us internal revenue service: p15a--1998

8/14/2019 US Internal Revenue Service: p15a--1998

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

2. Employee or Independent Contractor? ..... 4

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

4. Religious Exemptions ................................. 7

5. Wages and Other Compensation ................ 8

6. Employee Fringe Benefits ........................... 12

7. Sick Pay Reporting ...................................... 14

8. Special Rules for Paying Taxes ................. 20

9. Pensions and Annuities .............................. 22

10. Alternative Methods for FiguringWithholding .................................................. 23

Formula Tables for Percentage MethodWithholding ............................................... 25

Wage Bracket Percentage Method Tables ..... 28

Combined Income Tax, Employee SocialSecurity Tax, and Employee Medicare TaxWithholding Tables ................................... 37

11. Tables for Withholding on Distributions ofIndian Gaming Profits to Tribal Members 58

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

Important Reminder

Electronic deposit of taxes. If your total deposits of

social security, Medicare, railroad retirement, and with-held income taxes were more than $50,000 in 1996,you must make electronic deposits for alldepository taxliabilities that occur after 1997. When determiningwhether you exceeded the $50,000 deposit threshold,combine deposits of only the following tax returns youfiled: Forms 941, 941M, 941PR, 941SS, 943, 945,and CT1. If you were required to deposit by electronicfunds transfer in prior years, you must continue to doso in 1998. The Electronic Federal Tax PaymentSystem (EFTPS) must be used to make electronic de-posits. If you are required to make deposits by elec-tronic funds transfer and fail to do so, you may besubject to a 10% penalty. However, if you were first

required to use EFTPS on or after July 1, 1997, nopenalties for failure to use EFTPS will be imposed priorto July 1, 1998. Use EFTPS to deposit taxes reportedon any of the following tax forms:

Form 720, Quarterly Federal Excise Tax Return

Form 940 or 940EZ, Employer's Annual FederalUnemployment (FUTA) Tax Return

Form 941, Employer's Quarterly Federal Tax Return(including Forms 941M, 941PR, and 941SS)

Form 943, Employer's Annual Tax Return for Agri-cultural Employees

Department of the TreasuryInternal Revenue Service

Publica tion 15 -A(Rev. January 1998)Cat. No. 21453T

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

Publica tion 15)

Get forms and other information faster and easier by:COMPUTER

World Wide Web www.irs.ustreas.gov FTP ftp.irs.ustreas.gov IRIS at FedWorld (703) 321-8020

FAX From your FAX machine, dial (703) 368-9694


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Form 945, Annual Return of Withheld Federal In-come Tax

Form 990C, Farmers' Cooperative AssociationIncome Tax Return

Form 990PF, Return of Private Foundation orSection 4947(a)(1) Nonexempt Charitable TrustTreated as a Private Foundation

Form 990T, Exempt Organization Business In-come Tax Return

Form 1042, Annual Withholding Tax Return for U.S.Source Income of Foreign Persons

Form 1120 or 1120A, U.S. Corporation IncomeTax Return

Form 2438, Undistributed Capital Gains Tax Return

Form CT1, Employer's Annual Railroad Retire-ment Tax Return

Employers who are not required to make electronic

deposits may voluntarily participate in EFTPS. To enrollin EFTPS, call 18009458400 or 18005554477.For general information about EFTPS, call18008291040.

IntroductionThis publication supplements Circular E, Employer'sTax Guide (Pub. 15). It contains specialized and de-tailed employment tax information supplementing thebasic information provided in Circular E. It also con-tains:

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.

Ordering publications and forms. See the backcover of this booklet for how to get publications andforms.

Telephone help. You can call the IRS with your taxquestions Monday through Friday during regular busi-ness hours. Check your telephone book for the localnumber or call 18008291040.

Telephone help using TTY/TDD equipment. If youhave access to TTY/TDD equipment, you can call18008294059 with your tax question or to orderforms and publications. You may also use this number

for problem resolution assistance.

