US Internal Revenue Service: p15a--2001

8/14/2019 US Internal Revenue Service: p15a--2001

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Contents1. Who Are Employees? .................................. 2

2. Employee or Independent Contractor? ..... 5

3. Employees of Exempt Organizations ........ 7

4. Religious Exemption ................................... 8

5. Wages and Other Compensation ............... 9

6. Employee Fringe Benefits ........................... 13

7. Sick Pay Reporting ...................................... 15

8. Special Rules for Paying Taxes ................. 21

9. Pensions and Annuities .............................. 23

10. Alternative Methods for FiguringWithholding .................................................. 24

Formula Tables for Percentage Method

Withholding ............................................... 25Wage Bracket Percentage Method Tables ..... 28Combined Income Tax, Employee Social

Security Tax, and Employee Medicare TaxWithholding Tables ................................... 37

11. Tables for Withholding on Distributionsof Indian Gaming Profits to TribalMembers ....................................................... 58

Index .................................................................. 60

Quick and Easy Access to Tax Help andForms ........................................................... 61

IntroductionThis publication supplements Circular E, Employer's

Tax Guide. It contains specialized and detailed em-ployment tax information supplementing the basic in-formation provided in Circular E. It also contains:

Alternative methods and tables for figuring incometax withholding.

Combined income tax, employee social security tax,and employee Medicare tax withholding tables.

Tables for withholding on distributions of Indiangaming profits to tribal members.

Telephone help. You can call the IRS with your taxquestions. Check your telephone book for the localnumber or call 18008291040.

Help for people with disabilities. Telephone help isavailable using TTY/TDD equipment. You can call18008294059 with your tax question or to orderforms and publications. You may also use this numberfor problem resolution assistance.

Department of the TreasuryInternal Revenue Service

Publica tion 15 -A(Rev. January 2001)Cat. No. 21453T

Employer'sSupplementalTax Guide(Supplement toCircular E,Employer's Tax Guide

(Publica tion 15 )


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Ordering publications and forms. See page 61 forinformation on how to obtain forms and publications.

Useful ItemsYou may want to see:

Publication

15 Circular E, Employer's Tax Guide

15-B Employer's Tax Guide to Fringe Benefits51 Agricultural Employer's Tax Guide

509 Tax Calendars for 2001

225 Farmer's Tax Guide

515 Withholding of Tax on Nonresident Aliensand Foreign Corporations

535 Business Expenses

553 Highlights of 2000 Tax Changes

583 Starting a Business and Keeping Records

1635 Understanding Your EIN

Items To NoteElectronic deposit requirement. Certain employersare required to make deposits of employment taxesusing the Electronic Federal Tax Payment System(EFTPS). If you are required to use EFTPS and fail todo so, you may be subject to a 10% penalty. See Cir-cular E for more information.

If you are not required to use EFTPS, you may par-ticipate voluntarily. To enroll in or get more informationabout EFTPS, call 1-800-945-8400 or 1-800-555-4477.

Electronic submission of Forms W-4, W-4P, W-4S,W-4V, and W-5. You may set up a system to electron-ically receive any or all of the following forms from anemployee or payee:

Form W-4, Employee's Withholding AllowanceCertificate

Form W-4P, Withholding Certificate for Pension orAnnuity Payments

Form W-4S, Request for Federal Income TaxWithholding From Sick Pay

Form W-4V, Voluntary Withholding Request Form W-5, Employee's Advance Earned Income

Credit Certificate

If you establish an electronic system to receive anyof these forms, you do not need to process that formin a paper version.

For each form that you establish an electronic sub-mission system for, you must meet the following re-quirements:

1) The electronic system must ensure that the infor-mation received by the payer is the information sentby the payee. The system must document all oc-

casions of user access that result in a submission.In addition, the design and operation of the elec-tronic system, including access procedures, mustmake it reasonably certain that the person access-ing the system and submitting the form is the per-son identified on the form.

2) The electronic system must provide exactly thesame information as the paper form.

3) The electronic submission must be signed with anelectronic signature by the payee whose name ison the form. The electronic signature must be thefinal entry in the submission.

4) Upon request, you must furnish a hard copy of anycompleted electronic form to the IRS and a state-ment that, to the best of the payer's knowledge, theelectronic form was submitted by the named payee.The hard copy of the electronic form must provideexactly the same information as, but need not bea facsimile of, the paper form. For Forms W-4 andW-5, the signature must be under penalty of perjury,and must contain the same language that appearson the paper version of the form. The electronic

system must inform the employee that he or shemust make a declaration contained in the perjurystatement and that the declaration is made bysigning the Form W-4 or W-5.

5) You must meet all recordkeeping requirements thatapply to the paper forms.

For more information, see:

Form W-4Regulations section 31.3402(f)(5)-1 Form W-5Announcement 993 (99-3 IRB 15) Forms W-4P, W-4S, and W-4VAnnouncement

99-6 (99-4 IRB 24)

Photographs of MissingChildrenThe Internal Revenue Service is a proud partner withthe National Center for Missing and Exploited Children.Photographs of missing children selected by the Centermay appear in this booklet on pages that would other-wise be blank. You can help bring these children homeby looking at the photographs and calling1800THE-LOST (18008435678) if you recognizea child.

1. Who Are Employees?Before you can know how to treat payments you makefor services, you must first know the business relation-ship that exists between you and the person performingthe services. The person performing the services maybe

An independent contractor.

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A common-law employee.

A statutory employee.

A statutory nonemployee.

This discussion explains these four categories. Alater discussion, Employee or Independent Contrac-tor? (section 2), points out the differences between anindependent contractor and an employee and gives

examples from various types of occupations. If an indi-vidual who works for you is not an employee under thecommon-law rules (see section 2), you generally do nothave to withhold Federal income tax from that individ-ual's pay. However, in some cases you may be requiredto withhold under backup withholding requirements onthese payments. See Circular E for information onbackup withholding.

Independent ContractorsPeople such as lawyers, contractors, subcontractors,public stenographers, and auctioneers who follow anindependent trade, business, or profession in whichthey offer their services to the public, are generally notemployees. However, whether such people are em-ployees or independent contractors depends on thefacts in each case. The general rule is that an individualis an independent contractor if you, the payer, have theright to control or direct only the result of the work andnot the means and methods of accomplishing the result.

Common-Law EmployeesUnder common-law rules, anyone who performs ser-vices for you is your employee if you can control whatwill be done and how it will be done. This is so evenwhen you give the employee freedom of action. Whatmatters is that you have the right to control the detailsof how the services are performed. For a discussion offacts that indicate whether an individual providing ser-vices is an independent contractor or employee, seeEmployee or Independent Contractor? (section 2).

If you have an employer-employee relationship, itmakes no difference how it is labeled. The substance of the relationship, not the label, governs the worker'sstatus. Nor does it matter whether the individual isemployed full time or part time.

For employment tax purposes, no distinction is madebetween classes of employees. Superintendents, man-agers, and other supervisory personnel are all employ-ees. An officer of a corporation is generally an em-ployee; however, an officer who performs no servicesor only minor services, and neither receives nor is en-titled to receive any pay, is not considered an em-ployee. A director of a corporation is not an employee.

You generally have to withhold and pay income, so-cial security, and Medicare taxes on wages you pay tocommon-law employees. However, the wages of cer-tain employees may be exempt from one or more ofthese taxes. See Employees of Exempt Organiza-tions (section 3) and Religious Exemptions (section4).

Leased employees. Under certain circumstances, acorporation furnishing workers to various professionalpeople and firms is the employer of those workers foremployment tax purposes. For example, a professionalservice corporation may provide the services of secre-taries, nurses, and other similarly trained workers to itssubscribers.

The service corporation enters into contracts with thesubscribers under which the subscribers specify theservices to be provided and the fee to be paid to theservice corporation for each individual furnished. Theservice corporation has the right to control and directthe worker's services for the subscriber, including theright to discharge or reassign the worker. The servicecorporation hires the workers, controls the payment oftheir wages, provides them with unemployment insur-ance and other benefits, and is the employer for em-ployment tax purposes. For information on employeeleasing as it relates to pension plan qualification re-quirements, see Leased employees in Pub. 560, Re-tirement Plans for Small Business (SEP, SIMPLE, andKeogh Plans).

Additional information. For more information aboutthe treatment of special types of employment, thetreatment of special types of payments, and similarsubjects, get Circular E or Circular A (for agriculturalemployers).

Statutory EmployeesFour categories of workers who are independent con-tractors under common law are treated by statute asemployees.

1) A driver who distributes beverages (other than milk)or meat, vegetable, fruit, or bakery products; or whopicks up and delivers laundry or dry cleaning, if the

driver is your agent or is paid on commission.2) A full-time life insurance sales agent whose princi-

pal business activity is selling life insurance or an-nuity contracts, or both, primarily for one life insur-ance company.

