits depends on meeting prescribed

conditions after termination. Example. An officer of a corporation receives a goldenparachute payment of $400,000. This is more than three

The amount of weekly benefits payable is basedtimes greater than his or her average compensation of

upon state unemployment benefits, other compensa-$100,000 over the previous 5-year period. The excesstion allowable under state law, and the amount ofparachute payment is $300,000 ($400,000 minus

regular weekly pay.$100,000). The corporation cannot deduct the $300,000

The right to benefits does not accrue until a pre- and must withhold the excise tax of $60,000 (20% ofscribed period after termination. $300,000).

Benefits are not attributable to the performance ofReporting golden parachute payments. Golden para-

particular services.chute payments to employees must be reported on Form

No employee has any right to the benefits until quali- W-2. See the Instructions for Forms W-2 and W-3 forfied and eligible to receive benefits. details. For nonemployee reporting of these payments,

see Box 7. Nonemployee Compensationin the Instructions Benefits may not be paid in a lump sum.

for Form 1099-MISC.

Withholding on taxable supplemental unemployment

Exempt payments. Payments by most small businessbenefits must be based on the withholding certificate corporations and payments under certain qualified plans(Form W-4) that the employee gave to you.

are exempt from the golden parachute rules. See section280G(b)(5) and (6) for more information.

Golden Parachute Payments

Interest-Free andA golden parachute payment, in general, is a paymentmade under a contract entered into by a corporation and Below-Market-Interest-Rate Loanskey personnel. Under the agreement, the corporation

In general, if an employer lends an employee more thanagrees to pay certain amounts to its key personnel in the$10,000 at an interest rate less than the current applicableevent of a change in ownership or control of the corpora-federal rate (AFR), the difference between the interest paidtion. Payments to employees under golden parachute con-and the interest that would be paid under the AFR istracts are subject to social security, Medicare, FUTA taxes,considered additional compensation to the employee. Thisand federal income tax withholding. See Regulations sec-

rule applies to a loan of $10,000 or less if one of itstion 1.280G-1 for more information.principal purposes is the avoidance of federal tax.No deduction is allowed to the corporation for any ex-

This additional compensation to the employee is sub-cess parachute payment. To determine the amount of theject to social security, Medicare, and FUTA taxes, but notexcess parachute payment, you must first determine ifto federal income tax withholding. Include it in compensa-there is a parachute payment for purposes of sectiontion on Form W-2 (or Form 1099-MISC for an independent280G. A parachute payment for purposes of section 280Gcontractor). The AFR is established monthly and publishedis any payment that meets all of the following.by the IRS each month in the Internal Revenue Bulletin.You can get these rates by calling 1-800-829-4933 or by1. The payment is in the nature of compensation.visiting IRS.gov. For more information, see section 7872

2. The payment is to, or for the benefit of, a disqualifiedand its related regulations.

individual (defined below).

3. The payment is contingent on a change in ownership Leave Sharing Plansof the corporation, the effective control of the corpo-ration, or the ownership of a substantial portion of the If you establish a leave sharing plan for your employeesassets of the corporation. that allows them to transfer leave to other employees for

medical emergencies, the amounts paid to the recipients of4. The payment has an aggregate present value of atthe leave are considered wages. These amounts are in-least three times the individuals base amount. Thecludible in the gross income of the recipients and arebase amount is the average annual compensation forsubject to social security, Medicare, and FUTA taxes, andservice includible in the individuals gross incomefederal income tax withholding. Do not include theseover the most recent 5 taxable years.amounts in the income of the transferors. These rulesapply only to leave sharing plans that permit employees to

Disqualified individual. A disqualified individual, re- transfer leave to other employees for medical emergen-ferred to in item 2 above, is anyone who at any time during cies.



