Following is IRS Publication 525. This is the general publication covering taxable and non taxable compensation. The IRS provides that all income received from an employer, no matter what form it is , is taxable. Except where the Internal Revenue code exempts it from being taxable.
Publication 525 – Main Contents
Table of Contents
Retirement Plan Contributions
Special Rules for Certain Employees
Members of Religious Orders
Business and Investment Income
Rents From Personal Property
S Corporation Income
Sickness and Injury Benefits
Long-Term Care Insurance Contracts
Other Sickness and Injury Benefits
Life Insurance Proceeds
Welfare and Other Public Assistance Benefits
Generally, you must include in gross income everything you receive in payment for personal services. In addition to wages, salaries, commissions, fees, and tips, this includes other forms of compensation such as fringe benefits and stock options.
You should receive a Form W–2, Wage and Tax Statement, from your employer showing the pay you received for your services. Include your pay on line 7 of Form 1040 or Form 1040A, or on line 1 of Form 1040EZ, even if you do not receive a Form W–2.
Childcare providers. If you provide child care, either in the child’s home or in your home or other place of business, the pay you receive must be included in your income. If you are not an employee, you are probably self-employed and must include payments for your services on Schedule C (Form 1040), Profit or Loss From Business, or Schedule C–EZ (Form 1040), Net Profit From Business. You generally are not an employee unless you are subject to the will and control of the person who employs you as to what you are to do and how you are to do it.
Baby-sitting. If you baby-sit for relatives or neighborhood children, whether on a regular basis or only periodically, the rules for childcare providers apply to you.
This section discusses many types of employee compensation. The subjects are arranged in alphabetical order.
Advance commissions and other earnings. If you receive advance commissions or other amounts for services to be performed in the future and you are a cash method taxpayer, you must include these amounts in your income in the year you receive them.
If you repay unearned commissions or other amounts in the same year you receive them, reduce the amount included in your income by the repayment. If you repay them in a later tax year, you can deduct the repayment as an itemized deduction on your Schedule A (Form 1040), or you may be able to take a credit for that year. See Repayments, later.
Allowances and reimbursements. If you receive travel, transportation, or other business expense allowances or reimbursements from your employer, get Publication 463, Travel, Entertainment, Gift, and Car Expenses. If you are reimbursed for moving expenses, get Publication 521, Moving Expenses.
Back pay awards. Include in income amounts you are awarded in a settlement or judgment for back pay. These include payments made to you for damages, unpaid life insurance premiums, and unpaid health insurance premiums. They should be reported to you by your employer on Form W–2.
Bonuses and awards. Bonuses or awards you receive for outstanding work are included in your income and should be shown on your Form W–2. These include prizes such as vacation trips for meeting sales goals. If the prize or award you receive is goods or services, you must include the fair market value of the goods or services in your income. However, if your employer merely promises to pay you a bonus or award at some future time, it is not taxable until you receive it or it is made available to you.
Employee achievement award. If you receive tangible personal property (other than cash, a gift certificate, or an equivalent item) as an award for length-of-service or safety achievement, you generally can exclude its value from your income. However, the amount you can exclude is limited to your employer’s cost and cannot be more than $1,600 ($400 for awards that are not qualified plan awards) for all such awards you receive during the year. Your employer can tell you whether your award is a qualified plan award. Your employer must make the award as part of a meaningful presentation, under conditions and circumstances that do not create a significant likelihood of it being disguised pay.
However, the exclusion does not apply to the following awards.
A length-of-service award if you received it for less than 5 years of service or if you received another length-of-service award during the year or the previous 4 years.
A safety achievement award if you are a manager, administrator, clerical employee, or other professional employee or if more than 10% of eligible employees previously received safety achievement awards during the year.
Ben Green received three employee achievement awards during the year: a non-qualified plan award of a watch valued at $250, and two qualified plan awards of a stereo valued at $1,000 and a set of golf clubs valued at $500. Assuming that the requirements for qualified plan awards are otherwise satisfied, each award by itself would be excluded from income. However, because the $1,750 total value of the awards is more than $1,600, Ben must include $150 ($1,750 – $1,600) in his income.
Government cost-of-living allowances. Cost-of-living allowances generally are included in your income. However, they are not included in your income if you are a federal civilian employee or a federal court employee who is stationed in Alaska, Hawaii, or outside the United States.
