Table of Contents
You can generally deduct the pay you give your employees for the services they perform. The pay may be in cash, property, or services. It may include wages, or salaries, or other compensation such as: vacation allowances, bonuses, commissions, and fringe benefits. For information about deducting employment taxes, see chapter 5.
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Empowerment zone and renewal community employment credit.
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Indian employment credit.
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Work opportunity credit.
Reduce your deduction for employee wages by the amount of any employment credits you claim. For more information about these credits, see Publication 954, Tax Incentives for Distressed Communities.
Publication
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15 (Circular E), Employer's Tax Guide
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15-A Employer's Supplemental Tax Guide
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15-B Employer's Tax Guide to Fringe Benefits
See chapter 12 for information about getting publications and forms.
To be deductible, your employees' pay must be an ordinary and necessary expense and you must pay or incur it. These and other requirements that apply to all business expenses are explained in chapter 1.
In addition, the pay must meet both of the following tests.
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Test 1. It must be reasonable.
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Test 2. It must be for services performed.
The form or method of figuring the pay does not affect its deductibility. For example, bonuses and commissions based on sales or earnings, and paid under an agreement made before the services were performed, are both deductible.
Determine the reasonableness of pay by the facts and circumstances. Generally, reasonable pay is the amount that like enterprises pay for the same, or similar, services.
You must be able to prove that the pay is reasonable. Base this determination on the circumstances that exist when you contract for the services, not those that exist when the reasonableness is questioned. If the pay is excessive, the excess is disallowed.
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The duties performed by the employee.
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The volume of business handled.
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The character and amount of responsibility.
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The complexities of your business.
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The amount of time required.
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The cost of living in the locality.
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The ability and achievements of the individual employee performing the service.
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The pay compared with the gross and net income of the business, as well as with distributions to shareholders if the business is a corporation.
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Your policy regarding pay for all your employees.
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The history of pay for each employee.
You must be able to prove the payment was made for services actually performed.
Some of the ways you may provide pay to your employees in addition to regular wages or salaries are discussed next. For specialized and detailed information on employees' pay and the employment tax treatment of employees' pay, see Publication 15, Publication 15-A, and Publication 15-B.
You can generally deduct amounts you pay to your employees as awards, whether paid in cash or property. If you give property to an employee as an employee achievement award, your deduction may be limited.
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It is given to an employee for length of service or safety achievement.
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It is awarded as part of a meaningful presentation.
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It is awarded under conditions and circumstances that do not create a significant likelihood of disguised pay.
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The employee receives the award after his or her first 5 years of employment.
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The employee did not receive another length-of-service award (other than one of very small value) during the same year or in any of the prior 4 years.
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It is given to a manager, administrator, clerical employee, or other professional employee.
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During the tax year, more than 10% of your employees, excluding those listed in (1), have already received a safety achievement award (other than one of very small value).
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$400 for awards that are not qualified plan awards.
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$1,600 for all awards, whether or not qualified plan awards.
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The employee was a 5% owner at any time during the year or the preceding year.
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The employee received more than $100,000 in pay for the preceding year.
Deduct achievement awards as a nonwage business expense on your return or business schedule.
You can generally deduct a bonus paid to an employee if you intended the bonus as additional pay for services, not as a gift, and the services were performed. However, the total bonuses, salaries, and other pay must be reasonable for the services performed. If the bonus is paid in property, see Property, later.
If you pay or reimburse education expenses for an employee, you can deduct the payments if they are part of a qualified educational assistance program. Deduct them on the “Employee benefit programs” or other appropriate line of your tax return. For information on educational assistance programs, see Educational Assistance in section 2 of Publication 15-B.
A fringe benefit is a form of pay for the performance of services. You can generally deduct the cost of fringe benefits.
You may be able to exclude all or part of the value of some fringe benefits from your employees' pay. You also may not owe employment taxes on the value of the fringe benefits. See Table 2-1 in Publication 15-B for details.
Your deduction for the cost of fringe benefits for activities generally considered entertainment, amusement, or recreation, or for a facility used in connection with such an activity (for example, a company aircraft) for certain officers, directors, and more-than-10% shareholders is limited.
See Pub. 15-B for an extensive discussion of fringe benefits.
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Meals whose value you include in an employee's wages.
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Meals that qualify as a de minimus fringe benefit as discussed in section 2 of Publication 15-B. This generally includes meals you furnish to employees at your place of business if more than half of these employees are provided the meals for your convenience.
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Meals you furnish to your employees at the work site when you operate a restaurant or catering service.
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Meals you furnish to your employees as part of the expense of providing recreational or social activities, such as a company picnic.
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Meals you are required by federal law to furnish to crew members of certain commercial vessels (or would be required to furnish if the vessels were operated at sea). This does not include meals you furnish on vessels primarily providing luxury water transportation.
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Meals you furnish on an oil or gas platform or drilling rig located offshore or in Alaska. This includes meals you furnish at a support camp that is near and integral to an oil or gas drilling rig located in Alaska.
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Accident and health plans.
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Adoption assistance.
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Cafeteria plans.
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Dependent care assistance.
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Educational assistance.
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Life insurance coverage.
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Welfare benefit funds.
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The cost you would have been able to deduct using the cash method of accounting if you had paid for the benefits directly.
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The contributions added to a reserve account that are needed to fund claims incurred but not paid as of the end of the year. These claims can be for supplemental unemployment benefits, severance pay, or disability, medical, or life insurance benefits.
You generally can deduct as wages an advance you make to an employee for services performed if you do not expect the employee to repay the advance. However, if the employee performs no services, treat the amount you advanced as a loan. If the employee does not repay the loan, treat it as income to the employee.
If you transfer property (including your company's stock) to an employee as payment for services, you can generally deduct it as wages. The amount you can deduct is the property's fair market value on the date of the transfer less any amount the employee paid for the property.
You can claim the deduction only for the tax year in which your employee includes the property's value in income. Your employee is deemed to have included the value in income if you report it on Form W-2 in a timely manner.
You treat the deductible amount as received in exchange for the property, and you must recognize any gain or loss realized on the transfer, unless it is the company's stock transferred as payment for services. Your gain or loss is the difference between the fair market value of the property and its adjusted basis on the date of transfer.
These rules also apply to property transferred to an independent contractor for services, generally reported on Form 1099-MISC.
You can generally deduct the amount you pay or reimburse employees for business expenses incurred for your business. However, your deduction may be limited.
If you make the payment under an accountable plan, deduct it in the category of the expense paid. For example, if you pay an employee for travel expenses incurred on your behalf, deduct this payment as a travel expense. If you make the payment under a nonaccountable plan, deduct it as wages and include it in the employee's W-2.
See Reimbursement of Travel, Meals, and Entertainment in chapter 11 for more information about deducting reimbursements and an explanation of accountable and nonaccountable plans.
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