Useful ItemsYou may want to see:

Publication

15 Circular E, Employer's Tax Guide

51 Circular A, Agricultural Employer's TaxGuide

509 Tax Calendars for 1998

515 Withholding of Tax on Nonresident Aliensand Foreign Corporations

535 Business Expenses

553 Highlights of 1997 Tax Changes

583 Starting a Business and Keeping Records

1635 Understanding Your EIN

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.

A common-law employee.

A statutory employee.

A statutory nonemployee.

This discussion explains these four categories. Alater discussion, Employee or Independent Contrac-tor? in section 2, points out the differences betweenan independent contractor and an employee and givesexamples 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 backup withhold on these payments. See Circular Efor information on backup 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.

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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, see

Employee or Independent Contractor? in section 2.If you have an employer-employee relationship, itmakes no difference how it is labeled. The substanceof the relationship, not the labelgoverns 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, but a director is not. An officer who performsno services or only minor services, and neither receivesnor is entitled to receive any pay, is not considered anemployee.

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 in section 3 and Religious Exemptions in sec-tion 4.

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, Keogh, andSIMPLE 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 the common law are treated by statuteas employees. They are called statutory employees:

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 thedriver 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 or

supplies 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 statutory employees'wages 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.

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 employeemeans 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 W2 to a statutory employee, and checkstatutory employee in box 15. Show your paymentsto the employee as other compensation in box 1. Also,show social security wages in box 3, social security taxwithheld in box 4, Medicare wages in box 5, and Med-icare tax withheld in box 6. The statutory employee candeduct his or her trade or business expenses from thepayments shown on Form W2. He or she reportsearnings as a statutory employee on line 1 of Schedule

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C (Form 1040). (A statutory employee's business ex-penses are not subject to the reduction by 2% of hisor her adjusted gross income that applies to com-mon-law employees.)

Statutory NonemployeesThere are two categories of statutory nonemployees:direct sellersand 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 sale

of) 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 similarbasis 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 thedelivery or distribution of newspapers or shoppingnews (including any services directly related to suchdelivery 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 EmployeesConsequences 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 that

worker. 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 business

providing 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?

2. Employee or IndependentContractor?An employer must generally withhold income taxes,withhold and pay social security and Medicare taxes,and pay unemployment taxes on wages paid to anemployee. An employer does not generally have towithhold or pay any taxes on payments to independentcontractors.

Common-law rules. To determine whether an individ-ual is an employee or an independent contractor underthe common law, the relationship of the worker and thebusiness must be examined. All evidence of control andindependence must be considered. In anyemployeeindependent contractor determination, allinformation that provides evidence of the degree ofcontrol and the degree of independence must be con-sidered.

Facts that provide evidence of the degree of controland 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. An em-ployee is generally subject to the business's in-structions about when, where, and how to work.Even if no instructions are given, sufficient behav-ioral control may exist if the employer has the rightto control how the work results are achieved.

Training the business gives the worker. An em-ployee may be trained to perform services in a par-

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ticular manner. Independent contractors ordinarilyuse their own methods.

Financial control. Facts that show whether thebusiness has a right to control the business aspects ofthe worker's job include:

The extent to which the worker has unreimbursedbusiness expenses. Independent contractors aremore likely to have unreimbursed expenses than

employees. Fixed ongoing costs that are incurredregardless of whether work is currently being per-formed are especially important. However, employ-ees may also incur unreimbursed expenses in con-nection with the services they perform for theirbusiness.

The extent of the worker's investment. An inde-pendent contractor often has a significant invest-ment in the facilities he or she uses in performingservices for someone else. However, a significantinvestment is not required.

The extent to which the worker makes servicesavailable to the relevant market.

How the business pays the worker. An employee isgenerally paid by the hour, week, or month. An in-dependent contractor is usually paid by the job.However, it is common in some professions, suchas law, to pay independent contractors hourly.

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

Type of relationship. Facts that show the parties'type of 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 pen-sion plan, vacation pay, or sick pay.