Allowances and differentials that increase your basic pay as an incentive for taking a less desirable post of duty are part of your compensation and must be included in income. For example, your compensation includes Foreign Post, Foreign Service, and Overseas Tropical differentials. For more information, get Publication 516, U.S. Government Civilian Employees Stationed Abroad.
Note received for services. If your employer gives you a secured note as payment for your services, you must include the fair market value (usually the discount value) of the note in your income for the year you receive it. When you later receive payments on the note, a proportionate part of each payment is the recovery of the fair market value that you previously included in your income. Do not include that part again in your income. Include the rest of the payment in your income in the year of payment.
If your employer gives you a nonnegotiable unsecured note as payment for your services, payments on the note that are credited toward the principal amount of the note are compensation income when you receive them.
Severance pay. Amounts you receive as severance pay are taxable. A lump-sum payment for cancellation of your employment contract must be included in your income in the tax year you receive it.
Accrued leave payment. If you are a federal employee and receive a lump-sum payment for accrued annual leave when you retire or resign, this amount will be included as wages on your Form W–2.
If you resign from one agency and are reemployed by another agency, you may have to repay part of your lump-sum annual leave payment to the second agency. You can reduce gross wages by the amount you repaid in the same tax year in which you received it. Attach to your tax return a copy of the receipt or statement given to you by the agency you repaid to explain the difference between the wages on your return and the wages on your Forms W–2.
Outplacement services. If you choose to accept a reduced amount of severance pay so that you can receive outplacement services (such as training in resumé writing and interview techniques), you must include the unreduced amount of the severance pay in income.
However, you can deduct the value of these outplacement services (up to the difference between the severance pay included in income and the amount actually received) as a miscellaneous deduction (subject to the 2% limit) on Schedule A (Form 1040).
Sick pay. Pay you receive from your employer while you are sick or injured is part of your salary or wages. In addition, you must include in your income sick pay benefits received from any of the following payers.
A welfare fund.
A state sickness or disability fund.
An association of employers or employees.
An insurance company, if your employer paid for the plan.
However, if you paid the premiums on an accident or health insurance policy, the benefits you receive under the policy are not taxable. For more information, see Other Sickness and Injury Benefits under Sickness and Injury Benefits, later.
Social security and Medicare taxes paid by employer. If you and your employer have an agreement that your employer pays your social security and Medicare taxes without deducting them from your gross wages, you must report the amount of tax paid for you as taxable wages on your tax return. The payment is also treated as wages for figuring your social security and Medicare taxes and your social security and Medicare benefits. However, these payments are not treated as social security and Medicare wages if you are a household worker or a farm worker.
Stock appreciation rights. Do not include a stock appreciation right granted by your employer in income until you exercise (use) the right. When you use the right, you are entitled to a cash payment equal to the fair market value of the corporation’s stock on the date of use, minus the fair market value on the date the right was granted. You include the cash payment in income in the year you use the right.
Fringe benefits you receive in connection with the performance of your services are included in your income as compensation unless you pay fair market value for them or they are specifically excluded by law. Abstaining from the performance of services (for example, under a covenant not to compete) is treated as the performance of services for purposes of these rules.
See Valuation of Fringe Benefits, later in this discussion, for information on how to determine the amount to include in income.
Recipient of fringe benefit. You are the recipient of a fringe benefit if you perform the services for which the fringe benefit is provided. You are considered to be the recipient even if it is given to another person, such as a member of your family. An example is a car your employer gives to your spouse for services you perform. The car is considered to have been provided to you and not to your spouse.
You do not have to be an employee of the provider to be a recipient of a fringe benefit. If you are a partner, director, or independent contractor, you can also be the recipient of a fringe benefit.
Provider of benefit. Your employer or another person for whom you perform services is the provider of a fringe benefit regardless of whether that person actually provides the fringe benefit to you. The provider can be a client or customer of an independent contractor.
Accounting period. You must use the same accounting period your employer uses to report your taxable non-cash fringe benefits. Your employer has the option to report taxable non-cash fringe benefits by using either of the following rules.
The general rule: benefits are reported for a full calendar year (January 1 – December 31).