3) An individual who works at home on materials orgoods that you supply and that must be returned toyou or to a person you name, if you also furnishspecifications for the work to be done.

4) A full-time traveling or city salesperson who workson your behalf and turns in orders to you fromwholesalers, retailers, contractors, or operators ofhotels, restaurants, or other similar establishments.The goods sold must be merchandise for resale orsupplies for use in the buyer's business operation.The work performed for you must be thesalesperson's principal business activity. SeeSalesperson in section 2.

Social security and Medicare taxes. Withhold socialsecurity and Medicare taxes from the wages of statutoryemployees if all three of the following conditions apply.

The service contract states or implies that substan-tially all the services are to be performed personallyby them.

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They do not have a substantial investment in theequipment and property used to perform the ser-vices (other than an investment in transportationfacilities).

The services are performed on a continuing basisfor the same payer.

Federal unemployment (FUTA) tax. For FUTA tax,the term employee means the same as it does for so-cial security and Medicare taxes, except that it does notinclude statutory employees in categories 2 and 3above. Thus, any individual who is an employee undercategory 1 or 4 is also an employee for FUTA tax pur-poses and subject to FUTA tax.

Income tax. Do not withhold income tax from thewages of statutory employees.

Reporting payments to statutory employees. Fur-nish a Form W-2 to a statutory employee, and checkstatutory employee in box 15 (box 13 on the 2001

Form W-2). Show your payments to the employee asother compensation in box 1. Also, show social securitywages in box 3, social security tax withheld in box 4,Medicare wages in box 5, and Medicare tax withheld inbox 6. The statutory employee can deduct his or hertrade or business expenses from the payments shownon Form W-2. He or she reports earnings as a statutoryemployee on line 1 of Schedule C or C-EZ (Form 1040).(A statutory employee's business expenses aredeductible on Schedule C or C-EZ (Form 1040) and arenot subject to the reduction by 2% of his or her adjustedgross income that applies to common-law employees.)

Statutory NonemployeesThere are two categories of statutory nonemployees:direct sellers and licensed real estate agents. Theyare treated as self-employed for all Federal tax pur-poses, including income and employment taxes, if:

1) Substantially all payments for their services as di-rect sellers or real estate agents are directly relatedto sales or other output, rather than to the numberof hours worked and

2) Their services are performed under a written con-tract providing that they will not be treated as em-ployees for Federal tax purposes.

Direct sellers. Direct sellers include persons fallingwithin any of the following three groups:

1) Persons engaged in selling (or soliciting the saleof) consumer products in the home or place ofbusiness other than in a permanent retail estab-lishment.

2) Persons engaged in selling (or soliciting the saleof) consumer products to any buyer on a buy-sellbasis, a deposit-commission basis, or any similar

basis prescribed by regulations, for resale in thehome or at a place of business other than in apermanent retail establishment.

3) Persons engaged in the trade or business of deliv-ering or distributing newspapers or shopping news(including any services directly related to such de-livery or distribution).

Direct selling includes activities of individuals whoattempt to increase direct sales activities of their directsellers and who earn income based on the productivityof their direct sellers. Such activities include providingmotivation and encouragement; imparting skills, knowl-edge, or experience; and recruiting. For more informa-tion on direct sellers, see Pub. 911, Direct Sellers.

Licensed real estate agents. This category includesindividuals engaged in appraisal activities for real estatesales if they earn income based on sales or other out-put.

Misclassification of Employees

Consequences of treating an employee as an inde-pendent contractor. If you classify an employee asan independent contractor and you have no reasonablebasis for doing so, you may be held liable for employ-ment taxes for that worker (the relief provisions, dis-cussed below, will not apply). See Internal RevenueCode section 3509 for more information.

Relief provisions. If you have a reasonable basis fornot treating a worker as an employee, you may be re-lieved from having to pay employment taxes for thatworker. To get this relief, you must file all requiredFederal information returns on a basis consistent withyour treatment of the worker. You (or your predecessor)must not have treated any worker holding a substan-tially similar position as an employee for any periodsbeginning after 1977.

Technical service specialists. This relief provisiondoes not apply to a worker who provides services toanother business (the client) as a technical servicespecialist under an arrangement between the businessproviding the worker, such as a technical services firm,and the client. A technical service specialist is an en-gineer, designer, drafter, computer programmer, sys-tems analyst, or other similarly skilled worker engagedin a similar line of work.

This rule does not affect the determination of whethersuch workers are employees under the common-lawrules. The common-law rules control whether the spe-cialist is treated as an employee or an independentcontractor. However, if you directly contract with atechnical service specialist to provide services for yourbusiness rather than for another business, you may stillbe entitled to the relief provision. See Employee orIndependent Contractor? below.

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2. Employee or IndependentContractor?An employer must generally withhold income taxes,withhold and pay social security and Medicare taxes,and pay unemployment tax on wages paid to an em-ployee. An employer does not generally have to with-hold or pay any taxes on payments to independent

contractors.

Common-Law RulesTo determine whether an individual is an employee oran independent contractor under the common law, therelationship of the worker and the business must beexamined. All evidence of control and independencemust be considered. In any employee-independentcontractor determination, all information that providesevidence of the degree of control and the degree ofindependence must be considered.

Facts that provide evidence of the degree of control

and independence fall into three categories: behavioralcontrol, financial control, and the type of relationshipof the parties as shown below.

Behavioral control. Facts that show whether thebusiness has a right to direct and control how theworker does the task for which the worker is hired in-clude the type and degree of

Instructions the business gives the worker. Anemployee is generally subject to the business' in-structions about when, where, and how to work. All ofthe following are examples of types of instructionsabout how to do work:

When and where to do the work

What tools or equipment to use

What workers to hire or to assist with the work

Where to purchase supplies and services

What work must be performed by a specified indi-vidual

What order or sequence to follow

The amount of instruction needed varies among dif-ferent jobs. Even if no instructions are given, sufficientbehavioral control may exist if the employer has theright to control how the work results are achieved. Abusiness may lack the knowledge to instruct somehighly specialized professionals; in other cases, thetask may require little or no instruction. The key con-sideration is whether the business has retained the rightto control the details of a worker's performance or in-stead has given up that right.

Training the business gives the worker. An em-ployee may be trained to perform services in a partic-ular manner. Independent contractors ordinarily usetheir own methods.

Financial control. Facts that show whether the busi-ness has a right to control the business aspects of theworker's job include:

The extent to which the worker has unreimbursed business expenses. Independent contractorsare more likely to have unreimbursed expenses thanare employees. Fixed ongoing costs that are incurredregardless of whether work is currently being performedare especially important. However, employees may alsoincur unreimbursed expenses in connection with theservices they perform for their business.

The extent of the worker's investment. An inde-pendent contractor often has a significant investmentin the facilities he or she uses in performing servicesfor someone else. However, a significant investment isnot necessary for independent contractor status.

The extent to which the worker makes services available to the relevant market. An independentcontractor is generally free to seek out business op-portunities. Independent contractors often advertise,maintain a visible business location, and are availableto work in the relevant market.

How the business pays the worker. An employeeis generally guaranteed a regular wage amount for anhourly, weekly, or other period of time. This usually in-dicates that a worker is an employee, even when thewage or salary is supplemented by a commission. Anindependent contractor is usually paid by a flat fee forthe job. However, it is common in some professions,such as law, to pay independent contractors hourly.

The extent to which the worker can realize a profit or loss. An independent contractor can makea profit or loss.

Type of relationship. Facts that show the parties' typeof relationship include:

Written contracts describing the relationship the parties intended to create.

Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay.

The permanency of the relationship. If you engagea worker with the expectation that the relationship willcontinue indefinitely, rather than for a specific projector period, this is generally considered evidence thatyour intent was to create an employer-employee re-lationship.

The extent to which services performed by the worker are a key aspect of the regular business of the company. If a worker provides services that are akey aspect of your regular business activity, it is morelikely that you will have the right to direct and controlhis or her activities. For example, if a law firm hires anattorney, it is likely that it will present the attorney's workas its own and would have the right to control or directthat work. This would indicate an employer-employeerelationship.

IRS help. If you want the IRS to determine whether aworker is an employee, file Form SS-8, Determinationof Worker Status for Purposes of Federal EmploymentTaxes and Income Tax Withholding, with the IRS.

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Industry ExamplesThe following examples may help you properly classifyyour workers.

