Employee compensation includes wages, benefits, reimbursements, and employer‑provided perks. For tax purposes, employers must determine whether payments are taxable, deductible, or excludable, and whether they are subject to employment taxes.
Key Employee & Highly Compensated Employee (HCE)
A key employee meets one of these tests (lookback year):
- Officer earning over $220,000
- 5% owner
- 1% owner earning over $150,000
A highly compensated employee meets:
- 5% ownership in current or prior year
- Compensation over $155,000 in prior year
- Optional top‑20% election may exclude some employees
Deducting Employee Pay
Compensation is deductible if:
- Ordinary and necessary
- Reasonable
- Purely for services
Publicly held corporations may deduct only up to $1 million per year for each covered employee (PEO, PFO, and top three officers). Once covered, always covered.
Wages include salaries, bonuses, commissions, vacation pay, and taxable fringe benefits.
Reimbursement Rules
Accountable Plan
Not wages; no FICA, FUTA, or income tax withholding. Must meet:
- Expense is deductible and job‑related
- Employee substantiates within a reasonable time
- Employee returns excess amounts
Safe‑harbor timing:
- 30 days (advance)
- 60 days (substantiation)
- 120 days (return excess)
Nonaccountable Plan
Payments are wages and subject to full withholding.
Per Diem
Reimbursements within federal rates are treated as substantiated.
Non‑Cash Wages
Payments in goods, lodging, meals, or services are taxable at fair market value unless an exclusion applies.
Moving Expenses
- Military PCS moves: excludable
- Intelligence community moves (2026+): excludable
- All others: taxable and subject to withholding
The One Big Beautiful Bill Act permanently removed the exclusion for civilians.
De Minimis Meals
Excludable when value is small and infrequent. Includes:
- Coffee, snacks
- Occasional overtime meals
- Employee parties
- Employer‑operated eating facilities meeting cost‑recovery rules
Meals on Business Premises
Meals provided for the employer’s convenience are excludable. Applies to:
- Food‑service workers
- Employees on emergency call
Not excludable if employees may choose cash instead.
Lodging on Business Premises
Excludable if:
- Provided on premises
- For employer’s convenience
- Required as a condition of employment
Health Insurance
Employer‑paid health coverage for employees, spouses, and dependents is not wages. Coverage for children under age 27 is tax‑free. For 2% S‑corp shareholders, value is included in income for withholding but excluded from FICA/FUTA.
Retirement Plan Contributions
Employer contributions to qualified plans are deductible and not taxable to employees (except Roth contributions).
HSAs & MSAs
Employer contributions are excludable if reasonably expected to be tax‑free. Employee payroll contributions are taxable unless made through a Section 125 cafeteria plan.
Cafeteria Plans (Section 125)
Allow employees to choose between taxable and nontaxable benefits. Qualified benefits include:
- Health benefits
- Adoption assistance
- Dependent care
- Group‑term life
- HSAs
Must be a written plan.
Medical Reimbursements
Self‑insured medical reimbursements are generally not wages.
Fringe Benefits
Most fringe benefits are taxable unless specifically excluded. Taxable examples:
- Company cars for personal use
- Vacations
- Club memberships
- Event tickets
Nontaxable Fringe Benefits
- No‑additional‑cost services
- Qualified employee discounts
- Working condition fringes
- Nominal holiday gifts (not cash or gift cards)
- On‑premises athletic facilities
- Qualified tuition reduction
- Certain minimal‑value transportation benefits
- 2025 limits: $325/month for transit or parking
Achievement Awards
Tangible property awards may be excluded if:
- For length of service or safety achievement
- Part of a meaningful presentation
- Not disguised compensation
Limits:
- $400 for non‑qualified plan awards
- $1,600 total for all awards