EA2 Study Unit 4.1 - Compensation PDF

2 SU 4: Business Expenses 4.1 COMPENSATION A deduction is generally allowed for salaries, wages, and other forms of payment made to officers and employees. 1. Compensation must meet all of the following tests to be deductible: Ordinary and Necessary a. Payments must b...

2 SU 4: Business Expenses 4.1 COMPENSATION A deduction is generally allowed for salaries, wages, and other forms of payment made to officers and employees. 1. Compensation must meet all of the following tests to be deductible: Ordinary and Necessary a. Payments must be ordinary and necessary expenses directly related to the trade or business. 1) Certain wages or salaries paid by a company may be considered direct or indirect costs of producing property. a) If the property is inventory, the wages are added to inventory. b) The costs are capitalized and depreciated for any other property. Reasonable b. Reasonable pay is the amount that would ordinarily be paid for the services by a like enterprise under similar circumstances at the time the services are contracted. Paid or Incurred c. The expenses must have been paid or incurred during the tax year. Paid to Employees d. Employees are generally individuals who perform services for a company, and the company controls when and how the work is performed. 1) Individuals in business for themselves are generally not considered employees (Publication 15). 2) Direct sellers and qualified real estate agents are considered nonemployees. 1 Subunit 4.2 has information on cost of goods sold (COGS). 2. Cash Payments a. Bonuses paid to an employee for services actually performed may be deductible if they are reasonable for the type of services performed. b. Loans or advances made to employees may be deducted if it is doubtful that the employee will repay the loan. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 4: Business Expenses 3 c. Vacation pay is income to the employee whether or not the employee chooses to go on vacation. 1) Cash- and accrual-basis taxpayers deduct vacation pay when it is paid (received by the employee). 2) For accrual-basis taxpayers, the deduction is allowed for amounts vested by year- end and paid within 2 1/2 months after the close of the tax year. d. Unpaid salaries may be deducted by accrual-basis taxpayers if 1) Economic performance has occurred in the tax year, 2) There is an unconditional agreement to pay an employee, and 3) The payments are made within 2 1/2 months after the close of the tax year. a) Payments made to cash-basis related taxpayers (i.e., brothers, sisters, spouses, and lineal descendants) as wages are not deductible until the tax year in which the payment is made. e. Sick pay is deductible but limited to amounts not compensated by insurance or other means. 3. Noncash Payments a. Gifts of nominal value are deductible as nonwage business expenses. The deduction for gifts is limited to $25 per recipient per year. b. Gifts to an employee must not be excluded from income and are taxable to the employee. c. Transfers of property to an employee can also be considered compensation, and the fair market value of such property on the date of transfer is deductible. 1) A gain or loss is recognized on the transfer of the difference between fair market value and the adjusted basis. 4. Employee Benefit Programs a. Cafeteria plans allow employees to choose among two or more benefits consisting of cash and qualified benefits. 1) The participant does not include any benefit amounts in gross income unless the cash is chosen. 2) The employee must choose the benefit before the tax year begins. 3) Any unused benefit is forfeited. 4) If a cafeteria plan discriminates in favor of certain employees as to eligibility to participate in the plan, the favored employees are taxed on the taxable benefits they could have received under the plan. 5) Qualified (cafeteria plan) benefits include the following benefits: a) Accident and health benefits (but not medical savings accounts or long-term care insurance) b) Adoption assistance c) Dependent care assistance d) Group-term life insurance coverage (up to $50,000 including costs that cannot be excluded from wages) e) Group legal services f) Disability benefits Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 4 SU 4: Business Expenses 6) A cafeteria plan cannot include the following benefits: a) Archer medical savings accounts b) Athletic facilities c) De minimis (minimal) benefits d) Educational assistance e) Employee discounts f) Lodging on the taxpayer’s business premises g) Meals h) Moving expense reimbursements i) No-additional-cost services j) Scholarships and fellowships k) Transportation (commuting) benefits l) Tuition reduction m) Working condition benefits 7) Accident and health benefits apply to payments the taxpayer makes (directly or indirectly) to an employee, under an accident or health plan for employees, that are either of the following: a) Payments or reimbursements of medical expenses. b) Payments for specific injuries or illnesses (such as the loss of the use of an arm or leg). 