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H&rblockonline 8. H&rblockonline   Distributions and Rollovers Table of Contents DistributionsMinimum Required Distributions No Special 10-Year Tax Option Transfer of Interest in 403(b) ContractAfter-tax contributions. H&rblockonline Permissive service credit. H&rblockonline Tax-Free RolloversHardship exception to rollover rules. H&rblockonline Eligible retirement plans. H&rblockonline Nonqualifying distributions. H&rblockonline Second rollover. H&rblockonline Gift Tax Distributions Permissible distributions. H&rblockonline   Generally, a distribution cannot be made from a 403(b) account until the employee: Reaches age 59½, Has a severance from employment, Dies, Becomes disabled, In the case of elective deferrals, encounters financial hardship, or Has a qualified reservist distribution. H&rblockonline In most cases, the payments you receive or that are made available to you under your 403(b) account are taxable in full as ordinary income. H&rblockonline In general, the same tax rules apply to distributions from 403(b) plans that apply to distributions from other retirement plans. H&rblockonline These rules are explained in Publication 575. H&rblockonline Publication 575 also discusses the additional tax on early distributions from retirement plans. H&rblockonline Retired public safety officers. H&rblockonline   If you are an eligible retired public safety officer, distributions of up to $3,000, made directly from your 403(b) plan to pay accident, health, or long-term care insurance, are not included in your taxable income. H&rblockonline The premiums can be for you, your spouse, or your dependents. H&rblockonline   A public safety officer is a law enforcement officer, fire fighter, chaplain, or member of a rescue squad or ambulance crew. H&rblockonline   For additional information, see Publication 575. H&rblockonline Distribution for active reservist. H&rblockonline   The 10% penalty for early withdrawals will not apply to a qualified reservist distribution attributable to elective deferrals from a 403(b) plan. H&rblockonline A qualified reservist distribution is a distribution that is made: To an individual who is a reservist or national guardsman and who was ordered or called to active duty for a period in excess of 179 days or for an indefinite period; and During the period beginning on the date of the order or call to duty and ending at the close of the active duty period. H&rblockonline Minimum Required Distributions You must receive all, or at least a certain minimum, of your interest accruing after 1986 in the 403(b) plan by April 1 of the calendar year following the later of the calendar year in which you become age 70½, or the calendar year in which you retire. H&rblockonline Check with your employer, plan administrator, or provider to find out whether this rule also applies to pre-1987 accruals. H&rblockonline If not, a minimum amount of these accruals must begin to be distributed by the later of the end of the calendar year in which you reach age 75 or April 1 of the calendar year following retirement. H&rblockonline For each year thereafter, the minimum distribution must be made by the last day of the year. H&rblockonline If you do not receive the required minimum distribution, you are subject to a nondeductible 50% excise tax on the difference between the required minimum distribution and the amount actually distributed. H&rblockonline No Special 10-Year Tax Option A distribution from a 403(b) plan does not qualify as a lump-sum distribution. H&rblockonline This means you cannot use the special 10-year tax option to calculate the taxable portion of a 403(b) distribution. H&rblockonline For more information, see Publication 575. H&rblockonline Transfer of Interest in 403(b) Contract Contract exchanges. H&rblockonline   If you transfer all or part of your interest from a 403(b) contract to another 403(b) contract (held in the same plan), the transfer is tax free, and is referred to as a contract exchange. H&rblockonline This was previously known as a 90-24 transfer. H&rblockonline A contract exchange is similar to a 90-24 transfer with one major difference. H&rblockonline Previously, you were able to accomplish the transfer without your employer’s involvement. H&rblockonline After September 24, 2007, all such transfers are accomplished through a contract exchange requiring your employer’s involvement. H&rblockonline In addition, the plan must provide for the exchange and the transferred interest must be subject to the same or stricter distribution restrictions. H&rblockonline Finally, your accumulated benefit after the exchange must be equal to what it was before the exchange. H&rblockonline   Transfers that do not satisfy this rule are plan distributions and are generally taxable as ordinary income. H&rblockonline Plan-to-plan transfers. H&rblockonline   You may also transfer part or all of your interest from a 403(b) plan to another 403(b) plan if you are an employee of (or were formerly employed by) the employer of the plan to which you would like to transfer. H&rblockonline Both the initial plan and the receiving plan must provide for transfers. H&rblockonline Your accumulated benefit after the transfer must be at least equal to what it was before the transfer. H&rblockonline The new plan’s restrictions on distributions must be the same or stricter than those of the original plan. H&rblockonline Tax-free transfers for certain cash distributions. H&rblockonline   A tax-free transfer may also apply to a cash distribution of your 403(b) account from an insurance company that is subject to a rehabilitation, conservatorship, insolvency, or similar state proceeding. H&rblockonline To receive tax-free treatment, you must do all of the following: Withdraw all the cash to which you are entitled in full settlement of your contract rights or, if less, the maximum permitted by the state. H&rblockonline Reinvest the cash distribution in a single policy or contract issued by another insurance company or in a single custodial account subject to the same or stricter distribution restrictions as the original contract not later than 60 days after you receive the cash distribution. H&rblockonline Assign all future distribution rights to the new contract or account for investment in that contract or account if you received an amount that is less than what you are entitled to because of state restrictions. H&rblockonline   In addition to the preceding requirements, you must provide the new insurer with a written statement containing all of the following information: The gross amount of cash distributed under the old contract. H&rblockonline The amount of cash reinvested in the new contract. H&rblockonline Your investment in the old contract on the date you receive your first cash distribution. H&rblockonline   Also, you must attach the following items to your timely filed income tax return in the year you receive the first distribution of cash. H&rblockonline A copy of the statement you gave the new insurer. H&rblockonline A statement that includes: The words ELECTION UNDER REV. H&rblockonline PROC. H&rblockonline 92-44, The name of the company that issued the new contract, and The new policy number. H&rblockonline Direct trustee-to-trustee transfer. H&rblockonline   If you make a direct trustee-to-trustee transfer, from your governmental 403(b) account to a defined benefit governmental plan, it may not be includible in gross income. H&rblockonline   The transfer amount is not includible in gross income if it is made to: Purchase permissive service credits, or Repay contributions and earnings that were previously refunded under a forfeiture of service credit under the plan, or under another plan maintained by a state or local government employer within the same state. H&rblockonline After-tax contributions. H&rblockonline   For distributions beginning after December 31, 2006, after-tax contributions can be rolled over between a 403(b) plan and a defined benefit plan, IRA, or a defined contribution plan. H&rblockonline If the rollover is to or from a 403(b) plan, it must occur through a direct trustee-to-trustee transfer. H&rblockonline Permissive service credit. H&rblockonline   A permissive service credit is credit for a period of service recognized by a defined benefit governmental plan only if you voluntarily contribute to the plan an amount that does not exceed the amount necessary to fund the benefit attributable to the period of service and the amount contributed is in addition to the regular employee contribution, if any, under the plan. H&rblockonline   A permissive service credit may also include service credit for up to 5 years where there is no performance of service, or service credited to provide an increased benefit for service credit which a participant is receiving under the plan. H&rblockonline   Check with your plan administrator as to the type and extent of service that may be purchased by this transfer. H&rblockonline Tax-Free Rollovers You can generally roll over tax free all or any part of a distribution from a 403(b) plan to a traditional IRA or a non-Roth eligible retirement plan, except for any nonqualifying distributions, described later. H&rblockonline You may also roll over any part of a distribution from a 403(b) plan by converting it through a direct rollover, described below, to a Roth IRA. H&rblockonline Conversion amounts are generally includible in your taxable income in the year of the distribution from your 403(b) account. H&rblockonline See Publication 590 for more information about conversion into a Roth IRA. H&rblockonline Note. H&rblockonline A participant is required to roll over distribution amounts received within 60 days in order for the amount to be treated as nontaxable. H&rblockonline Distribution amounts that are rolled over within the 60 days are not subject to the 10% early distribution penalty. H&rblockonline Rollovers to and from 403(b) plans. H&rblockonline   You can generally roll over tax free all or any part of a distribution from an eligible retirement plan to a 403(b) plan. H&rblockonline Beginning January 1, 2008, distributions from tax-qualified retirement plans and tax-sheltered annuities can be converted by making a direct rollover into a Roth IRA subject to the restrictions that currently apply to rollovers from a traditional IRA into a Roth IRA. H&rblockonline Converted amounts are generally includible in your taxable income in the year of the distribution from your 403(b) account. H&rblockonline See Publication 590 for more information on conversion into a Roth IRA. H&rblockonline   If a distribution includes both pre-tax contributions and after-tax contributions, the portion of the distribution that is rolled over is treated as consisting first of pre-tax amounts (contributions and earnings that would be includible in income if no rollover occurred). H&rblockonline This means that if you roll over an amount that is at least as much as the pre-tax portion of the distribution, you do not have to include any of the distribution in income. H&rblockonline   For more information on rollovers and eligible retirement plans, see Publication 575. H&rblockonline If you roll over money or other property from a 403(b) plan to an eligible retirement plan, see Publication 575 for information about possible effects on later distributions from the eligible retirement plan. H&rblockonline Hardship exception to rollover rules. H&rblockonline   The IRS may waive the 60-day rollover period if the failure to waive such requirement would be against equity or good conscience, including cases of