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determine later, when the amount is reasonably ascertain-Nonqualified Deferred Compensationable, whether any additional taxes are required. If taxes

Plans are not paid before the amounts become reasonably as-certainable, when the amounts become reasonably ascer-tainable they are subject to social security, Medicare, andIncome Tax and ReportingFUTA taxes on the amounts deferred plus the income

Section 409A provides that all amounts deferred under a attributable to those amounts deferred. For more informa-nonqualified deferred compensation (NQDC) plan for all tion, see Regulations sections 31.3121(v)(2)-1 andtax years are currently includible in gross income (to the 31.3306(r)(2)-1.extent not subject to a substantial risk of forfeiture and not

previously included in gross income) and subject to addi- Tax-Sheltered Annuitiestional taxes, unless certain requirements are met pertain-ing to, among other things, elections to defer Employer payments made by an educational institution orcompensation and distributions under a NQDC plan. Sec- a tax-exempt organization to purchase a tax-shelteredtion 409A also includes rules that apply to certain trusts or annuity for an employee (annual deferrals) are included insimilar arrangements associated with NQDC plans if the the employees social security and Medicare wages if thetrusts or arrangements are located outside of the United payments are made because of a salary reduction agree-States, are restricted to the provision of benefits in connec- ment. However, they are not included in box 1 on Formtion with a decline in the financial health of the plan spon- W-2 in the year the deferrals are made and are not subjectsor, or contributions are made to the trust during certain to federal income tax withholding. See Regulations sectionperiods such as when a qualified plan of the service recipi- 31.3121(a)(5)-2 for the definition of a salary reductionent is underfunded. Employers must withhold federal in- agreement.come tax (but not the additional Section 409A taxes) on

any amount includible in gross income under section 409A. Contributions to a SimplifiedOther changes to the Internal Revenue Code provide thatEmployee Pension (SEP)the deferrals under a NQDC plan must be reported sepa-

rately on Form W-2 or Form 1099-MISC, whichever ap-An employers SEP contributions to an employees individ-plies. Specific rules for reporting are provided in theual retirement arrangement (IRA) are excluded from theinstructions to the forms. The provisions do not affect theemployees gross income. These excluded amounts areapplication or reporting of social security, Medicare, ornot subject to social security, Medicare, FUTA taxes, orFUTA taxes.federal income tax withholding. However, any SEP contri-The provisions do not prevent the inclusion of amountsbutions paid under a salary reduction agreement (SAR-in income or wages under other provisions of the InternalSEP) are included in wages for purposes of social securityRevenue Code or common law principles, such as whenand Medicare taxes and for FUTA. See Publication 560 foramounts are actually or constructively received or irrevo-more information about SEPs.cably contributed to a separate fund. For more information

about nonqualified deferred compensation plans, see Reg-Salary reduction simplified employee pensionsulations sections 1.409A-1 through 1.409A-6. Notice (SARSEP) repealed. You may not establish a SARSEP

2008-113 provides guidance on the correction of certain after 1996. However, SARSEPs established before Janu-operation failures of a NQDC plan. See Notice 2008-113, ary 1, 1997, may continue to receive contributions.2008-51 I.R.B. 1305, available atwww.irs.gov/irb/2008-51_IRB/ar12.html. Also see Notice

SIMPLE Retirement Plans2010-6, 2010-3 I.R.B. 275, available atwww.irs.gov/irb/2010-03_IRB/ar08.html and Notice Employer and employee contributions to a savings incen-2010-80, 2010-51 I.R.B. 853, available at tive match plan for employees (SIMPLE) retirement ac-www.irs.gov/irb/2010-51_IRB/ar08.html. count (subject to limitations) are excludable from the

employees income and are exempt from federal incomeSocial security, Medicare, and FUTA taxes. Employertax withholding. An employers nonelective (2%) or match-contributions to nonqualified deferred compensationing contributions are exempt from social security, Medi-(NQDC) plans, as defined in the applicable regulations, arecare, and FUTA taxes. However, an employees salary

treated as social security, Medicare, and FUTA wages reduction contributions to a SIMPLE are subject to socialwhen the services are performed or the employee nosecurity, Medicare, and FUTA taxes. For more informationlonger has a substantial risk of forfeiting the right to theabout SIMPLE retirement plans, see Publication 560.deferred compensation, whichever is later.