8) Nonemployee beneficiaries (e.g., spouses) may not participate in a cafeteria plan. b. When an employer makes payments or reimbursements for an employee’s qualified educational expenses, the employer generally is allowed to deduct the expenses. 1) Under an employer’s educational assistance program, the employee may exclude up to $5,250 from his or her gross income. 2) Graduate and undergraduate coursework qualify for the deduction. 3) Under the CARES Act, payments made by an employer to an employee or lender between March 27, 2020, and January 1, 2026, on any qualified educational loan incurred by the employee for his or her education may be excluded by the employer from the employee’s taxable wages. c. Dependent care assistance can be deducted when 1) The employer provides a dependent care facility for employees, 2) The employer contracts for services with a third-party dependent care provider, or 3) Employees are reimbursed for dependent care services. The maximum amount excludable from an employee’s gross income cannot exceed $5,000 ($2,500 MFS) per year. d. Group-term life insurance does not have to be included in an employee’s income if the employer does not provide more than $50,000 of coverage. e. An employer may deduct contributions paid or accrued to a welfare benefit fund, as long as the contributions for the year do not exceed benefits actually paid out during the year. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 4: Business Expenses 5 5. Fringe Benefits a. An employer can exclude from the employee’s income certain qualified fringe benefits provided by the employer. Examples include 1) No-additional-cost services (e.g., standby flights to flight attendants) 2) Qualified employee discounts 3) De minimis fringe benefits (e.g., non-cash achievement award up to $400 nonqualified plan/$1,600 qualified plan) 4) Qualified transportation fringes -- $300 per month for commuter or transit passes and $300 per month for parking 5) On-premises athletic facilities 6) Qualifying adoption expenses of $15,950 7) Occasional tickets to sporting events b. An employer car for personal use is included in wages. 6. Rules of Family Employment Child Employed by Parents a. Payments for the services of a child under age 18 who works for his or her parents in a trade or business are not subject to Social Security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child. 1) Payments for the services of a child under age 21 who works for his or her parent are not subject to federal unemployment (FUTA) tax. a) Although not subject to FUTA tax, the wages of a child may be subject to income tax withholding. One Spouse Employed by Another b. The wages for the services of an individual who works for his or her spouse in a trade or business are subject to income tax withholding and Social Security and Medicare taxes, but not to FUTA tax. Covered Services of a Child or Spouse c. The wages for the services of a child or spouse are subject to income tax withholding as well as to Social Security, Medicare, and FUTA taxes if (s)he works for 1) A corporation, even if it is controlled by the child’s parent or the individual’s spouse; 2) A partnership, even if the child’s parent is a partner, unless each partner is a parent of the child; 3) A partnership, even if the individual’s spouse is a partner; or 4) An estate, even if it is the estate of a deceased parent. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 6 SU 4: Business Expenses Parent Employed by Child d. The wages for the services of a parent employed by his or her child in a trade or business are subject to income tax withholding and Social Security and Medicare taxes. e. Social Security and Medicare taxes do not apply to wages paid to a parent for services not in a trade or business, but they do apply to domestic services if 1) The parent cares for a child who lives with a son or daughter and who is under age 18 or requires adult supervision for at least 4 continuous weeks in a calendar quarter due to a mental or physical condition and 2) The son or daughter is a widow or widower, divorced, or married to a person who, because of a physical or mental condition, cannot care for the child during such period. f. Wages paid to a parent employed by his or her child are not subject to FUTA tax, regardless of the type of services provided. Statutory Employees 7. An employer should indicate on the worker’s Form W-2 whether the worker is classified as a statutory employee. A statutory employee is an independent contractor who is treated as an employee for employment tax purposes. The most common type of statutory employee is a driver who distributes beverages (other than milk), meat, fruit, vegetables, or bakery products. a. Statutory employees report their wages, income, and allowable expenses on Schedule C, Form 1040. b. Statutory employees are not liable for self-employment tax because their employers must treat them as employees for Social Security tax purposes. 8. Documentation of Compensation Deductions W-2 a. Employers must file Form W-2 for wages paid to each employee from whom income, Social Security, or Medicare tax was withheld or income tax would have been withheld if the employee had claimed no more than one withholding allowance (Form W-4 for 2019 or earlier) or had not claimed exemption from withholding on Form W-4, Employee’s Withholding Certificate. 