Building and Construction IndustryExample 1. Jerry Jones has an agreement with

Wilma White to supervise the remodeling of her house.She did not advance funds to help him carry on the

work. She makes direct payments to the suppliers forall necessary materials. She carries liability and work-ers' compensation insurance covering Jerry and othershe engaged to assist him. She pays them an hourly rateand exercises almost constant supervision over thework. Jerry is not free to transfer his assistants to other

jobs. He may not work on other jobs while working forWilma. He assumes no responsibility to complete thework and will incur no contractual liability if he fails todo so. He and his assistants perform personal servicesfor hourly wages. They are employees of Wilma White.

Example 2. Milton Manning, an experiencedtilesetter, orally agreed with a corporation to performfull-time services at construction sites. He uses his owntools and performs services in the order designated bythe corporation and according to its specifications. Thecorporation supplies all materials, makes frequent in-spections of his work, pays him on a piecework basis,and carries workers' compensation insurance on him.He does not have a place of business or hold himselfout to perform similar services for others. Either partycan end the services at any time. Milton Manning is anemployee of the corporation.

Example 3. Wallace Black agreed with the SawdustCo. to supply the construction labor for a group ofhouses. The company agreed to pay all constructioncosts. However, he supplies all the tools and equip-ment. He performs personal services as a carpenterand mechanic for an hourly wage. He also acts as su-perintendent and foreman and engages other individ-uals to assist him. The company has the right to select,approve, or discharge any helper. A company repre-sentative makes frequent inspections of the con-struction site. When a house is finished, Wallace is paida certain percentage of its costs. He is not responsiblefor faults, defects of construction, or wasteful operation.At the end of each week, he presents the company witha statement of the amount he has spent, including thepayroll. The company gives him a check for that amountfrom which he pays the assistants, although he is notpersonally liable for their wages. Wallace Black and hisassistants are employees of the Sawdust Co.

Example 4. Bill Plum contracted with Elm Corpo-ration to complete the roofing on a housing complex.A signed contract established a flat amount for theservices rendered by Bill Plum. Bill is a licensed rooferand carries workers' compensation and liability insur-ance under the business name, Plum Roofing. He hireshis own roofers who are treated as employees forFederal employment tax purposes. If there is a problemwith the roofing work, Plum Roofing is responsible forpaying for any repairs. Bill Plum, doing business asPlum Roofing, is an independent contractor.

Example 5. Vera Elm, an electrician, submitted a job estimate to a housing complex for electrical workat $16 per hour for 400 hours. She is to receive $1,280every 2 weeks for the next 10 weeks. This is not con-sidered payment by the hour. Even if she works moreor less than 400 hours to complete the work, Vera Elmwill receive $6,400. She also performs additional elec-trical installations under contracts with other compa-nies, which she obtained through advertisements. Verais an independent contractor.

Trucking IndustryExample. Rose Trucking contracts to deliver mate-

rial for Forest Inc. at $140 per ton. Rose Trucking isnot paid for any articles that are not delivered. At times,Jan Rose, who operates as Rose Trucking, may alsolease another truck and engage a driver to complete thecontract. All operating expenses, including insurancecoverage, are paid by Jan Rose. All equipment isowned or rented by Jan, and she is responsible for allmaintenance. None of the drivers are provided by For-est Inc. Jan Rose, operating as Rose Trucking, is anindependent contractor.

Computer IndustryExample. Steve Smith, a computer programmer, is

laid off when Megabyte Inc. downsizes. Megabyteagrees to pay Steve a flat amount to complete a one-time project to create a certain product. It is not clearhow long it will take to complete the project, and Steveis not guaranteed any minimum payment for the hoursspent on the program. Megabyte provides Steve withno instructions beyond the specifications for the productitself. Steve and Megabyte have a written contract,which provides that Steve is considered to be an inde-

pendent contractor, is required to pay Federal and statetaxes, and receives no benefits from Megabyte. Mega-byte will file a Form 1099-MISC. Steve does the workon a new high-end computer which cost him $7,000.Steve works at home and is not expected or allowed toattend meetings of the software development group.Steve is an independent contractor.

Automobile IndustryExample 1. Donna Lee is a salesperson employed

on a full-time basis by Bob Blue, an auto dealer. Sheworks 6 days a week and is on duty in Bob's showroomon certain assigned days and times. She appraises

trade-ins, but her appraisals are subject to the salesmanager's approval. Lists of prospective customersbelong to the dealer. She has to develop leads andreport results to the sales manager. Because of herexperience, she requires only minimal assistance inclosing and financing sales and in other phases of herwork. She is paid a commission and is eligible for prizesand bonuses offered by Bob. Bob also pays the costof health insurance and group-term life insurance forDonna. Donna is an employee of Bob Blue.

Example 2. Sam Sparks performs auto repair ser-vices in the repair department of an auto sales com-pany. He works regular hours and is paid on a per-

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centage basis. He has no investment in the repairdepartment. The sales company supplies all facilities,repair parts, and supplies; issues instructions on theamounts to be charged, parts to be used, and the timefor completion of each job; and checks all estimates andrepair orders. Sam is an employee of the sales com-pany.

Example 3. An auto sales agency furnishes spacefor Helen Bach to perform auto repair services. She

provides her own tools, equipment, and supplies. Sheseeks out business from insurance adjusters and otherindividuals and does all the body and paint work thatcomes to the agency. She hires and discharges herown helpers, determines her own and her helpers'working hours, quotes prices for repair work, makes allnecessary adjustments, assumes all losses from un-collectible accounts, and receives, as compensation forher services, a large percentage of the gross collectionsfrom the auto repair shop. Helen is an independentcontractor and the helpers are her employees.

Attorney

Example. Donna Yuma is a sole practitioner whorents office space and pays for the following items:telephone, computer, on-line legal research linkup, faxmachine, and photocopier. Donna buys office suppliesand pays bar dues and membership dues for threeother professional organizations. Donna has a part-timereceptionist who also does the bookkeeping. She paysthe receptionist, withholds and pays Federal and stateemployment taxes, and files a Form W-2 each year.For the past 2 years, Donna has had only three clients,corporations with which there have been longstandingrelationships. Donna charges the corporations anhourly rate for her services, sending monthly bills de-tailing the work performed for the prior month. The bills

include charges for long distance calls, on-line researchtime, fax charges, photocopies, postage, and travel,costs for which the corporations have agreed to reim-burse her. Donna is an independent contractor.

Taxicab DriverExample. Tom Spruce rents a cab from Taft Cab

Co. for $150 per day. He pays the costs of maintainingand operating the cab. Tom Spruce keeps all fares hereceives from customers. Although he receives thebenefit of Taft's two-way radio communication equip-ment, dispatcher, and advertising, these items benefitboth Taft and Tom Spruce. Tom Spruce is an inde-

pendent contractor.

SalespersonTo determine whether salespersons are employeesunder the usual common-law rules, you must evaluateeach individual case. If a salesperson who works foryou does not meet the tests for a common-law em-ployee, discussed earlier, you do not have to withholdincome tax from his or her pay (see Statutory Em-ployees earlier). However, even if a salesperson is notan employee under the usual common-law rules, hisor her pay may still be subject to social security, Medi-care, and FUTA taxes. To determine whether a

salesperson is an employee for social security, Medi-care, and FUTA tax purposes, the salesperson mustmeet all eight elements of the statutory employee test.A salesperson is an employee for social security,Medicare, and FUTA tax purposes if he or she:

1) Works full time for one person or company except,possibly, for sideline sales activities on behalf ofsome other person,

2) Sells on behalf of, and turns his or her orders overto, the person or company for which he or sheworks,

3) Sells to wholesalers, retailers, contractors, or oper-ators of hotels, restaurants, or similar establish-ments,

4) Sells merchandise for resale, or supplies for use inthe customer's business,

5) Agrees to do substantially all of this work per-sonally,

6) Has no substantial investment in the facilities usedto do the work, other than in facilities for transpor-

tation,7) Maintains a continuing relationship with the person

or company for which he or she works, and

8) Is not an employee under common-law rules.

3. Employees of ExemptOrganizationsMany nonprofit organizations are exempt from in-come tax. Although they do not have to pay income tax

themselves, they must still withhold income tax from thepay of their employees. However, there are specialsocial security, Medicare, and Federal unemployment(FUTA) tax rules that apply to the wages they pay theiremployees.

Section 501(c)(3) organizations. Nonprofit organiza-tions that are exempt from income tax under section501(c)(3) of the Internal Revenue Code include anycommunity chest, fund, or foundation organized andoperated exclusively for religious, charitable, scientific,testing for public safety, literary or educational pur-poses, fostering national or international amateur sportscompetition, or for the prevention of cruelty to children

or animals. These organizations are usually corpo-rations and are exempt from income tax under section501(a).

Social security and Medicare taxes. Wages paidto employees of section 501(c)(3) organizations aresubject to social security and Medicare taxes unlessone of the following situations applies:

1) The organization pays an employee less than $100in a calendar year.