Amounts deferred are subject to social security, Medi-care, and FUTA taxes at that time unless the amount that isdeferred cannot be reasonably ascertained; for example, if 6. Sick Pay Reportingbenefits are based on final pay. If the value of the futurebenefit is based on any factors that are not yet reasonably Special rules apply to the reporting of sick pay payments toascertainable, you may choose to estimate the value of the employees. How these payments are reported depends onfuture benefit and withhold and pay social security, Medi- whether the payments are made by the employer or a thirdcare, and FUTA taxes on that amount. You will have to party, such as an insurance company.

http://www.irs.gov/irb/2010-51_IRB/ar08.htmlhttp://www.irs.gov/irb/2010-03_IRB/ar08.htmlhttp://www.irs.gov/irb/2008-51_IRB/ar12.html


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Sick pay is usually subject to social security, Medicare, b. Permanent loss of the use of a member or func-tion of the body, orand FUTA taxes. For exceptions, see Social Security,

Medicare, and FUTA Taxes on Sick Pay, later in this c. Permanent disfigurement of the body.section. Sick pay may also be subject to either mandatory

Example. Donald was injured in a car accident andor voluntary federal income tax withholding, depending onlost an eye. Under a policy paid for by Donalds em-who pays it.ployer, Delta Insurance Co. paid Donald $20,000 ascompensation for the loss of his eye. Because the

Sick Pay payment was determined by the type of injury and wasunrelated to Donalds absence from work, it is not sick

Sick pay generally means any amount paid under a planpay and is not subject to federal employment taxes.because of an employees temporary absence from work

due to injury, sickness, or disability. It may be paid by eitherthe employer or a third party, such as an insurance com- Sick Pay Planpany. Sick pay includes both short- and long-term benefits.

A sick pay plan is a plan or system established by anIt is often expressed as a percentage of the employeesemployer under which sick pay is available to employeesregular wages.generally or to a class or classes of employees. This doesnot include a situation in which benefits are provided on aPayments That Are Not Sick Paydiscretionary or occasional basis with merely an intentionto aid particular employees in time of need.Sick pay does not include the following payments.

You have a sick pay plan or system if the plan is in1. Disability retirement payments. Disability retire- writing or is otherwise made known to employees, such as

ment payments are not sick pay and are not dis-by a bulletin board notice or your long and establishedcussed in this section. Those payments are subject practice. Some indications that you have a sick pay plan or

to the rules for federal income tax withholding from system include references to the plan or system in thepensions and annuities. See section 8. contract of employment, employer contributions to a plan,

or segregated accounts for the payment of benefits.2. Workers compensation. Payments because of a

work-related injury or sickness that are made under aDefinition of employer. The employer for whom the em-

workers compensation law are not sick pay and are ployee normally works, a term used in the following discus-not subject to employment taxes. But see Payments sion, is either the employer for whom the employee wasin the nature of workers compensationpublic em- working at the time that the employee became sick orployees, next. disabled or the last employer for whom the employee

worked before becoming sick or disabled, if that employer3. Payments in the nature of workersmade contributions to the sick pay plan on behalf of thecompensationpublic employees. State and localsick or disabled employee.

government employees, such as police officers andfirefighters, sometimes receive payments due to anNote. Contributions to a sick pay plan through a cafete-injury in the line of duty under a statute that is not the

ria plan (by direct employer contributions or salary reduc-general workers compensation law of a state. If the

tion) are employer contributions unless they are after-taxstatute limits benefits to work-related injuries or sick-

employee contributions (that is, included in taxableness and does not base payments on the em-

wages).ployees age, length of service, or prior contributions,the statute is in the nature of a workers compensa-

Third-Party Payers of Sick Paytion law. Payments under a statute in the nature of aworkers compensation law are not sick pay and are

Employers agent. An employers agent is a third partynot subject to employment taxes. For more informa-that bears no insurance risk and is reimbursed on ation, see Regulations section 31.3121(a)(2)-1.cost-plus-fee basis for payment of sick pay and similar

4. Medical expense payments. Payments under a def-

amounts. A third party may be your agent even if the thirdinite plan or system for medical and hospitalization party is responsible for determining which employees areexpenses, or for insurance covering these expenses, eligible to receive payments. For example, if a third partyare not sick pay and are not subject to employment provides administrative services only, the third party istaxes. your agent. If the third party is paid an insurance premium

and is not reimbursed on a cost-plus-fee basis, the third5. Payments unrelated to absence from work. Acci-party is not your agent. Whether an insurance company ordent or health insurance payments unrelated to ab-other third party is your agent depends on the terms of theirsence from work are not sick pay and are not subjectagreement with you.to employment taxes. These include payments for:

A third party that makes payments of sick pay as youra. Permanent loss of a member or function of the agent is not considered the employer and generally has no

body, responsibility for employment taxes. This responsibility



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remains with you. However, under an exception to this reason not to believe the information, it may rely on thatinformation for the following items.rule, the parties may enter into an agreement that makes

the third-party agent responsible for employment taxes. In The total wages paid to the employee during the

this situation, the third-party agent should use its owncalendar year.

name and employer identification number (EIN) (rather The last month in which the employee worked for thethan your name and EIN) for the responsibilities that it has

employer.assumed.