The special accounting period rule: benefits provided during the last 2 months of the calendar year (or any shorter period) are treated as paid during the following calendar year. For example, each year your employer reports the value of benefits provided during the last 2 months of the prior year and the first 10 months of the current year.
Your employer does not have to use the same accounting period for each fringe benefit, but must use the same period for all employees who receive a particular benefit.
You must use the same accounting period that you use to report the benefit to claim an employee business deduction (for use of a car, for example).
Form W–2. Your employer reports your taxable fringe benefits in box 1 (Wages, tips, other compensation) of Form W–2. The total value of your fringe benefits may also be noted in box 12. The value of your fringe benefits may be added to your other compensation on one Form W–2, or you may receive a separate Form W–2 showing just the value of your fringe benefits in box 1 with a notation in box 12.
Accident or Health Plan
Generally, the value of accident or health plan coverage provided to you by your employer is not included in your income. Benefits you receive from the plan may be taxable, as explained, later, under Sickness and Injury Benefits.
Long-term care coverage. Contributions by your employer to provide coverage for long-term care services generally are not included in your income. However, contributions made through a flexible spending or similar arrangement (such as a cafeteria plan) must be included in your income. This amount will be reported as wages in box 1 of your Form W–2.
Archer MSA contributions. Contributions by your employer to your Archer MSA generally are not included in your income. Their total will be reported in box 12 of Form W–2 with code R. You must report this amount on Form 8853, Archer MSAs and Long-Term Care Insurance Contracts. File the form with your return.
You may be able to exclude from your income amounts paid or expenses incurred by your employer for qualified adoption expenses in connection with your adoption of an eligible child. See Publication 968, Tax Benefits for Adoption, for more information.
Adoption benefits are reported by your employer in box 12 of Form W–2 with code T. They also are included as social security and Medicare wages in boxes 3 and 5. However, they are not included as wages in box 1. To determine the taxable and nontaxable amounts, you must complete Part III of Form 8839, Qualified Adoption Expenses. File the form with your return.
If your employer provides you with the free or low-cost use of an employer-operated gym or other athletic club on your employer’s premises, the value is not included in your compensation. The gym must be used primarily by employees, their spouses, and their dependent children.
If your employer pays for a fitness program provided to you at an off-site resort hotel or athletic club, the value of the program is included in your compensation.
De Minimis (Minimal) Benefits
If your employer provides you with a product or service and the cost of it is so small that it would be unreasonable for the employer to account for it, the value is not included in your income. Generally, the value of benefits such as discounts at company cafeterias, cab fares home when working overtime, and company picnics are not included in your income. Also see Employee Discounts, later.
Holiday gifts. If your employer gives you a turkey, ham, or other item of nominal value at Christmas or other holidays, do not include the value of the gift in your income. However, if your employer gives you cash, a gift certificate, or a similar item that you can easily exchange for cash, you include the value of that gift as extra salary or wages regardless of the amount involved.
Dependent Care Benefits
If your employer provides dependent care benefits under a qualified plan, you may be able to exclude these benefits from your income. Dependent care benefits include:
Amounts your employer pays directly to either you or your care provider for the care of your qualifying person while you work, and
The fair market value of care in a daycare facility provided or sponsored by your employer.
The amount you can exclude is limited to the lesser of:
The total amount of dependent care benefits you received during the year,
The total amount of qualified expenses you incurred during the year,
Your earned income,
Your spouse’s earned income, or
$5,000 ($2,500 if married filing separately).
Your employer must show the total amount of dependent care benefits provided to you during the year under a qualified plan in box 10 of your Form W–2. Your employer also will include any dependent care benefits over $5,000 in your wages shown in box 1 of your Form W–2.
To claim the exclusion, you must complete either Part III of Form 2441, Child and Dependent Care Expenses, or Part III of Schedule 2 (Form 1040A), Child and Dependent Care Expenses for Form 1040A Filers. (You cannot use Form 1040EZ.)
See the instructions for Form 2441 or Schedule 2 (Form 1040A) for more information.
You can exclude from your income up to $5,250 of qualified employer-provided educational assistance. The exclusion applies to undergraduate and graduate-level courses. For more information, get Publication 970.
If your employer sells you property or services at a discount, you may be able to exclude the amount of the discount from your income. The exclusion applies to discounts on property or services offered to customers in the ordinary course of the line of business in which you work. However, it does not apply to discounts on real prope