2) The organization is a church or church-controlledorganization opposed for religious reasons to thepayment of social security and Medicare taxes and

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has filed Form 8274, Certification by Churches andQualified Church-Controlled Organizations ElectingExemption From Employer Social Security andMedicare Taxes, to elect exemption from socialsecurity and Medicare taxes. The organization musthave filed for exemption before the first date onwhich a quarterly employment tax return (Form 941)would otherwise be due.

An employee of a church or church-controlledorganization that is exempt from social security andMedicare taxes must pay self-employment tax if theemployee is paid $108.28 or more in a year. How-ever, an employee who is a member of a qualifiedreligious sect can apply for an exemption from theself-employment tax by filing Form 4029, Applica-tion for Exemption From Social Security and Medi-care Taxes and Waiver of Benefits. See Membersof recognized religious sects opposed to insur-ance in section 4.

Federal unemployment tax. An organization thatis exempt from income tax under section 501(c)(3) ofthe Internal Revenue Code is also exempt from theFederal unemployment (FUTA) tax. This exemptioncannot be waived.

Note: An organization wholly owned by a state or its political subdivision should contact the appropriate state official for information about reporting and getting social security and Medicare coverage for its employees.

Other than section 501(c)(3) organizations.Nonprofit organizations that are not section 501(c)(3)organizations may also be exempt from income taxunder section 501(a) or section 521. However, theseorganizations are not exempt from withholding income,

social security, or Medicare tax from their employees'pay, or from paying FUTA tax. Two special rules forsocial security, Medicare, and FUTA taxes apply.

1) If an employee is paid less than $100 during a cal-endar year, his or her wages are not subject to so-cial security and Medicare taxes.

2) If an employee is paid less than $50 in a calendarquarter, his or her wages are not subject to FUTAtax for the quarter.

The above rules do not apply to employees who workfor pension plans and other similar organizations de-

scribed in section 401(a).

4. Religious ExemptionsSpecial rules apply to the treatment of ministers forsocial security purposes. An exemption from social se-curity is available for ministers and certain other reli-gious workers and members of certain recognized reli-gious sects. For more information on getting anexemption, see Pub. 517, Social Security and OtherInformation for Members of the Clergy and ReligiousWorkers.

Ministers. Ministers are individuals who are duly or-dained, commissioned, or licensed by a religious bodyconstituting a church or church denomination. They aregiven the authority to conduct religious worship, performsacerdotal functions, and administer ordinances andsacraments according to the prescribed tenets andpractices of that religious organization.

A minister who performs services for you subject toyour will and control is your employee. The common-law rules discussed in sections 1 and 2 should be ap-plied to determine whether a minister is your employeeor is self-employed. The earnings of a minister are notsubject to income, social security, and Medicare taxwithholding. They are subject to self-employment taxand income tax. You do not withhold these taxes fromwages earned by a minister. However, you may agreewith the minister to voluntarily withhold tax to cover theminister's liability for self-employment tax and incometax.

Form W-2. If your employee is an ordained minister,report all taxable compensation as wages in box 1 onForm W-2. Include in this amount expense allowancesor reimbursements paid under a nonaccountable plan,discussed in section 5 of Circular E. Do not include aparsonage allowance (excludable housing allowance)in this amount. You may report a parsonage or rentalallowance (housing allowance), utilities allowance, andthe rental value of housing provided in a separatestatement or in box 14 on Form W-2. Do not show onForm W-2 or 941 any amount as social security orMedicare wages, or any withholding for social securityor Medicare taxes. If you withheld tax from the ministerunder a voluntary agreement, this amount should beshown in box 2 on Form W-2 as Federal income taxwithheld. For more information on ministers, see Pub.517.

Exemptions for ministers and others. Certain or-dained ministers, Christian Science practitioners, andmembers of religious orders who have not taken a vowof poverty, who are subject to self-employment tax, mayapply to exempt their earnings from the tax on religiousgrounds. The application must be based on conscien-tious opposition to public insurance because of per-sonal religious considerations. The exemption appliesonly to qualified services performed for the religiousorganization. See Rev. Proc. 91-20, 1991-1 C.B. 524,for guidelines to determine whether an organization isa religious order or whether an individual is a memberof a religious order.

To apply for the exemption, the employee should file

Form 4361, Application for Exemption From Self-Employment Tax for Use by Ministers, Members ofReligious Orders and Christian Science Practitioners.See Pub. 517 for more information about Form 4361.

Members of recognized religious sects opposed toinsurance. If you belong to a recognized religious sector a division of such sect that is opposed to insurance,you may qualify for an exemption from the self-employment tax. To qualify, you must beconscientiously opposed to accepting the benefits ofany public or private insurance that makes paymentsbecause of death, disability, old age, or retirement, or

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makes payments toward the cost of, or provides ser-vices for, medical care (including social security andMedicare benefits). If you buy a retirement annuity froman insurance company, you will not be eligible for thisexemption. Religious opposition based on the teachingsof the sect is the only legal basis for the exemption. Inaddition, your religious sect (or division) must have ex-isted since December 31, 1950.

Self-employed. If you are self-employed and amember of a recognized religious sect opposed to in-surance, you can apply for exemption by filing Form4029, Application for Exemption From Social Securityand Medicare Taxes and Waiver of Benefits, and waiveall social security benefits.

Employees. The social security and Medicare taxexemption available to the self-employed who aremembers of a recognized religious sect opposed to in-surance is also available to their employees who aremembers of such a sect. This applies to partnershipsonly if each partner is a member of the sect. This ex-emption for employees applies only if both the em-ployee and the employer are members of such a sect,and the employer has an exemption. To get the ex-emption, the employee must file Form 4029.

An employee of a church or church-controlled or-ganization that is exempt from social security andMedicare taxes can also apply for an exemption onForm 4029.

5. Wages and OtherCompensationCircular E provides a general discussion of taxablewages. The following topics supplement that dis-cussion.

Employee Achievement AwardsDo not withhold income, social security, or Medicaretaxes on the fair market value of an employeeachievement award if it is excludable from your em-ployee's gross income. To be excludable from youremployee's gross income, the award must be tangiblepersonal property (not cash or securities) given to anemployee for length of service or safety achievement,awarded as part of a meaningful presentation, andawarded under circumstances that do not indicate thatthe payment is disguised compensation. Excludableemployee achievement awards also are not subject toFUTA tax.

Limits. The most you can exclude for the cost of allemployee achievement awards to the same employeefor the year is $400. A higher limit of $1,600 applies toqualified plan awards. These awards are employeeachievement awards under a written plan that does notdiscriminate in favor of highly compensated employees.An award cannot be treated as a qualified plan awardif the average cost per recipient of all awards under allyour qualified plans is more than $400.

If during the year an employee receives awards notmade under a qualified plan and also receives awardsunder a qualified plan, the exclusion for the total cost

of all awards to that employee cannot be more than$1,600. The $400 and $1,600 limits cannot be addedtogether to exclude more than $1,600 for the cost ofawards to any one employee during the year.

Educational Assistance ProgramsThe income exclusion from employee gross income islimited to $5,250 per employee in educational assist-ance during a calendar year. The excludable amount

is not subject to income tax withholding or other em-ployment taxes. The education need not be job related.However, the exclusion does not apply to graduate levelcourses. For more information on educational assist-ance programs, see Regulations section 1.127-2. Theexclusion expires for courses beginning on or afterDecember 31, 2001.

Scholarship and FellowshipPaymentsOnly amounts you pay as a qualified scholarship to acandidate for a degree may be excluded from the re-cipient's gross income. A qualified scholarship is any

amount granted as a scholarship or fellowship that isused for:

Tuition and fees required to enroll in, or to attend,an educational institution or

Fees, books, supplies, and equipment that are re-quired for courses at the educational institution.

Any amounts you pay for room and board, and anyamounts you pay for teaching, research, or other ser-vices required as a condition of receiving the scholar-ship, are not excludable from the recipient's gross in-come. A qualified scholarship is not subject to socialsecurity, Medicare, and FUTA taxes, or income taxwithholding. For more information, see Pub. 520,Scholarships and Fellowships.

Outplacement ServicesIf you provide outplacement services to your employeesto help them find new employment (such as careercounseling, resume assistance, or skills assessment),the value of these benefits may be income to them andsubject to all withholding taxes. However, the value ofthese services will not be subject to any employmenttaxes if:

1) You derive a substantial business benefit from

providing the services (such as improved employeemorale or business image) separate from the ben-efit you would receive from the mere payment ofadditional compensation, and

2) The employee would be able to deduct the cost ofthe services as employee business expenses if heor she had paid for them.