The permanency of the relationship. If you engagea worker with the expectation that the relationshipwill continue indefinitely, rather than for a specificproject or period, this is generally considered evi-dence that your intent was to create an employer-employee relationship.

The extent to which services performed by theworker are a key aspect of the regular business ofthe company. If a worker provides services that are

a key aspect of your regular business activity, it ismore likely that you will have the right to direct andcontrol his or her activities. For example, if a law firmhires an attorney, it is likely that it will present theattorney's work as its own and would have the rightto control or direct that work. This would indicate anemployer-employee relationship.

IRS help. If you want the IRS to determine whether aworker is an employee, file Form SS8, Determinationof Employee Work Status for Purposes of Federal Em-ployment Taxes and Income Tax Withholding, with theIRS.

Industry ExamplesThe following examples may help you properly classifyyour workers.

Building and Construction Industry

Example 1. Jerry Jones has an agreement withWilma 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 isan employee 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.

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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 Industry

Example. Rose Trucking contracts to deliver mate-rial for Forest Inc. at $140 per ton. Rose Trucking is notpaid for any articles that are not delivered. At times, JanRose, who operates as Rose Trucking, may also leaseanother 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 Industry

Example. Steve Smith, a computer programmer, islaid 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 1099MISC. 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 Industry

Example 1. Donna Lee is a salesperson employedon 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-

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 Smith 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 W2 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, mailing costs, andtravel, costs for which the corporations have agreed toreimburse. Donna is an independent contractor.

Taxicab Driver

Example. Tom Spruce rents a cab from Taft CabCo. 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

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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 personor 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 taxthemselves, 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 described in section 501(c)(3) of the InternalRevenue Code include any community chest, fund, orfoundation organized and operated exclusively for reli-gious, charitable, scientific, testing for public safety, lit-erary, or educational purposes, or to foster national orinternational amateur sports competition, or for the

prevention of cruelty to children or animals. These or-ganizations are usually corporations and are exemptfrom income tax under section 501(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 wholly owned by a state or itspolitical subdivision. Such an organization shouldcontact the appropriate state official for information

about reporting and getting social security andMedicare coverage for its employees.

3) The organization is a church or church-controlledorganization opposed to the payment of social se-curity and Medicare taxes for religious reasons andhas filed Form 8274, Certification by Churches andQualified Church-Controlled Organizations ElectingExemption From Employer Social Security andMedicare Taxes, to elect exemption from social

security 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 de-scribed in section 501(c)(3) of the Internal RevenueCode that is exempt from income tax is also exemptfrom the Federal unemployment (FUTA) tax. This ex-emption cannot be waived.

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.

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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 section 1 should be applied to

determine whether a minister is your employee or isself-employed. The earnings of a minister are not sub-

ject to income, social security, and Medicare tax with-holding. They are subject to self-employment tax andincome 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 W2. If your employee is an ordainedminister, report all taxable compensation as wages inbox 1 on Form W2. Include in this amount expenseallowances or reimbursements paid under a nonac-countable plan, discussed in section 5 of Circular E.

Do not include a parsonage allowance (excludablehousing allowance) in this amount. You may report aparsonage or rental allowance (housing allowance),utilities allowance, and the rental value of housing pro-vided, in a separate statement or as Other in box 14on Form W2. Do not show on Forms W2 or 941 anyamount as social security or Medicare wages, or anywithholding for social security or Medicare taxes. If youwithheld tax from the minister under a voluntaryagreement, this amount should be shown in box 2 asFederal income tax withheld. For more information onministers, 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. 9120, 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

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 toFederal unemployment 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

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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 starting after June 30, 1996. For more infor-mation on educational assistance programs, see Reg-ulations section 1.127-2. The exclusion will expire forcourses beginning on or after June 1, 2000, unlessextended by law.