casualty, disaster, or other events beyond the reasonable control of an individual. H&rblockonline   To obtain a hardship exception, you must apply to the IRS for a waiver of the 60-day rollover requirement. H&rblockonline You apply for the waiver by following the general instructions used in requesting a letter ruling. H&rblockonline These instructions are stated in Revenue Procedure 2013-4, 2013-1 I. H&rblockonline R. H&rblockonline B. H&rblockonline 126 available at www. H&rblockonline irs. H&rblockonline gov/irb/2013-01_IRB/ar09. H&rblockonline html, or see the latest annual update. H&rblockonline You must also pay a user fee with the application. H&rblockonline The user fee for a rollover that is less than $50,000 is $500. H&rblockonline For rollovers that are $50,000 or more, see Revenue Procedure 2013-8, 2013-1 I. H&rblockonline R. H&rblockonline B. H&rblockonline 237 available at www. H&rblockonline irs. H&rblockonline gov/irb/2013-01_IRB/ar13. H&rblockonline html, or see the latest annual update. H&rblockonline   In determining whether to grant a waiver, the IRS will consider all relevant facts and circumstances, including: Whether errors were made by the financial institution; Whether you were unable to complete the rollover due to death, disability, hospitalization, incarceration, restrictions imposed by a foreign country, or postal error; Whether you used the amount distributed (for example, in the case of payment by check, whether you cashed the check); and How much time has passed since the date of distribution. H&rblockonline   For additional information on rollovers, see Publication 590. H&rblockonline Eligible retirement plans. H&rblockonline   The following are considered eligible retirement plans. H&rblockonline Individual retirement arrangements. H&rblockonline Roth IRA. H&rblockonline 403(b) plans. H&rblockonline Government eligible 457 plans. H&rblockonline Qualified retirement plans. H&rblockonline  If the distribution is from a designated Roth account, then the only eligible retirement plan is another designated Roth account or a Roth IRA. H&rblockonline Nonqualifying distributions. H&rblockonline   You cannot roll over tax free: Minimum required distributions (generally required to begin at age 70½), Substantially equal payments over your life or life expectancy, Substantially equal payments over the joint lives or life expectancies of your beneficiary and you, Substantially equal payments for a period of 10 years or more, Hardship distributions, or Corrective distributions of excess contributions or excess deferrals, and any income allocable to the excess, or excess annual additions and any allocable gains. H&rblockonline Rollover of nontaxable amounts. H&rblockonline    You may be able to roll over the nontaxable part of a distribution (such as your after-tax contributions) made to another eligible retirement plan, traditional IRA, or Roth IRA. H&rblockonline The transfer must be made either through a direct rollover to an eligible plan that separately accounts for the taxable and nontaxable parts of the rollover or through a rollover to a traditional IRA or Roth IRA. H&rblockonline   If you roll over only part of a distribution that includes both taxable and nontaxable amounts, the amount you roll over is treated as coming first from the taxable part of the distribution. H&rblockonline Direct rollovers of 403(b) plan distributions. H&rblockonline   You have the option of having your 403(b) plan make the rollover directly to a traditional IRA, Roth IRA, or new plan. H&rblockonline Before you receive a distribution, your plan will give you information on this. H&rblockonline It is generally to your advantage to choose this option because your plan will not withhold tax on the distribution if you choose it. H&rblockonline Distribution received by you. H&rblockonline   If you receive a distribution that qualifies to be rolled over, you can roll over all or any part of the distribution. H&rblockonline Generally, you will receive only 80% of the distribution because 20% must be withheld. H&rblockonline If you roll over only the 80% you receive, you must pay tax on the 20% you did not roll over. H&rblockonline You can replace the 20% that was withheld with other money within the 60-day period to make a 100% rollover. H&rblockonline Voluntary deductible contributions. H&rblockonline   For tax years 1982 through 1986, employees could make deductible contributions to a 403(b) plan under the individual retirement arrangement (IRA) rules instead of deducting contributions to a traditional IRA. H&rblockonline   If you made voluntary deductible contributions to a 403(b) plan under these traditional IRA rules, the distribution of all or part of the accumulated deductible contributions may be rolled over if it otherwise qualifies as a distribution you can roll over. H&rblockonline Accumulated deductible contributions are the deductible contributions: Plus Income allocable to the contributions, Gain allocable to the contributions, and Minus Expenses and losses allocable to the contributions, and Distributions from the contributions, income, or gain. H&rblockonline Excess employer contributions. H&rblockonline   The portion of a distribution from a 403(b) plan transferred to a traditional IRA that was previously included in income as excess employer contributions (discussed earlier) is not an eligible rollover distribution. H&rblockonline   Its transfer does not affect the rollover treatment of the eligible portion of the transferred amounts. H&rblockonline However, the ineligible portion is subject to the traditional IRA contribution limits and may create an excess IRA contribution subject to a 6% excise tax (see chapter 1 of Publication 590). H&rblockonline Qualified domestic relations order. H&rblockonline   You may be able to roll over tax free all or any part of an eligible rollover distribution from a 403(b) plan that you receive under a qualified domestic relations order (QDRO). H&rblockonline If you receive the interest in the 403(b) plan as an employee's spouse or former spouse under a QDRO, all of the rollover rules apply to you as if you were the employee. H&rblockonline You can roll over your interest in the plan to a traditional IRA or another 403(b) plan. H&rblockonline For more information on the treatment of an interest received under a QDRO, see Publication 575. H&rblockonline Spouses of deceased employees. H&rblockonline   If you are the spouse of a deceased employee, you can roll over the qualifying distribution attributable to the employee. H&rblockonline You can make the rollover to any eligible retirement plan. H&rblockonline   After you roll money and other property over from a 403(b) plan to an eligible retirement plan, and you take a distribution from that plan, you will not be eligible to receive the capital gain treatment or the special averaging treatment for the distribution. H&rblockonline Second rollover. H&rblockonline   If you roll over a qualifying distribution to a traditional IRA, you can, if certain conditions are satisfied, later roll the distribution into another 403(b) plan. H&rblockonline For more information, see IRA as a holding account (conduit IRA) for rollovers to other eligible plans in chapter 1 of Publication 590. H&rblockonline Nonspouse beneficiary. H&rblockonline   A nonspouse beneficiary may make a direct rollover of a distribution from a 403(b) plan of a deceased participant if the rollover is a direct transfer to an inherited IRA established to receive the distribution. H&rblockonline If the rollover is a direct trustee-to-trustee transfer to an IRA established to receive the distribution: The transfer will be treated as an eligible rollover distribution. H&rblockonline The IRA will be considered an inherited account. H&rblockonline The required minimum distribution rules that apply in instances where the participant dies before the entire interest is distributed will apply to the transferred IRA. H&rblockonline    For more information on IRAs, see Publication 590. H&rblockonline Frozen deposits. H&rblockonline   The 60-day period usually allowed for completing a rollover is extended for any time that the amount distributed is a frozen deposit in a financial institution. H&rblockonline The 60-day period cannot end earlier than 10 days after the deposit ceases to be a frozen deposit. H&rblockonline   A frozen deposit is any deposit that on any day during the 60-day period cannot be withdrawn because: The financial institution is bankrupt or insolvent, or The state where the institution is located has placed limits on withdrawals because one or more banks in the state are (or are about to be) bankrupt or insolvent. H&rblockonline Gift Tax If, by choosing or not choosing an election, or option, you provide an annuity for your beneficiary at or after your death, you may have made a taxable gift equal to the value of the annuity. H&rblockonline Joint and survivor annuity. H&rblockonline   If the gift is an interest in a joint and survivor annuity where only you and your spouse have the right to receive payments, the gift will generally be treated as qualifying for the unlimited marital deduction. H&rblockonline More information. H&rblockonline   For information on the gift tax, see Publication 559, Survivors, Executors, and Administrators. H&rblockonline Prev  Up  Next   Home   More Online Publications
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H&rblockonline Publication 15-A - Main Content Table of Contents 1. H&rblockonline Who Are Employees?Independent Contractors Common-Law Employees Statutory Employees Statutory Nonemployees Misclassification of Employees 2. H&rblockonline Employee or Independent Contractor?Common-Law Rules Industry Examples 3. H&rblockonline Employees of Exempt OrganizationsSocial security and Medicare taxes. H&rblockonline FUTA tax. H&rblockonline 4. H&rblockonline Religious Exemptions and Special Rules for MinistersForm W-2. H&rblockonline Self-employed. H&rblockonline Employees. H&rblockonline 5. H&rblockonline Wages and Other CompensationRelocating for Temporary Work Assignments Employee Achievement Awards Scholarship and Fellowship Payments Outplacement Services Withholding for Idle Time Back Pay Supplemental Unemployment Benefits Golden Parachute Payments Interest-Free and Below-Market-Interest-Rate Loans Leave Sharing Plans Nonqualified Deferred Compensation Plans Tax-Sheltered Annuities Contributions to a Simplified Employee Pension (SEP) SIMPLE Retirement Plans 6. H&rblockonline Sick Pay ReportingSick Pay Payments That Are Not Sick Pay Sick Pay Plan Third-Party Payers of Sick Pay Social Security, Medicare, and FUTA Taxes on Sick Pay Income Tax Withholding on Sick Pay Depositing and Reporting Example of Figuring and Reporting Sick Pay 7. H&rblockonline Special Rules for Paying TaxesCommon Paymaster Agents Reporting Agents Employee's Portion of Taxes Paid by Employer International Social Security Agreements 8. H&rblockonline Pensions and AnnuitiesFederal Income Tax Withholding 9. H&rblockonline Alternative Methods for Figuring WithholdingTerm of continuous employment. H&rblockonline Formula Tables for Percentage Method Withholding (for Automated Payroll Systems) Wage Bracket Percentage Method Tables (for Automated Payroll Systems) Combined Federal Income Tax, Employee Social Security Tax, and Employee Medicare Tax Withholding Tables 10. H&rblockonline Tables for Withholding on Distributions of Indian Gaming Profits to Tribal MembersWithholding Tables How To Get Tax Help 1. H&rblockonline Who Are Employees? Before you can know how to treat payments that you make to workers for services, you must