However, if you receive no additional benefit fromproviding the services, or if the services are not pro-vided on the basis of employee need, then the valueof the services is treated as wages and is subject toincome tax withholding and social security and Medi-

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care taxes. Similarly, if an employee receives the out-placement services in exchange for reduced severancepay (or other taxable compensation), then the amountthe severance pay is reduced is treated as wages foremployment tax purposes.

Dependent Care AssistanceProgramsThe maximum amount you can exclude from your em-ployee's gross income for dependent care assistanceis $5,000 ($2,500 for married taxpayers filing separatereturns). The excluded amount is not subject to socialsecurity, Medicare, and FUTA taxes, or income taxwithholding. If the dependent is cared for in a facilityat your place of business, the amount to exclude fromthe employee's income is based on his or her use of thefacility and the value of the services provided. Reportdependent care assistance payments in box 10 onForm W-2. For more information, see Pub. 15-B, Em-ployer's Tax Guide to Fringe Benefits.

Dependent care providers. If you were the providerof dependent care or pay the provider directly, youremployee may ask you for help in getting a completedForm W-10, Dependent Care Provider's Identificationand Certification. The dependent care credit and theexclusion for employer-provided dependent care as-sistance benefits generally cannot be claimed by youremployee unless the dependent care provider is iden-tified by name, address, and (if not an exempt organ-ization) taxpayer identification number. The dependentcare recipient may use Form W-10 to request this in-formation.

Adoption Assistance PlansYour employees may be able to exclude from gross

income payments or reimbursements you make underan adoption assistance program. Amounts you pay orincur for an employee's qualified adoption expenses arenot subject to income tax withholding. However, theseamounts (including adoption benefits paid from a cafe-teria plan, but not including adoption benefits forfeitedfrom a cafeteria plan) are subject to social security,Medicare, and FUTA taxes. If the adoption assistancebenefits are part of a cafeteria plan, they are still subjectto these employment taxes. Report adoption benefitsin box 13, using code T, on Form W-2 (box 12 on the2001 Form W-2). See Pub. 968, Tax Benefits forAdoption, for more information.

Withholding for Idle TimePayments made under a voluntary guarantee to em-ployees for idle time (any time during which an em-ployee performs no services) are wages for the pur-poses of social security, Medicare, and FUTA taxes,and income tax withholding.

Back PayTreat back pay as wages in the year paid and withholdand pay employment taxes as required. If back pay wasawarded by a court or government agency to enforcea Federal or state statute protecting an employee's right

to employment or wages, special rules apply for re-porting those wages to the Social Security Adminis-tration. These rules also apply to litigation actions, andsettlement agreements or agency directives that areresolved out of court and not under a court decree ororder. Examples of pertinent statutes include, but arenot limited to, the National Labor Relations Act, FairLabor Standards Act, Equal Pay Act, and Age Dis-crimination in Employment Act. Get Pub. 957, Report-ing Back Pay and Special Wage Payments to the SocialSecurity Administration, and Form SSA-131, EmployerReport of Special Wage Payments, for details.

Supplemental UnemploymentBenefitsIf you pay, under a plan, supplemental unemploymentbenefits to a former employee, all or part of the pay-ments may be taxable and subject to income tax with-holding, depending on how the plan is funded. Amountsthat represent a return to the employee of amountspreviously subject to tax are not taxable and are notsubject to withholding. You should withhold income taxon the taxable part of the payments made, under a plan,to an employee who is involuntarily separated becauseof a reduction in force, discontinuance of a plant oroperation, or other similar condition. It does not matterwhether the separation is temporary or permanent. Thetaxable part is not subject to social security, Medicare,or FUTA taxes.

Withholding on taxable supplemental unemploymentbenefits must be based on the withholding certificate(Form W-4) the employee gave you.

Golden Parachutes (ExcessiveTermination Payments)A golden parachute is a contract entered into by acorporation and key personnel under which the corpo-ration agrees to pay certain amounts to the key per-sonnel in the event of a change in ownership or controlof the corporation. Payments under golden parachutecontracts, like any termination pay, are subject to socialsecurity, Medicare, and FUTA taxes, and income taxwithholding.

Beginning with payments under contracts enteredinto, significantly amended, or renewed after June 14,1984, no deduction is allowed to the corporation forexcess parachute payments. The employee is subjectto a 20% nondeductible excise tax to be withheld by thecorporation on all excess payments. The payment is

generally considered an excess parachute payment ifit equals or exceeds three times the average annualcompensation of the recipient over the previous 5-yearperiod. The amount over the average is the excessparachute payment.

Example. An officer of a corporation receives agolden parachute payment of $400,000. This is morethan three times greater than his or her average com-pensation of $100,000 over the previous 5-year period.The excess parachute payment is $300,000 ($400,000minus $100,000). The corporation cannot deduct the$300,000 and must withhold the excise tax of $60,000(20% of $300,000).

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Exempt payments. Most small business corporationsare exempt from the golden parachute rules. See Codesection 280G for more information.

Interest-Free andBelow-Market-Interest-Rate LoansIf an employer lends an employee more than $10,000at an interest rate less than the current applicableFederal rate (AFR), the difference between the interestpaid and the interest that would be paid under the AFRis considered additional compensation to the employee.This rule applies to a loan of $10,000 or less if one ofits principal purposes is the avoidance of Federal tax.

This additional compensation to the employee issubject to social security, Medicare, and FUTA taxes,but not to income tax withholding. Include it in com-pensation on Form W-2 (or Form 1099-MISC for anindependent contractor). The AFR is establishedmonthly and published by the IRS each month in theInternal Revenue Bulletin. You can get these rates bycalling 18008291040 or by accessing the IRS'sInternet Web Site at www.irs.gov. For more informa-tion, see Pub. 15-B.

Group-Term Life InsuranceYou may exclude the cost of life insurance benefits forthe first $50,000 of coverage for each employee, if yourplan meets the following requirements.

1) It provides a general death benefit that is not in-cluded in income.

2) You provide it to a group of employees.

3) It provides an amount of insurance to each em-ployee based on a formula that prevents individualselection, using factors such as age, years of ser-

vice, pay, or position.4) You provide it under a policy you carry directly or

indirectly. Even if you do not pay any of the policy'scost, you are considered to carry it if you arrangefor payment of its cost by your employees andcharge at least one employee less than, and atleast one employee more than, the cost of his orher insurance. Determine the cost of the insurance,for this purpose, using the table for the monthly costper $1,000 of insurance below. Note: Until January1, 2003, you may use the table previously in effectto make this determination. See Reg. 1.79-1 or theJanuary 1999 revision of Pub. 15-A.

5) It meets certain nondiscrimination requirements.See Pub. 15-B for more information.

The tax treatment is the same if the premiums are paidthrough a cafeteria plan (section 125). See CafeteriaPlans, later. This taxable insurance cost can be treatedas paid by the pay period, by the quarter, or on anybasis as long as the cost is treated as paid at least oncea year.

Benefits extending beyond one year. Group-term lifeinsurance may be provided as part of a policy that in-cludes permanent benefits. Permanent benefits are

any benefits that extend beyond one policy year, suchas insurance with a paid-up or cash surrender value.

If your policy includes permanent benefits, you mustinclude in your employees' wages the cost of the per-manent benefits minus the amount the employee paysfor them.

For more information, see section 1.79-1(d) of theRegulations.

Amount included in wages. Include in wages the costof group-term life insurance you provided to an em-ployee for more than $50,000 of coverage, or for cov-erage that discriminated in favor of the employee. Thisamount is subject to social security and Medicare taxes,but not FUTA tax or income tax withholding.

Monthly cost. If the group-term life insurance planmeets the exclusion requirements listed above, figurethe monthly cost of this insurance on the amount ofcoverage exceeding $50,000. The taxable cost is basedon the following table rather than on the employer'sactual premium costs for the insurance coverage. Youdetermine the monthly cost of group-term life insuranceby multiplying the number of thousands of dollars ofinsurance coverage (figured to the nearest 10th) by theappropriate cost per thousand per month. You deter-mine age on the last day of the tax year. If you providegroup-term life insurance for a period of coverage ofless than 1 month, you prorate the monthly cost overthat period. The monthly cost of each $1,000 of group-term life insurance protection is as follows:

Coverage for dependents. Group-term life insurancecoverage paid by the employer for the spouse or de-pendents of an employee may be excludable from in-come as a de minimis fringe benefit (see section 6).This part of the coverage that the employee paid on anafter-tax basis is also excludable from income. For thispurpose, the cost is figured using the monthly cost tableabove.