The employee contributions to the sick pay planThird party not employers agent. A third party that made with after-tax dollars.makes payments of sick pay other than as an agent of the

employer is liable for federal income tax withholding (if The third party should not rely on statements regardingrequested by the employee) and the employee part of the these items made by the employee.social security and Medicare taxes.

The third party is also liable for the employer part of the Social Security, Medicare, and FUTAsocial security and Medicare taxes and the FUTA tax,

Taxes on Sick Payunless the third party transfers this liability to the employerfor whom the employee normally works. This liability istransferred if the third party takes the following steps. Employer. If you pay sick pay to your employee, you must

generally withhold employee social security and Medicare1. Withholds the employee social security and Medi- taxes from the sick pay. You must timely deposit employee

care taxes from the sick pay payments. and employer social security and Medicare taxes andFUTA tax. There are no special deposit rules for sick pay.2. Makes timely deposits of the employee social secur-See section 11 of Publication 15 (Circular E) for moreity and Medicare taxes.information on the deposit rules.

3. Notifies the employer for whom the employee nor-mally works of the payments on which employee Amounts not subject to social security, Medicare, ortaxes were withheld and deposited. The third party FUTA taxes. The following payments, whether made bymust notify the employer within the time required for the employer or a third party, are not subject to socialthe third partys deposit of the employee part of the security, Medicare, or FUTA taxes (different rules apply tosocial security and Medicare taxes. For instance, if federal income tax withholding).the third party is a monthly schedule depositor, it

Payments after an employees death or disabilitymust notify the employer by the 15th day of theretirement. Social security, Medicare, and FUTAmonth following the month in which the sick paytaxes do not apply to amounts paid under a definitepayment is made because that is the day by whichplan or system, as defined under Sick Pay Plan,the deposit is required to be made. The third partyearlier in this section, on or after the termination ofshould notify the employer as soon as information onthe employment relationship because of death or

payments is available so that an employer required disability retirement. However, even if there is a defi-to make electronic deposits can make them timely.nite plan or system, amounts paid to a former em-For multi-employer plans, see the special rule dis-ployee are subject to social security, Medicare, andcussed next.FUTA taxes if they would have been paid even if theemployment relationship had not terminated be-Multi-employer plan timing rule. A special rule ap-cause of death or disability retirement. For example,plies to sick pay payments made to employees by aa payment to a disabled former employee for unusedthird-party insurer under an insurance contract with avacation time would have been made whether or notmulti-employer plan established under a collectively bar-the employee retired on disability. Therefore, thegained agreement. If the third-party insurer making thepayment is wages and is subject to social security,

payments complies with steps 1 and 2 above and gives theMedicare, and FUTA taxes.

plan (rather than the employer) the required timely noticedescribed in step 3 above, then the plan (not the third-party Payments after calendar year of employees

insurer) must pay the employer part of the social security death. Sick pay paid to the employees estate orand Medicare taxes and the FUTA tax. Similarly, if within survivor after the calendar year of the employeessix business days of the plans receipt of notification, the death is not subject to social security, Medicare, or

FUTA taxes. Also, see Amounts not subject to incomeplan gives notice to the employer for whom the employeetax withholding under Income Tax Withholding onnormally works, the employer (not the plan) must pay theSick Pay, later in this section.employer part of the social security and Medicare taxes

and the FUTA tax. Example. Sandra became entitled to sick pay onNovember 24, 2011, and died on December 31, 2011.

Reliance on information supplied by the employer. A On January 12, 2012, Sandras sick pay for the periodthird party that pays sick pay should request information from December 24 through December 31, 2011, wasfrom the employer to determine amounts that are not paid to her survivor. The payment is not subject tosubject to employment taxes. Unless the third party has social security, Medicare, or FUTA taxes.