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 anyamount 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 social

security, Medicare, and Federal unemployment taxes,or income tax withholding. For more information, seePub. 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 fromproviding 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 to

income tax withholding and social security and Medi-care tax. 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 AssistancePrograms

The 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 Federal unemployment taxes,or income tax withholding. If the dependent is cared forin a facility at your place of business, the amount toexclude from the employee's income is based on hisor her use of the facility and the value of the servicesprovided. Report dependent care assistance paymentsin box 10 on Form W2. For more information, seechapter 5 in Pub. 535.

Dependent care providers. If you were the provider

of dependent care or pay the provider directly, youremployee may ask you for help in getting a completedForm W10, 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 request this information on FormW10.

Adoption Assistance Plans

Your employees may be able to exclude from grossincome 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 are subject to social security, Medicare, andFederal unemployment taxes. If the adoption assist-ance benefits are part of a cafeteria plan, they are stillsubject to these employment taxes. Report adoptionbenefits in box 13, using code T, on Form W2. SeePub. 968, Tax Benefits for Adoption, for more informa-tion.

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 Federalunemployment taxes, and the withholding of incometax.

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

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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 Social

Security Administration, and Form SSA131, 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 taxwithhholding, depending on how the plan is funded.Amounts that represent a return to the employee ofamounts previously subject to tax are not taxable andare not subject to withholding. You should withhold in-come tax on the taxable part of the payments made,

under a plan, to an employee who is involuntarily sep-arated because of a reduction in force, discontinuanceof a plant or operation, or other similar condition. It doesnot matter whether the separation is temporary or per-manent. The taxable part is not subject to social secu-rity, Medicare, or Federal unemployment 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 Federal unemployment taxes,and income tax withholding.

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).

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

Interest-Free andBelow-Market-Interest-Rate LoansIf an employer lends an employee more than $10,000at less than the applicable Federal interest rate, the

employer is considered to have paid additional com-pensation to the employee equal to the difference be-tween the applicable Federal interest rate and the in-terest rate charged. This rule applies to any such loan,regardless of amount, if one of its principal purposes isthe avoidance of Federal tax.

This additional compensation to the employee issubject to social security, Medicare, and Federal un-employment taxes, but not to income tax withholding.Include it in compensation on Form W2 (or Form1099MISC for an independent contractor). For moreinformation, see chapter 8 in Pub. 535.

Group-Term Life InsuranceInclude in wages the cost of group-term life insuranceyou provided to an employee for coverage over$50,000, or for coverage that discriminated in favor ofthe employee. This amount is subject to social security,Medicare, and Federal unemployment taxes, but notincome tax withholding. The tax treatment is the sameif the premiums are paid through a cafeteria plan (sec-tion 125). See Cafeteria Plans on the next page. Thistaxable insurance cost can be treated as paid by thepay period, by the quarter, or on any basis as long asthe cost is treated as paid at least once a year.

Monthly cost. You determine the monthly cost ofgroup-term life insurance by multiplying the number ofthousands of dollars of insurance coverage (figured tothe nearest 10th) by the appropriate cost per thousandper month. You determine age on the last day of the taxyear. If you provide group-term life insurance for a pe-riod of coverage of less than 1 month, you prorate themonthly cost over that period. The monthly cost of each$1,000 of group-term life insurance protection is asfollows:

Plan requirements. To exclude the cost of life insur-ance benefits from the income of your employees, yourplan must meet certain eligibility and nondiscriminationrequirements. For more information, see chapter 5 inPub. 535.

Age CostUnder 30 ....................................................................... $ .0830 through 34 ................................................................ .0935 through 39 ................................................................ .11

40 through 44 ................................................................ .1745 through 49 ................................................................ .2950 through 54 ................................................................ .4855 through 59 ................................................................ .7560 through 64 ................................................................ 1.1765 through 69 ................................................................ 2.1070 and over ................................................................... 3.76

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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 W2 using codes M and

N.. See the Instructions for Form W2.