first know the business relationship that exists between you and the person performing the services. H&rblockonline The person performing the services may be: An independent contractor, A common-law employee, A statutory employee, or A statutory nonemployee. H&rblockonline This discussion explains these four categories. H&rblockonline A later discussion, Employee or Independent Contractor in section 2, points out the differences between an independent contractor and an employee and gives examples from various types of occupations. H&rblockonline If an individual who works for you is not an employee under the common-law rules (see section 2), you generally do not have to withhold federal income tax from that individual's pay. H&rblockonline However, in some cases you may be required to withhold under the backup withholding requirements on these payments. H&rblockonline See Publication 15 (Circular E) for information on backup withholding. H&rblockonline Independent Contractors People such as doctors, veterinarians, and auctioneers who follow an independent trade, business, or profession in which they offer their services to the public, are generally not employees. H&rblockonline However, whether such people are employees or independent contractors depends on the facts in each case. H&rblockonline The general rule is that an individual is an independent contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result. H&rblockonline Common-Law Employees Under common-law rules, anyone who performs services for you is generally your employee if you have the right to control what will be done and how it will be done. H&rblockonline This is so even when you give the employee freedom of action. H&rblockonline What matters is that you have the right to control the details of how the services are performed. H&rblockonline For a discussion of facts that indicate whether an individual providing services is an independent contractor or employee, see section 2. H&rblockonline If you have an employer-employee relationship, it makes no difference how it is labeled. H&rblockonline The substance of the relationship, not the label, governs the worker's status. H&rblockonline It does not matter whether the individual is employed full time or part time. H&rblockonline For employment tax purposes, no distinction is made between classes of employees. H&rblockonline Superintendents, managers, and other supervisory personnel are all employees. H&rblockonline An officer of a corporation is generally an employee; however, an officer who performs no services or only minor services, and neither receives nor is entitled to receive any pay, is not considered an employee. H&rblockonline A director of a corporation is not an employee with respect to services performed as a director. H&rblockonline You generally have to withhold and pay income, social security, and Medicare taxes on wages that you pay to common-law employees. H&rblockonline However, the wages of certain employees may be exempt from one or more of these taxes. H&rblockonline See Employees of Exempt Organizations (section 3) and Religious Exemptions and Special Rules for Ministers (section 4). H&rblockonline Leased employees. H&rblockonline   Under certain circumstances, a firm that furnishes workers to other firms is the employer of those workers for employment tax purposes. H&rblockonline For example, a temporary staffing service may provide the services of secretaries, nurses, and other similarly trained workers to its clients on a temporary basis. H&rblockonline   The staffing service enters into contracts with the clients under which the clients specify the services to be provided and a fee is paid to the staffing service for each individual furnished. H&rblockonline The staffing service has the right to control and direct the worker's services for the client, including the right to discharge or reassign the worker. H&rblockonline The staffing service hires the workers, controls the payment of their wages, provides them with unemployment insurance and other benefits, and is the employer for employment tax purposes. H&rblockonline For information on employee leasing as it relates to pension plan qualification requirements, see Leased employee in Publication 560, Retirement Plans for Small Business. H&rblockonline Additional information. H&rblockonline   For more information about the treatment of special types of employment, the treatment of special types of payments, and similar subjects, see Publication 15 (Circular E) or Publication 51 (Circular A), Agricultural Employer's Tax Guide. H&rblockonline Statutory Employees If workers are independent contractors under the common law rules, such workers may nevertheless be treated as employees by statute, (also known as “statutory employees”) for certain employment tax purposes. H&rblockonline This would happen if they fall within any one of the following four categories and meet the three conditions described next under Social security and Medicare taxes . H&rblockonline A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers laundry or dry cleaning, if the driver is your agent or is paid on commission. H&rblockonline A full-time life insurance sales agent whose principal business activity is selling life insurance or annuity contracts, or both, primarily for one life insurance company. H&rblockonline An individual who works at home on materials or goods that you supply and that must be returned to you or to a person you name, if you also furnish specifications for the work to be done. H&rblockonline A full-time traveling or city salesperson who works on your behalf and turns in orders to you from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments. H&rblockonline The goods sold must be merchandise for resale or supplies for use in the buyer's business operation. H&rblockonline The work performed for you must be the salesperson's principal business activity. H&rblockonline See Salesperson in section 2. H&rblockonline Social security and Medicare taxes. H&rblockonline   You must withhold social security and Medicare taxes from the wages of statutory employees if all three of the following conditions apply. H&rblockonline The service contract states or implies that substantially all the services are to be performed personally by them. H&rblockonline They do not have a substantial investment in the equipment and property used to perform the services (other than an investment in facilities for transportation, such as a car or truck). H&rblockonline The services are performed on a continuing basis for the same payer. H&rblockonline Federal unemployment (FUTA) tax. H&rblockonline   For FUTA tax (the unemployment tax paid under the Federal Unemployment Tax Act), the term “employee” means the same as it does for social security and Medicare taxes, except that it does not include statutory employees defined above in categories 2 and 3. H&rblockonline Any individual who is a statutory employee described above under category 1 or 4 is also an employee for FUTA tax purposes and subject to FUTA tax. H&rblockonline Income tax. H&rblockonline   Do not withhold federal income tax from the wages of statutory employees. H&rblockonline Reporting payments to statutory employees. H&rblockonline   Furnish Form W-2 to a statutory employee, and check “Statutory employee” in box 13. H&rblockonline Show your payments to the employee as “other compensation” in box 1. H&rblockonline Also, show social security wages in box 3, social security tax withheld in box 4, Medicare wages in box 5, and Medicare tax withheld in box 6. H&rblockonline The statutory employee can deduct his or her trade or business expenses from the payments shown on Form W-2. H&rblockonline He or she reports earnings as a statutory employee on line 1 of Schedule C (Form 1040), Profit or Loss From Business, or Schedule C-EZ (Form 1040), Net Profit From Business. H&rblockonline A statutory employee's business expenses are deductible on Schedule C (Form 1040) or C-EZ (Form 1040) and are not subject to the reduction by 2% of his or her adjusted gross income that applies to common-law employees. H&rblockonline H-2A agricultural workers. H&rblockonline   On Form W-2, do not check box 13 (Statutory employee), as H-2A workers are not statutory employees. H&rblockonline Statutory Nonemployees There are three categories of statutory nonemployees: direct sellers, licensed real estate agents, and certain companion sitters. H&rblockonline Direct sellers and licensed real estate agents are treated as self-employed for all federal tax purposes, including income and employment taxes, if: Substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output, rather than to the number of hours worked, and Their services are performed under a written contract providing that they will not be treated as employees for federal tax purposes. H&rblockonline Direct sellers. H&rblockonline   Direct sellers include persons falling within any of the following three groups. H&rblockonline Persons engaged in selling (or soliciting the sale of) consumer products in the home or place of business other than in a permanent retail establishment. H&rblockonline Persons engaged in selling (or soliciting the sale of) consumer products to any buyer on a buy-sell basis, a deposit-commission basis, or any similar basis prescribed by regulations, for resale in the home or at a place of business other than in a permanent retail establishment. H&rblockonline Persons engaged in the trade or business of delivering or distributing newspapers or shopping news (including any services directly related to such delivery or distribution). H&rblockonline   Direct selling includes activities of individuals who attempt to increase direct sales activities of their direct sellers and who earn income based on the productivity of their direct sellers. H&rblockonline Such activities include providing motivation and encouragement; imparting skills, knowledge, or experience; and recruiting. H&rblockonline Licensed real estate agents. H&rblockonline   This category includes individuals engaged in appraisal activities for real estate sales if they earn income based on sales or other output. H&rblockonline Companion sitters. H&rblockonline   Companion sitters are individuals who furnish personal attendance, companionship, or household care services to children or to individuals who are elderly or disabled. H&rblockonline A person engaged in the trade or business of putting the sitters in touch with individuals who wish to employ them (that is, a companion sitting placement service) will not be treated as the employer of the sitters if that person does not receive or pay the salary or wages of the sitters and is compensated by the sitters or the persons who employ them on a fee basis. H&rblockonline Companion sitters who are not employees of a companion sitting placement service are generally treated as self-employed for all federal tax purposes. H&rblockonline Misclassification of Employees Consequences of treating an employee as an independent contractor. H&rblockonline   If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you are liable for employment taxes for that worker and the relief provision, discussed next, will not apply. H&rblockonline See section 2 in Publication 15 (Circular E) for more information. H&rblockonline Relief provision. H&rblockonline   If you have a reasonable basis for not treating a worker as an employee, you may be relieved from having to pay employment taxes for that worker. H&rblockonline To get this relief, you must file all required federal information returns on a basis consistent with your