Former employees. For group-term life insurance over$50,000 provided to former employees (includingretirees), the former employees must pay the employ-ee's share of social security and Medicare taxes withtheir income tax returns. You are not required to collectthose taxes. Use the table above to determine theamount of social security and Medicare taxes owed bythe former employee for coverage provided after sepa-ration from service. Report those uncollected amountsseparately in box 13 on Form W-2 using codes M andN (box 12 on the 2001 Form W-2). See the In-structions for Form W-2 and Form W-3.

Age Monthly CostUnder 25 ....................................................................... $ .0525 through 29 ................................................................ .0630 through 34 ................................................................ .0835 through 39 ................................................................ .0940 through 44 ................................................................ .1045 through 49 ................................................................ .1550 through 54 ................................................................ .2355 through 59 ................................................................ .4360 through 64 ................................................................ .6665 through 69 ................................................................ 1.2770 and over ................................................................... 2.06

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Workers' CompensationPublicEmployeesState and local government employees, such as policeofficers and firefighters, sometimes receive paymentsdue to injury in the line of duty under a statute that isnot the general workers' compensation law of a state.If the statute limits benefits to work-related injuries orsickness and does not base payments on the employ-ee's age, length of service, or prior contributions, thestatute is in the nature of a workers' compensationlaw. Payments under the statute are not subject toFUTA tax or income tax withholding, but they are sub-

ject to social security and Medicare taxes to the sameextent as the employee's regular wages. However, thepayments are no longer subject to social security andMedicare taxes after the expiration of 6 months follow-ing the last calendar month in which the employeeworked for the employer.

Leave Sharing PlansIf you establish a leave sharing plan for your employeesthat allows them to donate leave to other employees formedical emergencies, the amounts paid to the recipi-ents of the leave are considered wages. Theseamounts are includible in the gross income of the re-cipients and are subject to social security, Medicare,and FUTA taxes, and income tax withholding. Do notinclude these amounts in the income of the donors.

Cafeteria PlansCafeteria plans, including flexible spending arrange-ments, are benefit plans under which all participantsare employees who can choose from among cash and

certain qualified benefits. If the employee elects qual-ified benefits, employer contributions are excluded fromthe employee's wages if the benefits are excludablefrom gross income under a specific section of theInternal Revenue Code (other than scholarship andfellowship grants under section 117, employee fringebenefits under section 132, and educational assistanceprograms under section 127). The cost of group-termlife insurance that is includible in income only becausethe insurance exceeds $50,000 of coverage is consid-ered a qualified benefit under a special rule.

Generally, qualified benefits under a cafeteria planare not subject to social security, Medicare, and FUTAtaxes, or income tax withholding. However, group-term

life insurance that exceeds $50,000 of coverage issubject to social security and Medicare taxes, but notFUTA tax or income tax withholding, even when pro-vided as qualified benefits in a cafeteria plan. Adoptionassistance benefits provided in a cafeteria plan aresubject to social security, Medicare, and FUTA taxes,but not income tax withholding. If an employee electsto receive cash instead of any qualified benefit, it istreated as wages subject to all employment taxes. Formore information, see Pub.15-B.

Nonqualified DeferredCompensation Plans

Social security, Medicare, and FUTA taxes. Em-ployer contributions to nonqualified deferred compen-sation or nonqualified pension plans are treated as so-cial security, Medicare, and FUTA wages when theservices are performed or the employee no longer hasa substantial risk of forfeiting the right to the deferredcompensation, whichever is later. This is true whetherthe plan is funded or unfunded.

Amounts deferred are subject to social security,Medicare, and FUTA taxes unless the value of theamount deferred cannot be determined; for example, ifbenefits are based on final pay. If the value of the futurebenefit is based on any factors that are not yet rea-sonably determinable, you may estimate the value ofthe future benefit and withhold and pay social security,Medicare, and FUTA taxes on that amount. If amountsthat were not determinable in prior periods are nowdeterminable, they are subject to social security, Medi-care, and FUTA taxes on the amounts deferred plus theincome attributable to those amounts deferred. Formore information, see Regulations sections31.3121(v)(2)-1 and 31.3306(v)(2)-1.

Income tax withholding. Amounts deferred undernonqualified deferred compensation plans are not sub-

ject to income taxes until benefit payments begin.Withhold income tax on nonqualified plans as follows:

Funded plan. Withhold when the employees' rightsto amounts are not subject to substantial risk offorfeiture or are transferable free of such risk. Afunded plan is one in which an employerirrevocably contributes the deferred compensationto a separate fund, such as an irrevocable trust.

Unfunded plan. Generally, withhold when youmake payments to the employee, either construc-tively or actually.

For more information, see Regulations section31.3121(v)-1.

Employee Stock OptionsThere are three classes of stock optionsincentivestock options, employee stock purchase plan options,and nonstatutory options. Generally, incentive stockoptions and employee stock purchase plan options arenot taxable to the employee either when the options aregranted or when they are exercised (unless the stockis disposed of in a disqualifying disposition). However,the spread (between the exercise price and fair marketvalue of the stock at the time of exercise) on employeestock purchase plan options is subject to social security,Medicare, and FUTA taxes when the options are exer-cised. Additionally, the spread on nonstatutory optionsnormally is taxable to the employee as wages when theoptions are exercised (see Regulations section 1.837).These wages are subject to social security, Medicare,and FUTA taxes, and income tax withholding.

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Tax-Sheltered AnnuitiesEmployer payments made by an educational institutionor a tax-exempt organization to purchase a tax-sheltered annuity for an employee (annual deferrals)are included in the employee's social security andMedicare wages if the payments are made because ofa salary reduction agreement. They are not included inbox 1 on Form W-2 in the year the deferrals are madeand are not subject to income tax withholding.

Contributions to a SimplifiedEmployee Pension (SEP)An employer's SEP contributions to an employee's in-dividual retirement arrangement (IRA) are excludedfrom the employee's gross income. These excludedamounts are not subject to social security, Medicare,and FUTA taxes, or income tax withholding. However,any SEP contributions paid under a salary reductionagreement (SARSEP) are included in wages for pur-poses of social security and Medicare taxes and FUTA.See Pub. 560, for more information about SEPs.

Salary reduction simplified employee pensions

(SARSEP) repealed. You may not establish aSARSEP after 1996. However, SARSEPs establishedbefore January 1, 1997, may continue to receive con-tributions.

SIMPLE Retirement PlansEmployer and employee contributions to a savings in-centive match plan for employees (SIMPLE) retirementaccount (subject to limitations) are excludable from theemployee's income and are exempt from Federal in-come tax withholding. An employer's nonelective (2%)or matching contributions are exempt from social se-curity, Medicare, and FUTA taxes. However, an em-

ployee's salary reduction contributions to a SIMPLE aresubject to social security, Medicare, and FUTA taxes.For more information about SIMPLE retirement plans,see Pub. 560.

6. Employee Fringe BenefitsThe following fringe benefits provided by an employerare excluded from the employee's gross income. Thebenefits are not subject to social security, Medicare,and FUTA taxes, or income tax withholding.

1) No-additional-cost service. This is a service of-

fered for sale to customers in the course of theemployer's line of business in which the employeeworks that is provided at no substantial additionalcost, including lost revenue, to the employer. Ex-amples include airline, bus, and train tickets andtelephone services provided free or at reducedrates by an employer in the line of business in whichthe employee works.

2) Qualified employee discount. This is a discountthat, if offered for property, is not more than theemployer's gross profit percentage. If offered forservices, the discount is not more than 20% of theprice for services offered to customers.

3) Working condition benefit. This is property or aservice the employee could deduct as a businessexpense if he or she had paid for it. Examples in-clude a company car for business use and sub-scriptions to business magazines. Under specialrules, all of the use of a demonstrator car by an autosalesperson is excluded if there are substantial re-strictions on personal use.

4) De minimis benefit. This is a service or an itemof such small value (after taking into account howfrequently similar benefits are provided to employ-ees) as to make accounting for the benefit unrea-sonable or administratively impracticable. Exam-ples include typing of a personal letter by acompany secretary, occasional personal use of acompany copying machine, occasional parties orpicnics for employees, occasional supper moneyand taxi fare for employees working overtime, holi-day gifts with a low fair market value, occasionaltickets for entertainment events, coffee anddoughnuts furnished to employees, and group-termlife insurance provided by the employer for aspouse or dependent of the employee with a faceamount of $2,000 or less. Also exclude from theemployee's income meals at an eating facility op-erated by the employer for employees on or nearthe employer's business premises if the incomefrom the facility equals or exceeds the direct oper-ating costs of the facility.