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 toFederal unemployment tax or income tax withholding,but they are subject to social security and Medicaretaxes to the same extent as the employee's regularwages. However, the payments are no longer subjectto social security and Medicare taxes after the expira-tion of 6 months following the last calendar month inwhich the employee worked 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. These

amounts are includible in the gross income of the re-cipients and are subject to social security, Medicare,and Federal unemployment taxes, and income taxwithholding. Do not include these amounts in the in-come 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 andcertain qualified benefits. If the employee elects qual-ified benefits, employer contributions are excluded fromhis or her wages if the benefits are excludable from

gross income under a specific section of the InternalRevenue Code (other than scholarship and fellowshipgrants under section 117 and employee fringe benefitsunder section 132, and educational assistance pro-grams under section 127). The cost of group-term lifeinsurance that is includible in income only because theinsurance exceeds $50,000 of coverage is considereda qualified benefit under a special rule.

Generally, qualified benefits under a cafeteria planare not subject to social security, Medicare, and Federalunemployment taxes, or income tax withholding. How-ever, group-term life insurance that exceeds $50,000of coverage and adoption benefits are subject to social

security, Medicare, and Federal unemployment taxes,but not income tax withholding, even when provided asqualified benefits in a cafeteria plan. If an employeeelects to receive cash instead of any qualified benefit,it is treated as wages subject to all employment taxes.For more information, see chapter 5 in Pub. 535.

Nonqualified DeferredCompensation PlansEmployer contributions to nonqualified deferred com-pensation or nonqualified pension plans are treated associal security and Medicare wages when the servicesare performed or the employee no longer has a sub-stantial risk of forfeiting the right to the deferred com-pensation, whichever is later.

Withhold income tax on nonqualified plans as fol-lows:

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 employer irrevocablycontributes the deferred compensation to a separate

fund, such as an irrevocable trust.

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

Social security, Medicare, and withheld income taxeson these plans must be reported on Forms W2 and941. Get the Instructions for Form W2 for more infor-mation.

Employee Stock OptionsThere are two classes of stock options, statutory (cov-ered by a specific Code provision) and nonstatutory.

Generally, statutory stock options are not taxable to theemployee either when the option is granted or when itis exercised (unless the stock is disposed of in a dis-qualifying disposition). However, nonstatutory stockoptions normally are taxable to the employee as wageswhen the option is exercised (see Regulations section1.83-7). These wages are subject to social security andMedicare taxes, income tax withholding, and Federalunemployment (FUTA) tax.

Tax-Sheltered AnnuitiesEmployer payments made by an educational institutionor a tax-exempt organization to purchase a tax-

sheltered annuity for an employee are included in theemployee's social security and Medicare wages if thepayments are made because of a salary reductionagreement. They are not included in box 1 on FormW2 and 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,

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and Federal unemployment taxes, or income tax with-holding. However, any SEP contributions paid under asalary reduction agreement (SARSEP) are included inwages for purposes of social security and Medicaretaxes and the Federal unemployment tax. See Pub.560, Retirement Plans for Small Business (SEP, Keogh,and SIMPLE Plans), for more information about SEPs.

Salary reduction simplified employee pensions(SARSEP) repealed. You may not establish aSARSEP after 1996. However, SARSEPs established

before January 1, 1997, may continue to receive con-tributions.

SIMPLE Retirement PlansEmployer and employee contributions to a SIMPLE re-tirement account (subject to limitations) are excludablefrom the employee's income and are exempt fromFederal income tax withholding. An employer's none-lective (2%) or matching contributions are exempt fromsocial security, Medicare, and Federal unemployment(FUTA) taxes. However, an employee's salary reductioncontributions to a SIMPLE are subject 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 Federal unemployment taxes, or income tax with-holding.

1) A no-additional-cost service, which is a serviceoffered for sale to customers in the course of theemployer's line of business in which the employee

works. It 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) A qualified employee discountthat, if offered forproperty, is not more than the employer's grossprofit percentage. If offered for services, the dis-count is not more than 20% of the price for servicesoffered to customers.