treatment of the worker. H&rblockonline You (or your predecessor) must not have treated any worker holding a substantially similar position as an employee for any periods beginning after 1977. H&rblockonline Technical service specialists. H&rblockonline   This relief provision does not apply for a technical services specialist you provide to another business under an arrangement between you and the other business. H&rblockonline A technical service specialist is an engineer, designer, drafter, computer programmer, systems analyst, or other similarly skilled worker engaged in a similar line of work. H&rblockonline   This limit on the application of the rule does not affect the determination of whether such workers are employees under the common-law rules. H&rblockonline The common-law rules control whether the specialist is treated as an employee or an independent contractor. H&rblockonline However, if you directly contract with a technical service specialist to provide services for your business and not for another business, you may still be entitled to the relief provision. H&rblockonline Test proctors and room supervisors. H&rblockonline   The consistent treatment requirement does not apply to services performed after December 31, 2006, by an individual as a test proctor or room supervisor assisting in the administration of college entrance or placement examinations if the individual: Is performing the services for a section 501(c) organization exempt from tax under section 501(a) of the code, and Is not otherwise treated as an employee of the organization for employment taxes. H&rblockonline Voluntary Classification Settlement Program (VCSP). H&rblockonline   Employers who are currently treating their workers (or a class or group of workers) as independent contractors or other nonemployees and want to voluntarily reclassify their workers as employees for future tax periods may be eligible to participate in the VCSP if certain requirements are met. H&rblockonline To apply, use Form 8952, Application for Voluntary Classification Settlement Program (VCSP). H&rblockonline For more information, visit IRS. H&rblockonline gov and enter “VCSP” in the search box. H&rblockonline 2. H&rblockonline Employee or Independent Contractor? An employer must generally withhold federal income taxes, withhold and pay over social security and Medicare taxes, and pay unemployment tax on wages paid to an employee. H&rblockonline An employer does not generally have to withhold or pay over any federal taxes on payments to independent contractors. H&rblockonline Common-Law Rules To determine whether an individual is an employee or an independent contractor under the common law, the relationship of the worker and the business must be examined. H&rblockonline In any employee-independent contractor determination, all information that provides evidence of the degree of control and the degree of independence must be considered. H&rblockonline Facts that provide evidence of the degree of control and independence fall into three categories: behavioral control, financial control, and the type of relationship of the parties. H&rblockonline These facts are discussed next. H&rblockonline Behavioral control. H&rblockonline   Facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include the type and degree of: Instructions that the business gives to the worker. H&rblockonline   An employee is generally subject to the business' instructions about when, where, and how to work. H&rblockonline All of the following are examples of types of instructions about how to do work. H&rblockonline When and where to do the work. H&rblockonline What tools or equipment to use. H&rblockonline What workers to hire or to assist with the work. H&rblockonline Where to purchase supplies and services. H&rblockonline What work must be performed by a specified  individual. H&rblockonline What order or sequence to follow. H&rblockonline   The amount of instruction needed varies among different jobs. H&rblockonline Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. H&rblockonline A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. H&rblockonline The key consideration is whether the business has retained the right to control the details of a worker's performance or instead has given up that right. H&rblockonline Training that the business gives to the worker. H&rblockonline   An employee may be trained to perform services in a particular manner. H&rblockonline Independent contractors ordinarily use their own methods. H&rblockonline Financial control. H&rblockonline   Facts that show whether the business has a right to control the business aspects of the worker's job include: The extent to which the worker has unreimbursed business expenses. H&rblockonline   Independent contractors are more likely to have unreimbursed expenses than are employees. H&rblockonline Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. H&rblockonline However, employees may also incur unreimbursed expenses in connection with the services that they perform for their employer. H&rblockonline The extent of the worker's investment. H&rblockonline   An independent contractor often has a significant investment in the facilities or tools he or she uses in performing services for someone else. H&rblockonline However, a significant investment is not necessary for independent contractor status. H&rblockonline The extent to which the worker makes his or her services available to the relevant market. H&rblockonline   An independent contractor is generally free to seek out business opportunities. H&rblockonline Independent contractors often advertise, maintain a visible business location, and are available to work in the relevant market. H&rblockonline How the business pays the worker. H&rblockonline   An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. H&rblockonline This usually indicates that a worker is an employee, even when the wage or salary is supplemented by a commission. H&rblockonline An independent contractor is often paid a flat fee or on a time and materials basis for the job. H&rblockonline However, it is common in some professions, such as law, to pay independent contractors hourly. H&rblockonline The extent to which the worker can realize a profit or loss. H&rblockonline   An independent contractor can make a profit or loss. H&rblockonline Type of relationship. H&rblockonline   Facts that show the parties' type of relationship include: Written contracts describing the relationship the parties intended to create. H&rblockonline Whether or not the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay. H&rblockonline The permanency of the relationship. H&rblockonline If you engage a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that your intent was to create an employer-employee relationship. H&rblockonline The extent to which services performed by the worker are a key aspect of the regular business of the company. H&rblockonline If a worker provides services that are a key aspect of your regular business activity, it is more likely that you will have the right to direct and control his or her activities. H&rblockonline For example, if a law firm hires an attorney, it is likely that it will present the attorney's work as its own and would have the right to control or direct that work. H&rblockonline This would indicate an employer-employee relationship. H&rblockonline IRS help. H&rblockonline   If you want the IRS to determine whether or not a worker is an employee, file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS. H&rblockonline Industry Examples The following examples may help you properly classify your workers. H&rblockonline Building and Construction Industry Example 1. H&rblockonline Jerry Jones has an agreement with Wilma White to supervise the remodeling of her house. H&rblockonline She did not advance funds to help him carry on the work. H&rblockonline She makes direct payments to the suppliers for all necessary materials. H&rblockonline She carries liability and workers' compensation insurance covering Jerry and others that he engaged to assist him. H&rblockonline She pays them an hourly rate and exercises almost constant supervision over the work. H&rblockonline Jerry is not free to transfer his assistants to other jobs. H&rblockonline He may not work on other jobs while working for Wilma. H&rblockonline He assumes no responsibility to complete the work and will incur no contractual liability if he fails to do so. H&rblockonline He and his assistants perform personal services for hourly wages. H&rblockonline Jerry Jones and his assistants are employees of Wilma White. H&rblockonline Example 2. H&rblockonline Milton Manning, an experienced tile setter, orally agreed with a corporation to perform full-time services at construction sites. H&rblockonline He uses his own tools and performs services in the order designated by the corporation and according to its specifications. H&rblockonline The corporation supplies all materials, makes frequent inspections of his work, pays him on a piecework basis, and carries workers' compensation insurance on him. H&rblockonline He does not have a place of business or hold himself out to perform similar services for others. H&rblockonline Either party can end the services at any time. H&rblockonline Milton Manning is an employee of the corporation. H&rblockonline Example 3. H&rblockonline Wallace Black agreed with the Sawdust Co. H&rblockonline to supply the construction labor for a group of houses. H&rblockonline The company agreed to pay all construction costs. H&rblockonline However, he supplies all the tools and equipment. H&rblockonline He performs personal services as a carpenter and mechanic for an hourly wage. H&rblockonline He also acts as superintendent and foreman and engages other individuals to assist him. H&rblockonline The company has the right to select, approve, or discharge any helper. H&rblockonline A company representative makes frequent inspections of the construction site. H&rblockonline When a house is finished, Wallace is paid a certain percentage of its costs. H&rblockonline He is not responsible for faults, defects of construction, or wasteful operation. H&rblockonline At the end of each week, he presents the company with a statement of the amount that he has spent, including the payroll. H&rblockonline The company gives him a check for that amount from which he pays the assistants, although he is not personally liable for their wages. H&rblockonline Wallace Black and his assistants are employees of the Sawdust Co. H&rblockonline Example 4. H&rblockonline Bill Plum contracted with Elm Corporation to complete the roofing on a housing complex. H&rblockonline A signed contract established a flat amount for the services rendered by Bill Plum. H&rblockonline Bill is a licensed roofer and carries workers' compensation and liability insurance under the business name, Plum Roofing. H&rblockonline He hires his own roofers who are treated as employees for federal employment tax purposes. H&rblockonline If there is a problem with the roofing work, Plum Roofing is responsible for paying for any repairs. H&rblockonline Bill Plum, doing business as Plum Roofing, is an independent contractor. H&rblockonline Example 5. H&rblockonline Vera Elm, an electrician, submitted a job estimate to a housing complex for electrical work at $16 per hour for 400 hours. H&rblockonline She is to receive $1,280 every 2 weeks for the next 10 weeks. H&rblockonline This is not considered payment by the hour. H&rblockonline Even if she works more or less than 400 hours to complete the work, Vera Elm will receive $6,400. H&rblockonline She also performs additional electrical installations under contracts with other companies, that she obtained through advertisements. H&rblockonline Vera is an independent contractor. H&rblockonline Trucking Industry Example. H&rblockonline Rose Trucking contracts to deliver material for Forest, Inc. H&rblockonline , at $140 per ton. H&rblockonline Rose Trucking is not paid for any articles that are not delivered. H&rblockonline At times, Jan Rose, who operates as Rose Trucking, may also lease another truck and engage a driver to complete the contract. H&rblockonline All operating expenses, including insurance coverage, are paid by Jan Rose. H&rblockonline All equipment is owned or rented by Jan and she is responsible for all maintenance. H&rblockonline None of the drivers are provided by Forest, Inc. H&rblockonline Jan Rose, operating as Rose Trucking, is an independent contractor. H&rblockonline Computer Industry Example. H&rblockonline Steve Smith, a computer programmer, is laid off when Megabyte, Inc. H&rblockonline , downsizes. H&rblockonline Megabyte agrees to pay Steve a flat amount to complete a one-time project to create a certain product. H&rblockonline It is not clear how long that it will take to complete the project, and Steve is not guaranteed any minimum payment for the hours spent on the program. H&rblockonline Megabyte provides Steve with no instructions beyond the specifications for the product itself. H&rblockonline Steve and Megabyte have a written contract, which provides that Steve is considered to be an independent contractor, is required to pay federal and state taxes, and receives no benefits from Megabyte. H&rblockonline Megabyte will file Form 1099-MISC, Miscellaneous Income, to report the amount paid to Steve. H&rblockonline Steve works at home and is not expected or allowed to attend meetings of the software development group. H&rblockonline Steve is an independent contractor. H&rblockonline Automobile Industry Example 1. H&rblockonline Donna Lee is a salesperson employed on a full-time basis by Bob Blue, an auto dealer. H&rblockonline She works six days a week and is on duty in Bob's showroom on certain assigned days and times. H&rblockonline She appraises trade-ins, but her appraisals are subject to the sales manager's approval. H&rblockonline Lists of prospective customers belong to the dealer. H&rblockonline She is required to develop leads and report results to the sales manager. H&rblockonline Because of her experience, she requires only minimal assistance in closing and financing sales and in other phases of her work. H&rblockonline She is paid a commission and is eligible for prizes and bonuses offered by Bob. H&rblockonline Bob also pays the cost of health insurance and group-term life insurance for Donna. H&rblockonline Donna is an employee of Bob Blue. H&rblockonline Example 2. H&rblockonline Sam Sparks performs auto repair services in the repair department of an auto sales company. H&rblockonline He works regular hours and is paid on a percentage basis. H&rblockonline He has no investment in the repair department. H&rblockonline The sales company supplies all facilities, repair parts, and supplies; issues instructions on the amounts to be charged, parts to be used, and the time for completion of each job; and checks all estimates and repair orders. H&rblockonline Sam is an employee of the sales company. H&rblockonline Example 3. H&rblockonline An auto sales agency furnishes space for Helen Bach to perform auto repair services. H&rblockonline She provides her own tools, equipment, and supplies. H&rblockonline She seeks out business from insurance adjusters and other individuals and does all of the body and paint work that comes to the agency. H&rblockonline She hires and discharges her own helpers, determines her own and her helpers' working hours, quotes prices for repair work, makes all necessary adjustments, assumes all losses from uncollectible accounts, and receives, as compensation for her services, a large percentage of the gross collections from the auto repair shop. H&rblockonline Helen is an independent contractor and the helpers are her employees. H&rblockonline Attorney Example. H&rblockonline Donna Yuma is a sole practitioner who rents office space and pays for the following items: telephone, computer, on-line legal research linkup, fax machine, and photocopier. H&rblockonline Donna buys office supplies and pays bar dues and membership dues for three other professional organizations. H&rblockonline Donna has a part-time receptionist who also does the bookkeeping. H&rblockonline She pays the receptionist, withholds and pays federal and state employment taxes, and files a Form W-2 each year. H&rblockonline For the past 2 years, Donna has had only three clients, corporations with which there have been long-standing relationships. H&rblockonline Donna charges the corporations an hourly rate for her services, sending monthly bills detailing the work performed for the prior month. H&rblockonline The bills include charges for long distance calls, on-line research time, fax charges, photocopies, postage, and travel, costs for which the corporations have agreed to reimburse her. H&rblockonline Donna is an independent contractor. H&rblockonline Taxicab Driver Example. H&rblockonline Tom Spruce rents a cab from Taft Cab Co. H&rblockonline for $150 per day. H&rblockonline He pays the costs of maintaining and operating the cab. H&rblockonline Tom Spruce keeps all fares that he receives from customers. H&rblockonline Although he receives the benefit of Taft's two-way radio communication equipment, dispatcher, and advertising, these items benefit both Taft and Tom Spruce. H&rblockonline Tom Spruce is an independent contractor. H&rblockonline Salesperson To determine whether salespersons are employees under the usual common-law rules, you must evaluate each individual case. H&rblockonline If a salesperson who works for you does not meet the tests for a common-law employee, discussed earlier in this section, you do not have to withhold federal income tax from his or her pay (see Statutory Employees in section 1). H&rblockonline However, even if a salesperson is not an employee under the usual common-law rules for income tax withholding, his or her pay may still be subject to social security, Medicare, and FUTA taxes as a statutory employee. H&rblockonline To determine whether a salesperson is an employee for social security, Medicare, and FUTA tax purposes, the salesperson must meet all eight elements of the statutory employee test. H&rblockonline A salesperson is a statutory employee for social security, Medicare, and FUTA tax purposes if he or she: Works full time for one person or company except, possibly, for sideline sales activities on behalf of some other person, Sells on behalf of, and turns his or her orders over to, the person or company for which he or she works, Sells to wholesalers, retailers, contractors, or operators of hotels, restaurants, or similar establishments, Sells merchandise for resale, or supplies for use in the customer's business, Agrees to do substantially all of this work personally, Has no substantial investment in the facilities used to do the work, other than in facilities for transportation, Maintains a continuing relationship with the person or company for which he or she works, and Is not an employee under common-law rules. H&rblockonline 3. H&rblockonline Employees of Exempt Organizations Many nonprofit organizations are exempt from federal income tax. H&rblockonline Although they do not have to pay federal income tax themselves, they must still withhold federal income tax from the pay of their employees. H&rblockonline However, there are special social security, Medicare, and FUTA tax rules that apply to the wages that they pay their employees. H&rblockonline Section 501(c)(3) organizations. H&rblockonline   Nonprofit organizations that are exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code include any community chest, fund, or foundation organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary or educational purposes, fostering national or international amateur sports competition, or for the prevention of cruelty to children or animals. H&rblockonline These organizations are usually corporations and are exempt from federal income tax under section 501(a). H&rblockonline Social security and Medicare taxes. H&rblockonline   Wages paid to employees of section 501(c)(3) organizations are subject to social security and Medicare taxes unless one of the following situations applies. H&rblockonline The organization pays an employee less than $100 in a calendar year. H&rblockonline The organization is a church or church-controlled organization opposed for religious reasons to the payment of social security and Medicare taxes and has filed Form 8274, Certification by Churches and Qualified Church-Controlled Organizations Electing Exemption From Employer Social Security and Medicare Taxes, to elect exemption from social security and Medicare taxes. H&rblockonline The organization must have filed for exemption before the first date on which a quarterly employment tax return (Form 941) or annual employment tax return (Form 944) would otherwise be due. H&rblockonline   An employee of a church or church-controlled organization that is exempt from social security and Medicare taxes must pay self-employment tax if the employee is paid $108. H&rblockonline 28 or more in a year. H&rblockonline However, an employee who is a member of a qualified religious sect can apply for an exemption from the self-employment tax by filing Form 4029, Application for Exemption From Social Security and Medicare Taxes and Waiver of Benefits. H&rblockonline See Members of recognized religious sects opposed to insurance in section 4. H&rblockonline FUTA tax. H&rblockonline   An organization that is exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code is also exempt from FUTA tax. H&rblockonline This exemption cannot be waived. H&rblockonline Do not file Form 940 to report wages paid by these organizations or pay the tax. H&rblockonline Note. H&rblockonline An organization wholly owned by a state or its political subdivision should contact the appropriate state official for information about reporting and getting social security and Medicare coverage for its employees. H&rblockonline Other than section 501(c)(3) organizations. H&rblockonline   Nonprofit organizations that are not section 501(c)(3) organizations may also be exempt from federal income tax under section 501(a) or section 521. H&rblockonline However, these organizations are not exempt from withholding federal income, social security, or Medicare tax from their employees' pay, or from paying FUTA tax. H&rblockonline Two special rules for social security, Medicare, and FUTA taxes apply. H&rblockonline If an employee is paid less than $100 during a calendar year, his or her wages are not subject to social security and Medicare taxes. H&rblockonline If an employee is paid less than $50 in a calendar quarter, his or her wages are not subject to FUTA tax for the quarter. H&rblockonline The above rules do not apply to employees who work for pension plans and other similar organizations described in section 401(a). H&rblockonline 4. H&rblockonline Religious Exemptions and Special Rules for Ministers Special rules apply to the treatment of ministers for social security and Medicare tax purposes. H&rblockonline An exemption from social security and Medicare taxes is available for ministers and certain other religious workers and members of certain recognized