1) Every employer engaged in a trade or business who pays remuneration for services performed by an employee, including noncash payments, must furnish a Form W-2 to each employee even if the employee is related to the employer. 2) Employers must file Copy A of Form W-2 by January 31, 2024. a) Employers may owe a penalty for each Form W-2 that they file late. 3) Employers must furnish Copies B, C, and 2 of Form W-2 to their employees generally by January 31, 2024. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 4: Business Expenses 7 Form W-4 b. Employees provide Form W-4 to their employer to determine the amount from each paycheck to be withheld for federal income taxes. Form W-4 consists of five steps: 1) Step 1: Enter personal information (including name and filing status) a) Tax is withheld at different rates for single and married persons. 2) Step 2: Multiple jobs or spouse works 3) Step 3: Claim dependents and other credits (e.g., Child Tax Credit and the Credit for Other Dependents) a) Taxpayers can no longer claim personal exemptions or dependency exemptions. 4) Step 4: Other adjustments 5) Step 5: Sign the form c. The employee’s withholding amount is based solely on the standard deduction and tax rate for his or her filing status if only Step 1 and Step 5 are completed. d. If an employee fails to give the employer a properly completed Form W-4, the employer must withhold federal income taxes from the employee’s wages as if the employee selected single (or MFS) in Step 1 and made no entries to Step 2, Step 3, or Step 4. e. A new Form W-4 need only be filed when withholding adjustments need to be made (i.e., taxes withheld are increased or decreased). The new Form W-4 should be filed within 10 days of the changing event. f. An employee who incurred no income tax liability for his or her preceding tax year and anticipates no such liability for his or her current tax year may include statements to this effect on Form W-4. In such case, the employer may not withhold income tax from the employee’s wages. Form 1099 g. In general, by January 31 of the current year, employers/payers must provide employees/ recipients with the following forms: 1) 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. 2) 1099-INT, Interest Income 3) 1099-MISC, Miscellaneous Income 4) 1099-NEC, Nonemployee Compensation 5) 1099-K, Payment Card and Third Party Network Transactions Form 8300 – $10,000 9. Each person engaged in a trade or business who, in the course of that trade or business, receives more than $10,000 in cash in one transaction or in two or more related transactions, must file Form 8300. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 8 SU 4: Business Expenses 10. Depositing Obligations (e.g., employment tax) Employment Tax Deposits a. Employment taxes are withheld income tax, FICA contributions, and backup withholding on reportable payments. Once a tax liability arises, an employer must deposit the taxes based on their deposit schedule for the calendar year. An employer’s deposit schedule is determined before the beginning of each calendar year by looking back at the total tax liability reported during a lookback period. There are two deposit schedules: monthly and semi-weekly. Nonemployee Exemption 1) An employer does not withhold federal income tax for workers who are not common- law employees. Monthly Deposits b. Monthly deposits are required if the aggregate amount of employment taxes reported by the employer is $50,000 or less. Monthly deposits are due on the 15th day of the following month in which the payments were made. Semi-Weekly Deposits c. An employer is a semi-weekly depositor for the entire calendar year if the aggregate amount of employment taxes exceeds $50,000. 1) A monthly depositor will become a semi-weekly depositor on the first day after the employer becomes subject to the one-day rule, discussed below. 2) Semi-weekly deposits are generally due on either Wednesday or Friday, depending upon the timing of the employer’s pay period. One-Day Rule d. If an employer has accumulated $100,000 or more of undeposited employment taxes, then the taxes must be deposited by the close of the next business day. Form 941 Payers e. Employers use Form 941, Employer’s Quarterly Federal Tax Return, to 1) Report income taxes, Social Security tax, or Medicare tax withheld from employees’ paychecks or direct deposits 2) Pay these taxes if total tax liability for the quarter is less than $2,500 or an underpayment for the quarter f. The table to the right Quarter Ending Due Date lists the due dates: Jan.–Feb.–Mar. Mar. 31 Apr. 30 Apr.–May–June June 30 July 31 July–Aug.–Sept. Sept. 30 Oct. 31 Oct.–Nov.–Dec. Dec. 31 Jan. 31 Federal Unemployment Taxes g. The calendar year is divided into four quarters for purposes of determining when deposits of federal unemployment tax are necessary. 1) The periods end on March 31, June 30, September 30, and December 31. 2) If the employer owes more than $500 in undeposited federal unemployment tax at the end of a quarter, then the tax owed must be deposited by the end of the next month. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].