3) A working condition benefitthat is property or aservice the employee could deduct as a business

expense 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) A de minimis benefitthat 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. Examplesinclude typing of a personal letter by a companysecretary, occasional personal use of a company

copying machine, occasional parties or picnics foremployees, occasional supper money and taxi farefor employees working overtime, holiday gifts witha low fair market value, occasional tickets forentertainment events, and coffee and doughnutsfurnished to employees. Also exclude from theemployee's income meals at an eating facility op-erated by the employerfor 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) A qualified transportation benefit, which includestransit passes, transportation in a commuter high-way vehicle to and from work, and qualified parkingat or near the place of work. The combined exclu-sion for the transit passes and transportation cannotexceed $65 per month for 1998. The exclusion forparking cannot exceed $175 per month for 1998.For more information on this transportation fringebenefit, see chapter 4 in Pub. 535.

6) A qualified moving expense reimbursement,which includes any amount received, directly or in-directly, by an employee from an employer as a

payment for, or reimbursement of, expenses thatwould be deductible as moving expenses, if paidor incurred by the employee. For more informationon expenses that qualify for a deduction, see Pub.521, Moving Expenses.

7) An on-premises gym or other athletic facilityprovided and operated by the employer if substan-tially all the use is by employees, their spouses, andtheir dependent children.

8) A qualified tuition reduction, which an educa-tional organization provides its employees for edu-cation, generally below the graduate level. For moreinformation on a qualified tuition reduction, see Pub.520.

However, do not exclude the following fringe benefitsfrom the income of highly compensated employeesunless the benefits 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 a highlycompensated employee, see Pub. 535.

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 the fol-lowing services in connection with air transportation:catering, baggage handling, ticketing and reservations,

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

More information. For more detailed information on

fringe benefits, see chapter 4 in Pub. 535.

Withholding on and ReportingTaxable Noncash Fringe BenefitsUse the following guidelines for reporting and with-holding tax on taxable noncash fringe benefits.

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

time.

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 canwithhold 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 calendar

year 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 during1998, you can treat it as made in four payments of$250, each in a different pay period of 1998. 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 personal

property 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 you

chose 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 ordates 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 theoverpayment 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 W2.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 ofbenefits actually provided in the last 2 months of 1997would be treated as provided in 1998 together with thevalue of benefits provided in the first 10 months of 1998.This does not mean that all benefits treated as paid

during 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.

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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 useonly).

See Pub. 535 for information on these special valuationrules.

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 on a timely furnished Form W2.

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 W2. 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 value onForms 941 and W2. If you choose, you can use aseparate Form W2 for fringe benefits and any otherbenefit information.

Include the value of the fringe benefit in box 1 ofForm W2. Also include it in boxes 3 and 5 if applicable.

Show the total value of the fringe benefits provided inthe calendar year or other period in box 12 of FormW2. If you provided your employee with the use of ahighway motor vehicle and included 100% of its annuallease value in the employee's income, you must alsoreport it separately in box 12. If there is not enoughspace on the Form W2, you must report the value tothe employee on a separate schedule so that the em-ployee can compute the value of any business use ofthe 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 W2 but not earlier than with theemployee's last paycheck of the calendar year.

7. Sick Pay ReportingSick pay generally means any amount paid under aplan 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, such

as 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.

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. See Income Tax Withholding on SickPay later.

Sick pay plan. A sick pay plan is a plan or systemestablished by an employer under which sick pay is

available to employees generally or to a class orclasses of employees. A plan or system does not existif benefits are provided on a discretionary or occasionalbasis with merely a good intention to aid particularemployees in time of need.

The existence of a plan or system is shown if theplan is in writing or is otherwise made known to em-ployees, such as by a bulletin board notice or the longand established practice of the employer. Other indi-cations of the existence of a plan or system include,but are not limited to, references to the plan or systemin the contract of employment, employer contributionsto a plan, and segregated accounts for the payment ofbenefits.