religious sects. H&rblockonline For more information on getting an exemption, see Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers. H&rblockonline Ministers. H&rblockonline   Ministers are individuals who are duly ordained, commissioned, or licensed by a religious body constituting a church or church denomination. H&rblockonline They are given the authority to conduct religious worship, perform sacerdotal functions, and administer ordinances and sacraments according to the prescribed tenets and practices of that religious organization. H&rblockonline   Ministers are employees if they perform services in the exercise of ministry and are subject to your will and control. H&rblockonline The common-law rules discussed in section 1 and section 2 should be applied to determine whether a minister is your employee or is self-employed. H&rblockonline Whether the minister is an employee or self-employed, the earnings of a minister are not subject to federal income, social security, and Medicare tax withholding. H&rblockonline However, even if the minister is a common law employee, the earnings as reported on the minister's Form 1040 are subject to self-employment tax and federal income tax. H&rblockonline You do not withhold these taxes from wages earned by a minister, but if the minister is your employee, you may agree with the minister to voluntarily withhold tax to cover the minister's liability for self-employment tax and federal income tax. H&rblockonline For more information, see Publication 517. H&rblockonline Form W-2. H&rblockonline   If your minister is an employee, report all taxable compensation as wages in box 1 on Form W-2. H&rblockonline Include in this amount expense allowances or reimbursements paid under a nonaccountable plan, discussed in section 5 of Publication 15 (Circular E). H&rblockonline Do not include a parsonage allowance (excludable housing allowance) in this amount. H&rblockonline You may report a designated parsonage or rental allowance (housing allowance) and a utilities allowance, or the rental value of housing provided in a separate statement or in box 14 on Form W-2. H&rblockonline Do not show on Form W-2, Form 941, or Form 944 any amount as social security or Medicare wages, or any withholding for social security or Medicare taxes. H&rblockonline If you withheld federal income tax from the minister under a voluntary agreement, this amount should be shown in box 2 on Form W-2 as federal income tax withheld. H&rblockonline For more information on ministers, see Publication 517. H&rblockonline Exemptions for ministers and others. H&rblockonline   Certain ordained ministers, Christian Science practitioners, and members of religious orders who have not taken a vow of poverty may apply to exempt their earnings from self-employment tax on religious grounds. H&rblockonline The application must be based on conscientious opposition because of personal considerations to public insurance that makes payments in the event of death, disability, old age, or retirement, or that makes payments toward the cost of, or provides services for, medical care, including social security and Medicare benefits. H&rblockonline The exemption applies only to qualified services performed for the religious organization. H&rblockonline See Revenue Procedure 91-20, 1991-1 C. H&rblockonline B. H&rblockonline 524, for guidelines to determine whether an organization is a religious order or whether an individual is a member of a religious order. H&rblockonline   To apply for the exemption, the employee should file Form 4361, Application for Exemption From Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners. H&rblockonline See Publication 517 for more information about claiming an exemption from self-employment tax using Form 4361. H&rblockonline Members of recognized religious sects opposed to insurance. H&rblockonline   If you belong to a recognized religious sect or to a division of such sect that is opposed to insurance, you may qualify for an exemption from the self-employment tax. H&rblockonline To qualify, you must be conscientiously opposed to accepting the benefits of any public or private insurance that makes payments because of death, disability, old age, or retirement, or makes payments toward the cost of, or provides services for, medical care (including social security and Medicare benefits). H&rblockonline If you buy a retirement annuity from an insurance company, you will not be eligible for this exemption. H&rblockonline Religious opposition based on the teachings of the sect is the only legal basis for the exemption. H&rblockonline In addition, your religious sect (or division) must have existed since December 31, 1950. H&rblockonline Self-employed. H&rblockonline   If you are self-employed and a member of a recognized religious sect opposed to insurance, you can apply for exemption by filing Form 4029 to waive all social security and Medicare benefits. H&rblockonline Employees. H&rblockonline   The social security and Medicare tax exemption available to the self-employed who are members of a recognized religious sect opposed to insurance is also available to their employees who are members of such a sect. H&rblockonline This applies to partnerships only if each partner is a member of the sect. H&rblockonline This exemption for employees applies only if both the employee and the employer are members of such a sect, and the employer has an exemption. H&rblockonline To get the exemption, the employee must file Form 4029. H&rblockonline   An employee of a church or church-controlled organization that is exempt from social security and Medicare taxes can also apply for an exemption on Form 4029. H&rblockonline 5. H&rblockonline Wages and Other Compensation Publication 15 (Circular E) provides a general discussion of taxable wages. H&rblockonline Publication 15-B discusses fringe benefits. H&rblockonline The following topics supplement those discussions. H&rblockonline Relocating for Temporary Work Assignments If an employee is given a temporary work assignment away from his or her regular place of work, certain travel expenses reimbursed or paid directly by the employer in accordance with an accountable plan (see section 5 in Publication 15 (Circular E)) may be excludable from the employee's wages. H&rblockonline Generally, a temporary work assignment in a single location is one that is realistically expected to last (and does in fact last) for 1 year or less. H&rblockonline If the employee's new work assignment is indefinite, any living expenses reimbursed or paid by the employer (other than qualified moving expenses) must be included in the employee's wages as compensation. H&rblockonline For the travel expenses to be excludable: The new work location must be outside of the city or general area of the employee's regular work place or post of duty, The travel expenses must otherwise qualify as deductible by the employee, and The expenses must be for the period during which the employee is at the temporary work location. H&rblockonline If you reimburse or pay any personal expenses of an employee during his or her temporary work assignment, such as expenses for home leave for family members or for vacations, these amounts must be included in the employee's wages. H&rblockonline See chapter 1 of Publication 463, Travel, Entertainment, Gift, and Car Expenses, and section 5 of Publication 15 (Circular E), for more information. H&rblockonline These rules generally apply to temporary work assignments both inside and outside the U. H&rblockonline S. H&rblockonline Employee Achievement Awards Do not withhold federal income, social security, or Medicare taxes on the fair market value of an employee achievement award if it is excludable from your employee's gross income. H&rblockonline To be excludable from your employee's gross income, the award must be tangible personal property (not cash, gift certificates, or securities) given to an employee for length of service or safety achievement, awarded as part of a meaningful presentation, and awarded under circumstances that do not indicate that the payment is disguised compensation. H&rblockonline Excludable employee achievement awards also are not subject to FUTA tax. H&rblockonline Limits. H&rblockonline   The most that you can exclude for the cost of all employee achievement awards to the same employee for the year is $400. H&rblockonline A higher limit of $1,600 applies to qualified plan awards. H&rblockonline Qualified plan awards are employee achievement awards under a written plan that does not discriminate in favor of highly compensated employees. H&rblockonline An award cannot be treated as a qualified plan award if the average cost per recipient of all awards under all of your qualified plans is more than $400. H&rblockonline   If during the year an employee receives awards not made under a qualified plan and also receives awards under a qualified plan, the exclusion for the total cost of all awards to that employee cannot be more than $1,600. H&rblockonline The $400 and $1,600 limits cannot be added together to exclude more than $1,600 for the cost of awards to any one employee during the year. H&rblockonline Scholarship and Fellowship Payments Only amounts that you pay as a qualified scholarship to a candidate for a degree may be excluded from the recipient's gross income. H&rblockonline A qualified scholarship is any amount granted as a scholarship or fellowship that is used for: Tuition and fees required to enroll in, or to attend, an educational institution, or Fees, books, supplies, and equipment that are required for courses at the educational institution. H&rblockonline The exclusion from income does not apply to the portion of any amount received that represents payment for teaching, research, or other services required as a condition of receiving the scholarship or tuition reduction. H&rblockonline These amounts are reportable on Form W-2. H&rblockonline However, the exclusion will still apply for any amount received under two specific programs—the National Health Service Corps Scholarship Program and the Armed Forces Health Professions Scholarship and Financial Assistance Program—despite any service condition attached to those amounts. H&rblockonline Any amounts that you pay for room and board are not excludable from the recipient's gross income. H&rblockonline A qualified scholarship is not subject to social security, Medicare, and FUTA taxes, or federal income tax withholding. H&rblockonline For more information, see Publication 970, Tax Benefits for Education. H&rblockonline Outplacement Services If you provide outplacement services to your employees to help them find new employment (such as career counseling, resume assistance, or skills assessment), the value of these benefits may be income to them and subject to all withholding taxes. H&rblockonline However, the value of these services will not be subject to any employment taxes if: You derive a substantial business benefit from providing the services (such as improved employee morale or business image) separate from the benefit that you would receive from the mere payment of additional compensation, and The employee would be able to deduct the cost of the services as employee business expenses if he or she had paid for them. H&rblockonline However, if you receive no additional benefit from providing the services, or if the services are not provided on the basis of employee need, then the value of the services is treated as wages and is subject to federal income tax withholding and social security and Medicare taxes. H&rblockonline Similarly, if an employee receives