5) Qualified transportation fringe benefit. This in-cludes transit passes, transportation in a commuterhighway vehicle to and from work, and qualifiedparking at or near the place of work. The combinedexclusion for the transit passes and transportationcannot exceed $65 per month for 2001. The exclu-sion for parking cannot exceed $180 per month for2001. Employees may be given a choice of anyqualified transportation fringe benefit or cash com-pensation without losing the exclusion of the qual-ified transportation fringe benefit from income andemployment taxes. However, if an employeechooses the cash compensation option, the cash isincludible in the employee's income and subject toemployment taxes. The exclusion for qualifiedtransportation fringe benefits is not available topartners, 2% or more shareholders in an S corpo-ration, or independent contractors. For more infor-mation on qualified transportation fringe benefits,see Pub. 15-B.

6) qualified moving expense reimbursement, whichincludes any amount received, directly or indirectly,by an employee from an employer as a paymentfor, or reimbursement of, expenses that would bedeductible as moving expenses, if paid or incurredby the employee. For more information on ex-penses that qualify for a deduction, see Pub. 521,Moving Expenses.

7) On-premises gym or other athletic facility. Thisis a facility provided and operated by the employerif substantially all the use is by employees, theirspouses, and their dependent children.

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8) Qualified tuition reduction. This is a reduction fortuition, that an educational organization provides itsemployees, generally below the graduate level. Formore information on a qualified tuition reduction,see Pub. 520, Scholarships and Fellowships.

Do not exclude the following fringe benefits from theincome of highly compensated employees unless thebenefits are available to employees on anondiscriminatory basis.

No-additional-cost services (item 1). Qualified employee discounts (item 2). Meals provided at an employer-operated eating fa-

cility (included in item 4).

Qualified tuition reduction (item 8).

For more information, including the definition of ahighly compensated employee, see Pub. 15-B.

Special fringe benefit rules for airlines and theiraffiliates. Employees of a qualified affiliate of an airline

(a member of a group in which another member oper-ates the airline) who are directly engaged in providingairline-related services may exclude from their incomeas a no-additional-cost service the fair market value ofair transportation provided by the other member.Airline-related services means providing any of thefollowing services in connection with air transportation:catering, baggage handling, ticketing and reservations,flight planning and weather analysis, service at restau-rants and gift shops located at an airport, and similarservices.

Any use of air transportation provided by an airlineto parents of the airline's employees is also treated asuse by the employees. The employees are entitled to

exclude the fair market value of such transportationfrom their income as a no-additional-cost service.

More information. For more detailed information onnontaxable fringe benefits, see Pub. 15-B, Employer'sTax Guide to Fringe Benefits.

Taxable Noncash Fringe BenefitsUse the following guidelines for withholding, depositing,and reporting taxable noncash fringe benefits.

Valuation of fringe benefits. Generally, you mustdetermine the value of noncash fringe benefits no later

than January 31 of the next year. Prior to January 31,you may reasonably estimate the value of the fringebenefits for purposes of withholding and depositing ontime.

Choice of period for withholding, depositing, andreporting. For employment tax and withholding pur-poses, you can treat fringe benefits (including personaluse of employer-provided highway motor vehicles) aspaid on a pay period, quarter, semiannual, annual, orother basis. But the benefits must be treated as paidno less frequently than annually. You do not have tochoose the same period for all employees. You can

withhold more frequently for some employees than forothers.

You can change the period as often as you like aslong as you treat all the benefits provided in a calendaryear as paid no later than December 31 of the calendaryear.

You can also treat the value of a single fringe benefitas paid on one or more dates in the same calendaryear, even if the employee receives the entire benefitat one time. For example, if your employee receives afringe benefit valued at $1,000 in one pay period during2001, you can treat it as made in four payments of$250, each in a different pay period of 2001. You donot have to notify the IRS of the use of the periodsdiscussed above.

Transfer of property. The above choice for report-ing and withholding does not apply to a fringe benefitthat is a transfer of tangible or intangible personalproperty of a kind normally held for investment, or atransfer of real property. For this kind of fringe benefit,you must use the actual date the property was trans-ferred to the employee.

Withholding and depositing taxes. You can add thevalue of fringe benefits to regular wages for a payrollperiod and figure income tax withholding on the total.Or you can withhold Federal income tax on the valueof fringe benefits at the flat 28% rate applicable tosupplemental wages.

You must withhold the applicable income, social se-curity, and Medicare taxes on the date or dates youchose to treat the benefits as paid. Deposit the amountswithheld as discussed in section 11 of Circular E.

Amount of deposit. To estimate the amount of in-come tax withholding and employment taxes and todeposit it on time, make a reasonable estimate of thevalue of the fringe benefits provided on the date or

dates you chose to treat the benefits as paid. Determinethe estimated deposit by figuring the amount you wouldhave had to deposit if you had paid cash wages equalto the estimated value of the fringe benefits and with-held taxes from those cash wages. Even if you do notknow which employee will receive the fringe benefit onthe date the deposit is due, you should follow this pro-cedure.

If you underestimate the value of the fringe benefitsand deposit less than the amount you would have hadto deposit if the applicable taxes had been withheld, youmay be subject to a penalty.

If you overestimate the value of the fringe benefit andoverdeposit, you can either claim a refund or have the

overpayment applied to your next Form 941.If you deposited the required amount of taxes butwithheld a lesser amount from the employee, you canrecover from the employee the social security, Medi-care, or income taxes you deposited on the employee'sbehalf and included on the employee's Form W-2.However, you must recover the income taxes beforeApril 1 of the following year.

Special accounting rule. You can treat the value ofbenefits provided during the last 2 months of the cal-endar year, or any shorter period within the last 2months, as paid in the next year. Thus, the value of

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benefits actually provided in the last 2 months of 2000would be treated as provided in 2001 together with thevalue of benefits provided in the first 10 months of 2001.This does not mean that all benefits treated as paidduring the last 2 months of a calendar year can bedeferred until the next year. Only the value of benefitsactually provided during the last 2 months of the cal-endar year can be treated as paid in the next calendaryear.

Limitation. The special accounting rule cannot beused, however, for a fringe benefit that is a transfer oftangible or intangible personal property of a kindnormally held for investment, or a transfer of realproperty.

Conformity rules. Use of the special accountingrule is optional. You can use the rule for some fringebenefits but not others. The period of use need not bethe same for each fringe benefit. However, if you usethe rule for a particular fringe benefit, you must use itfor all employees who receive that benefit.

If you use the special accounting rule, your employeealso must use it for the same period as you use it. Butyour employee cannot use the special accounting ruleunless you do.

You do not have to notify the IRS if you use thespecial accounting rule. You may also, for appropriatereasons, change the period for which you use the rulewithout notifying the IRS. But you must report the in-come and deposit the withheld taxes as required for thechanged period.

Special rules for highway motor vehicles. If anemployee uses the employer's vehicle for personalpurposes, the value of that use must be determined bythe employer and included in the employee's wages.The value of the personal use must be based on fairmarket value or one of three special valuation rules:

The automobile lease valuation rule. The vehicle cents-per-mile rule. The commuting valuation rule (for commuting use

only).

See Pub. 15-B for information on these special valu-ation rules.

Election not to withhold income tax. You canchoose not to withhold income tax on the value of anemployee's personal use of a highway motor vehicleyou provided. You do not have to make this choice forall employees. You can withhold income tax from thewages of some employees but not others. You must,however, withhold the applicable social security andMedicare taxes on such benefits.

You can choose not to withhold income tax by:

1) Notifying the employee as described below that youchoose not to withhold and

2) Including the value of the benefits in boxes 1, 3, 5,and 12 (box 14 on the 2001 Form W-2) on a timelyfurnished Form W-2. For use of a separate state-ment in lieu of using box 12, see the Instructions forForms W-2 and W-3.

The notice must be in writing and must be providedto the employee by January 31 of the election year orwithin 30 days after a vehicle is first provided to theemployee, whichever is later. This notice must be pro-vided in a manner reasonably expected to come to theattention of the affected employee. For example, thenotice may be mailed to the employee, included with apaycheck, or posted where the employee could rea-sonably be expected to see it. You can also changeyour election not to withhold at any time by notifying theemployee in the same manner.

Amount to report on Forms 941 and W-2. The actualvalue of fringe benefits provided during a calendar year(or other period as explained under Special account-ing rule earlier) must be determined by January 31 ofthe following year. You must report the actual valueon Forms 941 and W-2. If you choose, you can use aseparate Form W-2 for fringe benefits and any otherbenefit information.

Include the value of the fringe benefit in box 1 ofForm W-2. Also include it in boxes 3 and 5 if applicable.You may show the total value of the fringe benefitsprovided in the calendar year or other period in box 12of Form W-2 (box 14 on the 2001 Form W-2). If youprovided your employee with the use of a highwaymotor vehicle and included 100% of its annual leasevalue in the employee's income, you must also reportit separately in box 12 (box 14 on the 2001 Form W-2)or provide it in a separate statement. If there is notenough space on the Form W-2, you must report thevalue to the employee on a separate schedule so thatthe employee can compute the value of any businessuse of the vehicle.