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) Worker's compensation. Payments because of awork-related injury or sickness that are made undera workers' compensation law are not sick pay andare not subject to employment taxes. But see

Workers' 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:

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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 $5,000

as 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.

Third-Party Payers of Sick Pay

Employer'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 than

your 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 agentof 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 employeesocial security and Medi-care taxes from the sick pay payments.

2) Makes timely deposits of the employeesocial 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 the

month following the month in which the sick paypayment is made, because that is the day by whichthe deposit is required to be made. For multi-employer plans, see the special rule discussednext.

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 collectively

bargained agreement. If the third-party insurer makingthe payments complies with steps 1 and 2 above andgives the plan (rather than the employer) the requiredtimely 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 thirdparty has reason not to believe the information, it mayrely on that information as to the following items:

The total wages you paid the employee during thecalendar year.

The last month in which the employee worked foryou.

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 Pay

Employer. 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 Federal unemployment (FUTA) tax.There are no special deposit rules for sick pay. Seesection 11 of Circular E for more information on the

deposit rules.

Amounts not subject to social security, Medicare,or FUTA taxes. The following payments, whethermade by you 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 employment

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relationship 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 theywould 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 employee

retired 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, 1997, and died December 26, 1997.On January 14, 1998, Sandra's sick pay for the pe-

riod from December 19 through December 26, 1997,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 service for the employerduring the period for which the payments are made.

Note: These paymentsaresubject 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 theregular wages and sick pay previously paid to theemployee during the year, exceed the applicablewage base. Because there is no Medicare tax wagebase, this exception does not apply to Medicare tax.The social security tax wage base for 1998 is$68,400. The FUTA tax wage base is $7,000.

Example. If an employee receives $65,000 inwages from an employer in 1998, and then receives$4,000 of sick pay, only the first $3,400 of the sickpay is subject to social security tax. All of the sickpay is subject to Medicare tax. None of the sick payis subject to FUTA tax. See Example of Figuringand Reporting Sick Pay later.

Payments after 6 months absence from work.Social security, Medicare, and FUTA taxes do notapply to sick pay paid more than 6 calendar monthsafter the last calendar month in which the employeeworked.

Example 1. Ralph's last day of work before hebecame entitled to receive sick pay was December10, 1997. He was paid sick pay for 9 months beforehis return to work on September 7, 1998. Sick pay

paid to Ralph after June 30, 1998, is not subject tosocial security, Medicare, or FUTA taxes.

Example 2. The facts are the same as in Exam-ple 1, except that Ralph worked 1 day during the9-month period, on February 16, 1998. Because the6-month period begins again in March, only the sickpay paid to Ralph after August 31, 1998, is exemptfrom social security, Medicare, and FUTA taxes.

Payments attributable to employee contribu-

tions. Social security, Medicare, and FUTA taxesdo not apply to payments, or parts of payments, at-tributable to employee contributions to a sick-payplan made with aftertaxdollars. (Contributions to asick-pay plan made on behalf of employees withemployees' pretax dollars under a cafeteria plan areemployer contributions.)

Group policy. If both the employer and the em-ployee contributed to the sick-pay plan under agroup insurance policy, figure the taxable sick payby multiplying it by the percentage of the policy'scost that was contributed by the employer for the 3policy years before the calendar year in which thesick pay is paid. If the policy has been in effect fewer

than 3 years, use the cost for the policy years ineffect or, if in effect less than 1 year, a reasonableestimate of the cost for the first policy year.

Example. Alan is employed by Edgewood Cor-poration. Because of an illness, he was absent fromwork for 3 months during 1998. Key InsuranceCompany paid Alan $2,000 sick pay for each monthof his absence under a policy paid for by contribu-tions from both Edgewood and its employees. All theemployees' contributions were paid with aftertaxdollars. For the 3 policy years before 1998,Edgewood paid 70% of the policy's cost and itsemployees paid 30%. Because 70% of the sick paypaid under the policy is due to Edgewood's contri-

butions, $1,400 ($2,000 70%) of each paymentmade to Alan is taxable sick pay. The remaining$600 of each payment that is due to employeecontributions is not taxable sick pay and is not sub-

ject to employment taxes. Also, see Example ofFiguring and Reporting Sick Pay later.