the outplacement services in exchange for reduced severance pay (or other taxable compensation), then the amount the severance pay is reduced is treated as wages for employment tax purposes. H&rblockonline Withholding for Idle Time Payments made under a voluntary guarantee to employees for idle time (any time during which an employee performs no services) are wages for the purposes of social security, Medicare, and FUTA taxes, and federal income tax withholding. H&rblockonline Back Pay Treat back pay as wages in the year paid and withhold and pay employment taxes as required. H&rblockonline If back pay was awarded by a court or government agency to enforce a federal or state statute protecting an employee's right to employment or wages, special rules apply for reporting those wages to the Social Security Administration. H&rblockonline These rules also apply to litigation actions and settlement agreements or agency directives that are resolved out of court and not under a court decree or order. H&rblockonline Examples of pertinent statutes include, but are not limited to, the National Labor Relations Act, Fair Labor Standards Act, Equal Pay Act, and Age Discrimination in Employment Act. H&rblockonline See Publication 957, Reporting Back Pay and Special Wage Payments to the Social Security Administration, and Form SSA-131, Employer Report of Special Wage Payments, for details. H&rblockonline Supplemental Unemployment Benefits If you pay, under a plan, supplemental unemployment benefits to a former employee, all or part of the payments may be taxable and subject to federal income tax withholding, depending on how the plan is funded. H&rblockonline Amounts that represent a return to the employee of amounts previously subject to tax are not taxable and are not subject to withholding. H&rblockonline You should withhold federal income tax on the taxable part of the payments made, under a plan, to an employee who is involuntarily separated because of a reduction in force, discontinuance of a plant or operation, or other similar condition. H&rblockonline It does not matter whether the separation is temporary or permanent. H&rblockonline There are special rules that apply in determining whether benefits qualify as supplemental unemployment benefits that are excluded from wages for social security, Medicare, and FUTA tax purposes. H&rblockonline To qualify as supplemental unemployment benefits for these purposes, the benefits must meet the following requirements. H&rblockonline Benefits are paid only to unemployed former employees who are laid off by the employer. H&rblockonline Eligibility for benefits depends on meeting prescribed conditions after termination. H&rblockonline The amount of weekly benefits payable is based upon state unemployment benefits, other compensation allowable under state law, and the amount of regular weekly pay. H&rblockonline The right to benefits does not accrue until a prescribed period after termination. H&rblockonline Benefits are not attributable to the performance of particular services. H&rblockonline No employee has any right to the benefits until qualified and eligible to receive benefits. H&rblockonline Benefits may not be paid in a lump sum. H&rblockonline Withholding on taxable supplemental unemployment benefits must be based on the withholding certificate (Form W-4) that the employee gave to you. H&rblockonline Golden Parachute Payments A golden parachute payment, in general, is a payment made under a contract entered into by a corporation and key personnel. H&rblockonline Under the agreement, the corporation agrees to pay certain amounts to its key personnel in the event of a change in ownership or control of the corporation. H&rblockonline Payments to employees under golden parachute contracts are subject to social security, Medicare, and FUTA taxes, and federal income tax withholding. H&rblockonline See Regulations section 1. H&rblockonline 280G-1 for more information. H&rblockonline No deduction is allowed to the corporation for any excess parachute payment. H&rblockonline To determine the amount of the excess parachute payment, you must first determine if there is a parachute payment for purposes of section 280G. H&rblockonline A parachute payment for purposes of section 280G is any payment that meets all of the following. H&rblockonline The payment is in the nature of compensation. H&rblockonline The payment is to, or for the benefit of, a disqualified individual. H&rblockonline A disqualified individual is anyone who at any time during the 12-month period prior to and ending on the date of the change in ownership or control of the corporation (the disqualified individual determination period) was an employee or independent contractor and was, in regard to that corporation, a shareholder, an officer, or highly compensated individual. H&rblockonline The payment is contingent on a change in ownership of the corporation, the effective control of the corporation, or the ownership of a substantial portion of the assets of the corporation. H&rblockonline The payment has an aggregate present value of at least three times the individual's base amount. H&rblockonline The base amount is the average annual compensation for service includible in the individual's gross income over the most recent 5 taxable years. H&rblockonline An excess parachute payment amount is the excess of any parachute payment over the base amount. H&rblockonline For more information, see Regulations section 1. H&rblockonline 280G-1. H&rblockonline The recipient of an excess parachute payment is subject to a 20% nondeductible excise tax. H&rblockonline If the recipient is an employee, the 20% excise tax is to be withheld by the corporation. H&rblockonline Example. H&rblockonline An officer of a corporation receives a golden parachute payment of $400,000. H&rblockonline This is more than three times greater than his or her average compensation of $100,000 over the previous 5-year period. H&rblockonline The excess parachute payment is $300,000 ($400,000 minus $100,000). H&rblockonline The corporation cannot deduct the $300,000 and must withhold the excise tax of $60,000 (20% of $300,000). H&rblockonline Reporting golden parachute payments. H&rblockonline   Golden parachute payments to employees must be reported on Form W-2. H&rblockonline See the General Instructions for Forms W-2 and W-3 for details. H&rblockonline For nonemployee reporting of these payments, see Box 7. H&rblockonline Nonemployee Compensation in the Instructions for Form 1099-MISC. H&rblockonline Exempt payments. H&rblockonline   Payments by most small business corporations and payments under certain qualified plans are exempt from the golden parachute rules. H&rblockonline See section 280G(b)(5) and (6) for more information. H&rblockonline Interest-Free and Below-Market-Interest-Rate Loans In general, if an employer lends an employee more than $10,000 at an interest rate less than the current applicable federal rate (AFR), the difference between the interest paid and the interest that would be paid under the AFR is considered additional compensation to the employee. H&rblockonline This rule applies to a loan of $10,000 or less if one of its principal purposes is the avoidance of federal tax. H&rblockonline This additional compensation to the employee is subject to social security, Medicare, and FUTA taxes, but not to federal income tax withholding. H&rblockonline Include it in compensation on Form W-2 (or Form 1099-MISC for an independent contractor). H&rblockonline The AFR is established monthly and published by the IRS each month in the Internal Revenue Bulletin. H&rblockonline You can get these rates by calling 1-800-829-4933 or by visiting IRS. H&rblockonline gov. H&rblockonline For more information, see section 7872 and its related regulations. H&rblockonline Leave Sharing Plans If you establish a leave sharing plan for your employees that allows them to transfer leave to other employees for medical emergencies, the amounts paid to the recipients of the leave are considered wages. H&rblockonline These amounts are includible in the gross income of the recipients and are subject to social security, Medicare, and FUTA taxes, and federal income tax withholding. H&rblockonline Do not include these amounts in the income of the transferors. H&rblockonline These rules apply only to leave sharing plans that permit employees to transfer leave to other employees for medical emergencies. H&rblockonline Nonqualified Deferred Compensation Plans Income Tax and Reporting Section 409A provides that all amounts deferred under a nonqualified deferred compensation (NQDC) plan for all tax years are currently includible in gross income (to the extent not subject to a substantial risk of forfeiture and not previously included in gross income) and subject to additional taxes, unless certain requirements are met pertaining to, among other things, elections to defer compensation and distributions under a NQDC plan. H&rblockonline Section 409A also includes rules that apply to certain trusts or similar arrangements associated with NQDC plans if the trusts or arrangements are located outside of the United States, are restricted to the provision of benefits in connection with a decline in the financial health of the plan sponsor, or contributions are made to the trust during certain periods such as when a qualified plan of the service recipient is underfunded. H&rblockonline Employers must withhold federal income tax (but not the additional Section 409A taxes) on any amount includible in gross income under section 409A. H&rblockonline Other changes to the Internal Revenue Code provide that the deferrals under a NQDC plan must be reported separately on Form W-2 or Form 1099-MISC, whichever applies. H&rblockonline Specific rules for reporting are provided in the instructions to the forms. H&rblockonline The provisions do not affect the application or reporting of social security, Medicare, or FUTA taxes. H&rblockonline The provisions do not prevent the inclusion of amounts in income or wages under other provisions of the Internal Revenue Code or common law principles, such as when amounts are actually or constructively received or irrevocably contributed to a separate fund. H&rblockonline For more information about nonqualified deferred compensation plans, see Regulations sections 1. H&rblockonline 409A-1 through 1. H&rblockonline 409A-6. H&rblockonline Notice 2008-113 provides guidance on the correction of certain operation failures of a NQDC plan. H&rblockonline Notice 2008-113, 2008-51 I. H&rblockonline R. H&rblockonline B. H&rblockonline 1305, is available at www. H&rblockonline irs. H&rblockonline gov/irb/2008-51_IRB/ar12. H&rblockonline html. H&rblockonline Also see Notice 2010-6, 2010-3 I. H&rblockonline R. H&rblockonline B. H&rblockonline 275, available at www. H&rblockonline irs. H&rblockonline gov/irb/2010-03_IRB/ar08. H&rblockonline html and Notice 2010-80, 2010-51 I. H&rblockonline R. H&rblockonline B. H&rblockonline 853, available at www. H&rblockonline irs. H&rblockonline gov/irb/2010-51_IRB/ar08. H&rblockonline html. H&rblockonline Social security, Medicare, and FUTA taxes. H&rblockonline   Employer contributions to nonqualified deferred compensation (NQDC) plans, as defined in the applicable regulations, are treated as wages subject to social security, Medicare, and FUTA taxes when the services are performed or the employee no longer has a substantial risk of forfeiting the right to the deferred compensation, whichever is later. H&rblockonline   Amounts deferred are subject to social security, Medicare, and FUTA taxes at that time