A tax professional is often asked when providing tax preparation or tax planning services as to the tax consequences when an employer compensates an employee. There are three basic types of benefits currently in use for compensating the key employee. These are direct compensation; perks or non-cash fringe benefits; and deferred compensation plans. There are basic differences among these three major types of compensation, including their respective tax implications for you, as the employer, and the employee.
Direct compensation: Direct compensation is comprised of immediate pay to employees in the form of salary, cash bonuses and qualified stock bonus plans. Direct compensation differs from fringe benefits in that it typically involves cash payments or other evidences of indebtedness to the executive that can be readily negotiated or sold for cash. Direct compensation also differs from deferred compensation in that its impact is immediate (or within a year’s time) rather than delayed until some future date. Generally, employees must recognize income in the year they receive direct compensation, and employers can deduct corresponding amounts in the year they pay direct compensation.
“Perks” or non-cash fringe benefits: Perks are those benefits that most employees think of as being fringe benefits. Thus, the perks that an employer may provide its employees consist of such non-cash benefits as company cars, exercise facilities and employee cafeterias.
Perks tend to differ from direct compensation in that they typically involve the use of employer-provided facilities or reimbursement of employer-induced expenses rather than the payment of cash or its equivalent. Like direct compensation and unlike deferred compensation, perks provide an immediate economic and financial benefit to participating employees. Generally, the Internal Revenue Code provides that all perks are taxable as wages to participating employees unless the perk is specifically exempted from taxation.
Deferred compensation: Deferred compensation refers to what would otherwise be direct compensation or a perk (i.e., fringe benefit), except that it is so structured as to postpone receipt of a portion of an employee’s taxable compensation until sometime after it has been earned by the employee. Conceptually, deferred compensation plans are a type of benefit located midway between the immediate benefits of direct compensation and perks, and the long-range benefits bestowed under a retirement plan. Some employers use deferred plans as “golden handcuffs”. Since the benefit the employee will receive is delayed until some future date and the employee may run the risk of forfeiture of receiving the benefit if not employed by that certain future date, the employee has a compelling reason to stay with the employer.
A common aim of a deferred compensation plan is to shift otherwise taxable compensation [Read more…] about COMPENSATING KEY EMPLOYEES