Income Tax Withholding on Sick PayThe requirements for income tax withholding on sickpay and the methods for figuring it differ depending onwhether the sick pay is paid by:

The employer,

An agent of the employer (defined earlier), or

A third party that is not the employer's agent.

Employer or employer's agent. Sick pay paid by youor your agent is subject to mandatory income tax with-holding. An employer or agent paying sick pay generallydetermines the income tax to be withheld based on theemployee's Form W4. The employee cannot choosehow much will be withheld by giving you or your agenta Form W4S. Sick pay paid by an agent is treated assupplemental wages. If the agent does not pay regularwages to the employee, the agent may choose to

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withhold income tax at a flat 28% rate, rather than atthe wage withholding rate.

Third party not an agent. Sick pay paid by a thirdparty that is not your agent is not subject to mandatoryincome tax withholding. However, an employee mayelect to have income tax withheld by submitting FormW4S to the third party.

If Form W4S has been submitted, the third partyshould withhold income tax on all payments of sick paymade 8 or more days after receiving the form. The thirdparty may, at its option, withhold income tax before 8days have passed.

The employee may request on Form W4S to havea specific whole dollar amount withheld. However, if therequested withholding would reduce any net paymentbelow $10, the third party should not withhold any in-come tax from that payment. The minimum amount ofwithholding that the employee can specify is $20 aweek.

If a particular payment is less than or greater than aregular payment, the amount withheld must be in thesame proportion to the particular payment as the regu-lar withholding is to a regular payment. For example, if$25 is withheld from a regular full payment of $100,then $20 (25%) should be withheld from a partial pay-ment of $80.

Amounts not subject to income tax withholding.The following amounts, whether paid by you or a thirdparty, are not wages subject to income tax withholding.

Payments after the employee's death. Sick paypaid to the employee's estate or survivor at any timeafter the employee's death is not subject to incometax withholding, regardless of who pays it.

Payments attributable to employee contribu-tions. Payments, or parts of payments, attributableto employee contributions made to a sick-pay planwith aftertax dollars are not subject to income taxwithholding. For more information, see the corre-sponding discussion in Amounts not subject tosocial security, Medicare, or FUTA taxes earlier.

Depositing and ReportingThis section discusses who is liable for depositing so-cial security, Medicare, FUTA, and withheld incometaxes on sick pay. These taxes must be deposited un-der the same rules that apply to deposits of taxes on

regular wage payments. See Circular E for informationon the deposit rules.This section also explains how sick pay should be

reported on Forms W2, W3, 940 or 940EZ, and 941.For additional information covering specific line num-bers and box numbers on these forms, see ReportingSick Pay on Forms 941, W2, and W3 later.

Sick Pay Paid by Employer or AgentIf you or your agent (defined earlier) makes sick paypayments, you deposit taxes and file Forms W2, W3,940, and 941 under the same rules that apply to regularwage payments.

However, the agreement between the parties mayrequire your agent to carry out responsibilities thatwould otherwise have been borne by you. In this situ-ation, your agent should use its own name and EIN(rather than yours) for the responsibilities it has as-sumed.

Reporting sick pay on Form W2. You may eithercombine the sick pay with other wages and prepare asingle Form W2 for each employee, or you may pre-

pare separate Forms W2 for each employee, one re-porting sick pay and the other reporting regular wages.A Form W2 must be prepared even if all the sick payis nontaxable (see item 9 in the following list of infor-mation that must be included on Form W-2). All FormsW2 must be given to the employees by January 31.

The Form W2 filed for the sick pay must include thefollowing information:

1) Employer's name, address, and EIN.

2) Employee's name, address, and SSN.

3) Sick pay the employee must include in income(box 1).

4)

us internal revenue service: p15a--1998

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