unless the amount that is deferred cannot be reasonably ascertained; for example, if benefits are based on final pay. H&rblockonline If the value of the future benefit is based on any factors that are not yet reasonably ascertainable, you may choose to estimate the value of the future benefit and withhold and pay social security, Medicare, and FUTA taxes on that amount. H&rblockonline You will have to determine later, when the amount is reasonably ascertainable, whether any additional taxes are required. H&rblockonline If taxes are not paid before the amounts become reasonably ascertainable, when the amounts become reasonably ascertainable they are subject to social security, Medicare, and FUTA taxes on the amounts deferred plus the income attributable to those amounts deferred. H&rblockonline For more information, see Regulations sections 31. H&rblockonline 3121(v)(2)-1 and 31. H&rblockonline 3306(r)(2)-1. H&rblockonline Tax-Sheltered Annuities Employer payments made by a public educational institution or a tax-exempt organization to purchase a tax-sheltered annuity for an employee (annual deferrals) are included in the employee's social security and Medicare wages, if the payments are made because of a salary reduction agreement. H&rblockonline However, they are not included in box 1 on Form W-2 in the year the deferrals are made and are not subject to federal income tax withholding. H&rblockonline See Regulations section 31. H&rblockonline 3121(a)(5)-2 for the definition of a salary reduction agreement. H&rblockonline Contributions to a Simplified Employee Pension (SEP) An employer's SEP contributions to an employee's individual retirement arrangement (IRA) are excluded from the employee's gross income. H&rblockonline These excluded amounts are not subject to social security, Medicare, or FUTA taxes, or federal income tax withholding. H&rblockonline However, any SEP contributions paid under a salary reduction agreement (SARSEP) are included in wages for purposes of social security, Medicare, and FUTA taxes. H&rblockonline See Publication 560 for more information about SEPs. H&rblockonline Salary reduction simplified employee pensions (SARSEP) repealed. H&rblockonline   You may not establish a SARSEP after 1996. H&rblockonline However, SARSEPs established before January 1, 1997, may continue to receive contributions. H&rblockonline SIMPLE Retirement Plans Employer and employee contributions to a savings incentive match plan for employees (SIMPLE) retirement account (subject to limitations) are excludable from the employee's income and are exempt from federal income tax withholding. H&rblockonline An employer's nonelective (2%) or matching contributions are exempt from social security, Medicare, and FUTA taxes. H&rblockonline However, an employee's salary reduction contributions to a SIMPLE are subject to social security, Medicare, and FUTA taxes. H&rblockonline For more information about SIMPLE retirement plans, see Publication 560. H&rblockonline 6. H&rblockonline Sick Pay Reporting The IRS expects to change the third-party sick pay recap reporting and filing requirements for wages paid in 2014. H&rblockonline Information about this change will be included in the revision of Publication 15-A that is expected to post to IRS. H&rblockonline gov in December 2014. H&rblockonline Special rules apply to the reporting of sick pay payments to employees. H&rblockonline How these payments are reported depends on whether the payments are made by the employer or a third party, such as an insurance company. H&rblockonline Sick pay is usually subject to social security, Medicare, and FUTA taxes. H&rblockonline For exceptions, see Social Security, Medicare, and FUTA Taxes on Sick Pay , later in this section. H&rblockonline Sick pay may also be subject to either mandatory or voluntary federal income tax withholding, depending on who pays it. H&rblockonline Sick Pay Sick pay generally means any amount paid under a plan because of an employee's temporary absence from work due to injury, sickness, or disability. H&rblockonline It may be paid by either the employer or a third party, such as an insurance company. H&rblockonline Sick pay includes both short- and long-term benefits. H&rblockonline It is often expressed as a percentage of the employee's regular wages. H&rblockonline Payments That Are Not Sick Pay Sick pay does not include the following payments. H&rblockonline Disability retirement payments. H&rblockonline Disability retirement payments are not sick pay and are not discussed in this section. H&rblockonline Those payments are subject to the rules for federal income tax withholding from pensions and annuities. H&rblockonline See section 8. H&rblockonline Workers' compensation. H&rblockonline Payments because of a work-related injury or sickness that are made under a workers' compensation law are not sick pay and are not subject to employment taxes. H&rblockonline But see Payments in the nature of workers' compensation—public employees next. H&rblockonline Payments in the nature of workers' compensation—public employees. H&rblockonline State and local government employees, such as police officers and firefighters, sometimes receive payments due to an injury in the line of duty under a statute that is not the general workers' compensation law of a state. H&rblockonline If the statute limits benefits to work-related injuries or sickness and does not base payments on the employee's age, length of service, or prior contributions, the statute is “in the nature of” a workers' compensation law. H&rblockonline Payments under a statute in the nature of a workers' compensation law are not sick pay and are not subject to employment taxes. H&rblockonline For more information, see Regulations section 31. H&rblockonline 3121(a)(2)-1. H&rblockonline Medical expense payments. H&rblockonline Payments under a definite plan or system for medical and hospitalization expenses, or for insurance covering these expenses, are not sick pay and are not subject to employment taxes. H&rblockonline Payments unrelated to absence from work. H&rblockonline Accident or health insurance payments unrelated to absence from work are not sick pay and are not subject to employment taxes. H&rblockonline These include payments for: Permanent loss of a member or function of the body, Permanent loss of the use of a member or function of the body, or Permanent disfigurement of the body. H&rblockonline Example. H&rblockonline Donald was injured in a car accident and lost an eye. H&rblockonline Under a policy paid for by Donald's employer, Delta Insurance Co. H&rblockonline paid Donald $20,000 as compensation for the loss of his eye. H&rblockonline Because the payment was determined by the type of injury and was unrelated to Donald's absence from work, it is not sick pay and is not subject to federal employment taxes. H&rblockonline Sick Pay Plan A sick pay plan is a plan or system established by an employer under which sick pay is available to employees generally or to a class or classes of employees. H&rblockonline This does not include a situation in which benefits are provided on a discretionary or occasional basis with merely an intention to aid particular employees in time of need. H&rblockonline You have a sick pay plan or system if the plan is in writing or is otherwise made known to employees, such as by a bulletin board notice or your long and established practice. H&rblockonline Some indications that you have a sick pay plan or system include references to the plan or system in the contract of employment, employer contributions to a plan, or segregated accounts for the payment of benefits. H&rblockonline Definition of employer. H&rblockonline   The employer for whom the employee normally works, a term used in the following discussion, is either the employer for whom the employee was working at the time that the employee became sick or disabled or the last employer for whom the employee worked before becoming sick or disabled, if that employer made contributions to the sick pay plan on behalf of the sick or disabled employee. H&rblockonline Note. H&rblockonline Contributions to a sick pay plan through a cafeteria plan (by direct employer contributions or salary reduction) are employer contributions unless they are after-tax employee contributions (that is, included in taxable wages). H&rblockonline Third-Party Payers of Sick Pay Employer's agent. H&rblockonline   An employer's agent is a third party that bears no insurance risk and is reimbursed on a cost-plus-fee basis for payment of sick pay and similar amounts. H&rblockonline A third party may be your agent even if the third party is responsible for determining which employees are eligible to receive payments. H&rblockonline For example, if a third party provides administrative services only, the third party is your agent. H&rblockonline If the third party is paid an insurance premium and is not reimbursed on a cost-plus-fee basis, the third party is not your agent. H&rblockonline Whether an insurance company or other third party is your agent depends on the terms of their agreement with you. H&rblockonline   A third party that makes payments of sick pay as your agent is not considered the employer and generally has no responsibility for employment taxes. H&rblockonline This responsibility remains with you. H&rblockonline However, under an exception to this rule, the parties may enter into an agreement that makes the third-party agent responsible for employment taxes. H&rblockonline In this situation, the third-party agent should use its own name and EIN (rather than your name and EIN) for the responsibilities that it has assumed. H&rblockonline Third party not employer's agent. H&rblockonline   A third party that makes payments of sick pay other than as an agent of the employer is liable for federal income tax withholding (if requested by the employee) and the employee part of the social security and Medicare taxes. H&rblockonline   The third party is also liable for the employer part of the social security and Medicare taxes, and the FUTA tax, unless the third party transfers this liability to the employer for whom the employee normally works. H&rblockonline This liability is transferred if the third party takes the following steps. H&rblockonline Withholds the employee social security and Medicare taxes from the sick pay payments. H&rblockonline Makes timely deposits of the employee social security and Medicare taxes. H&rblockonline Notifies the employer for whom the employee normally works of the payments on which employee taxes were withheld and deposited. H&rblockonline The third party must notify the employer within the time required for the third party's deposit of the employee part of the social security and Medicare taxes. H&rblockonline For instance, if the third party is a monthly schedule depositor, it must notify the employer by the 15th day of the month following the month in which the sick pay payment is made because that is the day by which the deposit is required to be made. H&rblockonline The third party should notify the employer as soon as information on payments is available so that an employer required to make electronic deposits can make them timely. H&rblockonline For multi-employer plans, see the special rule discussed next. H&rblockonline Multi-employer plan timing rule. H&rblockonline   A special rule applies to sick pay payments made to employees by a third-party insurer under an insurance contract with a multi-employer plan established under a collectively bargained agreement. H&rblockonline If the third-party insurer making the payments complies wi