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Payments to an employee entitled to disability effect less than 1 year, a reasonable estimate of theinsurance benefits. Payments to an employee cost for the first policy year.when the employee is entitled to disability insurance Example. Alan is employed by Edgewood Corpora-benefits under section 223(a) of the Social Security tion. Because of an illness, he was absent from workAct are not subject to social security and Medicare for 3 months during 2012. Key Insurance Companytaxes. This rule applies only if the employee became paid Alan $2,000 sick pay for each month of hisentitled to the Social Security Act benefits before the absence under a policy paid for by contributions fromcalendar year in which the payments are made, and both Edgewood and its employees. All of the employ-the employee performs no services for the employer ees contributions were paid with after-tax dollars. Forduring the period for which the payments are made. the 3 policy years before 2012, Edgewood paid 70%However, these payments are subject to FUTA tax. of the policys cost and its employees paid 30%.

Because 70% of the sick pay paid under the policy is Payments that exceed the applicable wage base.due to Edgewoods contributions, $1,400 ($2,000 Social security and FUTA taxes do not apply to pay-70%) of each payment made to Alan is taxable sickments of sick pay that, when combined with the regu-pay. The remaining $600 of each payment that is duelar wages and sick pay previously paid to the

employee during the year, exceed the applicable to employee contributions is not taxable sick pay andwage base. Because there is no Medicare tax wage is not subject to employment taxes. Also, see Exam-base, this exception does not apply to Medicare tax. ple of Figuring and Reporting Sick Pay, later in thisThe social security tax wage base for 2012 is section.$110,100. The FUTA tax wage base is $7,000.

Example. If an employee receives $100,000 inwages from an employer in 2012 and then receives Income Tax Withholding on Sick Pay

$15,000 of sick pay, only the first $10,100 of the sick The requirements for federal income tax withholding onpay is subject to social security tax. All of the sick paysick pay and the methods for figuring it differ depending onis subject to Medicare tax. None of the sick pay is

subject to FUTA tax. See Example of Figuring and whether the sick pay is paid by:Reporting Sick Pay, later in this section.

The employer, Payments after 6 months absence from work. So-

An agent of the employer (defined earlier in thiscial security, Medicare, and FUTA taxes do not apply

section), orto sick pay paid more than 6 calendar months after thelast calendar month in which the employee worked. A third party that is not the employers agent.

Example 1. Ralphs last day of work before he be-came entitled to receive sick pay was December 13, Employer or employers agent. Sick pay paid by you or2011. He was paid sick pay for 9 months before his your agent is subject to mandatory federal income taxreturn to work on September 12, 2012. Sick pay paid withholding. An employer or agent paying sick pay gener-to Ralph after June 30, 2012, is not subject to social ally determines the federal income tax to be withheldsecurity, Medicare, or FUTA taxes. based on the employees Form W-4. The employee cannotExample 2. The facts are the same as in Example 1, choose how much will be withheld by giving you or yourexcept that Ralph worked 1 day during the 9-month agent a Form W-4S. Sick pay paid by an agent is treatedperiod, on February 13, 2012. Because the 6-month as supplemental wages. If the agent does not pay regularperiod begins again in March, only the sick pay paid to wages to the employee, the agent may choose to withholdRalph after August 31, 2012, is exempt from social federal income tax at a flat 25% rate, rather than at thesecurity, Medicare, and FUTA taxes. wage withholding rate. See section 7 in Publication 15

(Circular E) for the flat rate (35%) when supplemental Payments attributable to employee contributions.

wage payments to an individual exceed $1 million duringSocial security, Medicare, and FUTA taxes do notthe year.apply to payments, or parts of payments, attributable

to employee contributions to a sick pay plan madeThird party not an agent. Sick pay paid by a third party

with after-tax dollars. Contributions to a sick pay plan that is not your agent is not subject to mandatory federalmade on behalf of employees with employees pre-taxincome tax withholding. However, an employee may electdollars under a cafeteria plan are employer contribu-to have federal income tax withheld by submitting Formtions.W-4S to the third party.Group policy. If both the employer and the employee

If Form W-4S has been submitted, the third party shouldcontributed to the sick pay plan under a group insur-withhold federal income tax on all payments of sick payance policy, figure the taxable sick pay by multiplyingmade 8 or more days after receiving the form. The thirdtotal sick pay by the percentage of the policys

irs publication 15a

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