If you use the special accounting rule, you must no-tify the affected employees of the period in which youused it. You must give the notice at or near the date

you give the Form W-2 but not earlier than with theemployee's last paycheck of the calendar year.

7. Sick Pay ReportingSpecial rules apply to the reporting of sick pay pay-ments to employees. How these payments are reporteddepends on whether the payments are made by theemployer or a third party, such as an insurance com-pany.

Sick pay is usually subject to social security, Medi-care, and FUTA taxes. For exceptions, see Social Se-curity, Medicare, and FUTA Taxes on Sick Pay later.Sick pay also may be subject to either mandatory orvoluntary Federal income tax withholding, dependingon who pays it.

Sick PaySick pay generally means any amount paid under a

plan because of an employee's temporary absencefrom work due to injury, sickness, or disability. It maybe paid by either the employer or a third party, suchas an insurance company. Sick pay includes both short-and long-term benefits. It is often expressed as a per-centage of the employee's regular wages.

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Payments That Are Not Sick PaySick pay does not include the following payments:

1) Disability retirement payments. Disability retire-ment payments are not sick pay and are not dis-cussed in this section. Those payments are subjectto the rules for income tax withholding from pen-sions and annuities. See section 9.

2) Workers' compensation. Payments because of a

work-related injury or sickness that are made undera workers' compensation law are not sick pay andare not subject to employment taxes. But seeWorkers' CompensationPublic Employees insection 5.

3) Medical expense payments. Payments under adefinite plan or system for medical andhospitalization expenses, or for insurance coveringthese expenses, are not sick pay and are not sub-

ject to employment taxes.

4) Payments unrelated to absence from work. Ac-cident or health insurance payments unrelated toabsence from work are not sick pay and are notsubject to employment taxes. These include pay-ments for:

a) Permanent loss of a member or function of thebody,

b) Permanent loss of the use of a member orfunction of the body, or

c) Permanent disfigurement of the body.

Example. Donald was injured in a car accidentand lost an eye. Under a policy paid for by Donald'semployer, Delta Insurance Co. paid Donald $5,000as compensation for the loss of his eye. Becausethe payment was determined by the type of injuryand was unrelated to Donald's absence from work,it is not sick pay and is not subject to employmenttaxes.

Sick Pay PlanA sick pay plan is a plan or system established by anemployer under which sick pay is available to employ-ees generally or to a class or classes of employees.This does not include a situation in which benefits areprovided on a discretionary or occasional basis withmerely an intention to aid particular employees in timeof need.

You have a sick pay plan or system if the plan is inwriting or is otherwise made known to employees, suchas by a bulletin board notice or your long and estab-lished practice. Some indications that you have a sickpay plan or system include references to the plan orsystem in the contract of employment, employer con-tributions to a plan, or segregated accounts for thepayment of benefits.

Definition of employer. The employer for whom the employee normally works, a term used in the follow-ing discussion, is either the employer for whom theemployee was working at the time the employee be-came sick or disabled or the last employer for whom the

employee worked before becoming sick or disabled, ifthat employer made contributions to the sick pay planon behalf of the sick or disabled employee.

Note: Contributions to a sick pay plan through a cafeteria plan (by direct employer contributions or salary reduction) are employer contributions unless they are aftertax employee contributions (included in taxable wages).

Third-Party Payers of Sick PayEmployer's agent. An employer's agent is a third partythat bears no insurance risk and is reimbursed on acost-plus-fee basis for payment of sick pay and similaramounts. A third party may be your agent even if thethird party is responsible for determining which em-ployees are eligible to receive payments. For example,if a third party provides administrative services only, thethird party is your agent. If the third party is paid aninsurance premium and is not reimbursed on a cost-plus-fee basis, the third party is not your agent. Whetheran insurance company or other third party is your agentdepends on the terms of the agreement with you.

A third party that makes payments of sick pay asyour agent is not considered the employer and gener-ally has no responsibility for employment taxes. Thisresponsibility remains with you. However, under anexception to this rule, the parties may enter into anagreement that makes the third-party agent responsiblefor employment taxes. In this situation, the third-partyagent should use its own name and EIN (rather thanyour name and EIN) for the responsibilities it has as-sumed.

Third party not employer's agent. A third party thatmakes payments of sick pay other than as an agent of the employer is liable for income tax withholding (ifrequested by the employee) and the employee part ofthe social security and Medicare taxes. The third partyis also liable for the employer part of the social securityand Medicare taxes and the FUTA tax, unless the thirdparty transfers this liability to the employer for whom theemployee normally works. This liability is transferred ifthe third party takes the following steps:

1) Withholds the employee social security and Medi-care taxes from the sick pay payments.

2) Makes timely deposits of the employee social se-curity and Medicare taxes.

3) Notifies the employer for whom the employeenormally works of the payments on which employeetaxes were withheld and deposited. The third partymust notify the employer within the time required forthe third party's deposit of the employee part of thesocial security and Medicare taxes. For instance, ifthe third party is a monthly schedule depositor, itmust notify the employer by the 15th day of themonth following the month in which the sick paypayment is made because that is the day by whichthe deposit is required to be made. The third partyshould notify the employer as soon as informationon payments is available so that an employer re-quired to make electronic deposits can make them

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timely. For multi-employer plans, see the specialrule discussed next.

Multi-employer plan timing rule. A special ruleapplies to sick pay payments made to employees by athird-party insurer under an insurance contract with amulti-employer plan established under a collectivelybargained agreement. If the third-party insurer makingthe payments complies with steps 1 and 2 above andgives the plan (rather than the employer) the required

timely notice described in step 3 above, then the plan(not the third-party insurer) must pay the employer partof the social security and Medicare taxes and the FUTAtax. Similarly, if, within 6 business days of the plan'sreceipt of notification, the plan gives notice to the em-ployer for whom the employee normally works, theemployer (not the plan) must pay the employer part ofthe social security and Medicare taxes and the FUTAtax.

Reliance on information supplied by the employer.A third party that pays sick pay should request infor-mation from the employer to determine amounts thatare not subject to employment taxes. Unless the third

party has reason not to believe the information, it mayrely on that information as to the following items:

The total wages paid the employee during the cal-endar year.

The last month in which the employee worked forthe employer.

The employee contributions to the sick pay planmade with aftertax dollars.

The third party should not rely on statements re-garding these items made by the employee.

Social Security, Medicare, and FUTATaxes on Sick PayEmployer. If you pay sick pay to your employee, youmust generally withhold employee social security andMedicare taxes from the sick pay. You must timely de-posit employee and employer social security and Med-icare taxes and FUTA tax. There are no special depositrules for sick pay. See section 11 of Circular E for moreinformation on the deposit rules.

Amounts not subject to social security, Medicare,or FUTA taxes. The following payments, whether madeby the employer or a third party, are not subject to socialsecurity, Medicare, or FUTA taxes (different rules applyto income tax withholding):

Payments after employee's death or disabilityretirement. Social security, Medicare, and FUTAtaxes do not apply to amounts paid under a definiteplan or system, as defined under Sick Pay Planearlier, on or after the termination of the employmentrelationship because of death or disability retire-ment.

However, even if there is a definite plan or sys-tem, amounts paid to a former employee are subjectto social security, Medicare, and FUTA taxes if they

would have been paid even if the employment re-lationship had not terminated because of death ordisability retirement. For example, a payment to adisabled former employee for unused vacation timewould have been made whether or not the employeeretired on disability. Therefore, the payment iswages and is subject to social security, Medicare,and FUTA taxes.

Payments after calendar year of employee'sdeath. Sick pay paid to the employee's estate orsurvivor after the calendar year of the employee'sdeath is not subject to social security, Medicare, orFUTA taxes. (Also see Amounts not subject toincome tax withholding under Income Tax With-holding on Sick Pay later.)

Example. Sandra became entitled to sick pay onNovember 30, 2000, and died December 26, 2000.On January 14, 2001, Sandra's sick pay for the pe-riod from December 19 through December 26, 2000,was paid to her survivor. The payment is not subjectto social security, Medicare, or FUTA taxes.

Payments to an employee entitled to disabilityinsurance benefits. Payments to an employeewhen the employee is entitled to disability insurancebenefits under section 223(a) of the Social SecurityAct are not subject to social security and Medicaretaxes. This rule applies only if the employee becameentitled to the Social Security Act benefits before thecalendar year in which the payments are made, andthe employee performs no services for the employerduring the period for which the payments are made.These payments are subject to FUTA tax.

Payments that exceed the applicable wage base.Social security and FUTA taxes do not apply topayments of sick pay that, when combined with ther

Documents

US Internal Revenue Service: p15a--2001