- A public agency obtains financing for low- income or first-time homebuyers to assist them in purchasing homes. The agency retains the services of an attorney to conduct closings on the properties. The agency issues one check to the attorney to be deposited in escrow. The amount of the check includes the proceeds of the loans as well as the closing fees for multiple properties. The closing costs include legal fees and other settlement expenses. The agency must issue a Form 1099 to the attorney. What amount should it report? The gross amount, the amount of the closing costs, or only the amount of the legal fees?
- Are liquidated and punitive damages subject to FICA taxes?
- If liquidated damages are not subject to FICA taxes, is an employer required to provide a Form 1099 to an individual who receives a legal settlement?
- What about a the legal settlement is related to termination of an employee?
- An employee of a town was laid off. During the period when he was receiving severance pay, he died. The remaining severance pay is paid to his widow (the beneficiary) before the end of the calendar year when the employee died. How is the payment of the severance pay treated for purposes of income tax, FICA tax and information reporting?
- A municipality has a group-term life insurance plan. The employer pays for the cost of insurance coverage under $50,000. The employee may purchase additional insurance which may exceed $50,000. Is any part of the premium taxable?
- A town official pursues a master's degree in public administration. The town pays the cost of the tuition for the courses and treats these payments as a taxable fringe benefit. The courses are job-related for the most part. Is the town treating this benefit correctly?
- A municipality reimburses its retirees for the cost of Medicare B premiums. Is this a taxable fringe benefit?
- A school district has no health insurance plan. It gives employees cash from accounts payable to pay for their own health insurance. Is this benefit taxable and subject to FICA?
- Is payment received for jury duty subject to income tax? What if jurors are paid for mileage from home to the courthouse?
A public agency obtains financing for low- income or first-time homebuyers to assist them in purchasing homes. The agency retains the services of an attorney to conduct closings on the properties. The agency issues one check to the attorney to be deposited in escrow. The amount of the check includes the proceeds of the loans as well as the closing fees for multiple properties. The closing costs include legal fees and other settlement expenses. The agency must issue a Form 1099 to the attorney. What amount should it report? The gross amount, the amount of the closing costs, or only the amount of the legal fees?
In the facts presented, the agency hired the attorney and is obligated to pay the legal fees. It is paying its own legal fees, not those of the homebuyers. Such fees are reportable to the attorney under Code section 6041. That section requires information reporting by persons engaged in a trade or business and making payment to another person in the course of such trade or business of fixed or determinable income of $600 or more. The legal fees paid to the attorney represent fixed or determinable income to him. If the fees total $600 or more, they should be reported to the attorney on a Form 1099-MISC as nonemployee compensation in Box 7.
The amount of the legal fees in this situation should be known to the agency. However, if they are not, then no part of the amount paid to the attorney is reportable under Code section 6041. Instead, the entire amount paid to the attorney is reportable under section 6045(f), which requires information reporting by any person engaged in a trade or business with respect to payments made to an attorney in connection with legal services. This requirement applies to the gross proceeds paid to the attorney, not just the amount that is fixed or determinable income to the attorney. The gross proceeds reportable under this section are included on Form 1099-MISC, Box 14. Section 6045(f) applies to payments made after December 31, 1997.
The gross amount paid to the attorney need not be reported under section 6045(f) if any portion of that payment is reportable to the attorney under section 6041 (or would be reportable if not for the dollar amount involved) or 6051 (payments to employees). Thus, if the agency must report the legal fees paid to the attorney under section 6041, or would be required to report were it not for the fact that the amount is under $600, it does not have the obligation to report the gross proceeds paid under section 6045(f).
Finally, the exception for reporting payments to a corporation does not apply. Reporting is required for payments to an attorney or law firm that is a corporation.
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Are liquidated and punitive damages subject to FICA taxes?
The term "liquidated damages" means damages for which the amount has been ascertained, either in a judgment or in an agreement. Typically, when a specific sum has been expressly agreed to by two parties as the amount of damages to be recovered in case of breach of an agreement, the sum is referred to as "liquidated damages."
It is necessary to look at the origin of the claim to determine whether employment taxes apply. Generally, FICA taxes apply to a dismissal payment.
Punitive damages are awarded to punish or make an example of a defendant based on outrageous conduct. Punitive damages are awarded in addition to compensatory damages for actual monetary losses. Because of the nature of punitive damages, they will not be the equivalent of wages on account of employment and consequently are not subject to FICA taxes.
Section 104 of the Internal Revenue Code deals with the treatment of punitive damages. Section 104(a)(2) excludes from income only "damages (other than punitive damages) received . . . on account of personal physical injuries or physical sickness." Therefore, punitive damages, even in connection with personal injuries, are not excludable from income. Subsection 104(c) provides a narrow exception to the rule of inclusion for punitive damages in a wrongful death action where state law provides the only damages that may be awarded are punitive damages. These rules apply generally to amounts received after August 20, 1996.
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If liquidated damages are not subject to FICA taxes, is an employer required to provide a Form 1099 to an individual who receives a legal settlement?
In general, a payer of damages, or its insurer, is required by section 6041 to report on Form 1099 when it makes payments of $600 or more, as a result of a judgment or a settlement. Generally, no information reporting is required for payments that are not subject to income tax. Thus there would be no reporting requirement for a payment of damages exclusively for physical injuries (with the exception of punitive damages, which are includible in income). See Internal Revenue Code section 104(a)(2).
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What about a legal settlement is related to termination of an employee?
Settlements of suits in cases of employee termination arise from a variety of causes of action. The settlement could be for a breach of contract, a tort, or a violation of any one of a number of federal or state statutes such as the Age Discrimination in Employment Act or the Americans With Disabilities Act. All the facts must be considered, for instance the complaint, the settlement document, a court's opinion, etc., to determine what the award is for. There is no simple answer to this question.
In general, severance payments are wages for employment and are subject to FICA taxes. If the payments arose in connection with the employment relationship and that the amounts were based on salary and years of service, these are indications that the settlement amounts are wages for employment.
Wages are generally subject to FICA tax when they are actually or constructively paid. Severance payments are subject to FICA tax in the year in which they are paid. The FICA tax rate and wage base are those in effect in the year of payment. FUTA tax and income tax withholding also apply.
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An employee of a town was laid off. During the period when he was receiving severance pay, he died. The remaining severance pay is paid to his widow (the beneficiary) before the end of the calendar year when the employee died. How is the payment of the severance pay treated for purposes of income tax, FICA tax and information reporting?
Severance pay is typically wages subject to FICA tax because the employee fully earned the right to the severance pay before death. Any payment made to a beneficiary or the estate of a former employee after the end of the calendar year when the employee died is exempt from FICA, however.
Payments made to a beneficiary or the decedent's estate before the close of the taxable year in which the decedent dies are subject to FICA taxes. For income tax purposes, however, these amounts are taxable to the beneficiary or the estate. They should be reported to the beneficiary or the estate on Form 1099-MISC.
To ensure that the deceased employee receives proper social security and Medicare credit, severance pay earned by the deceased employee before his death should be reported on Form W-2 as social security wages and Medicare wages, on the decreased employee's final Form W-2. However, only the income paid to the decedent should appear as "Wages, tips, other compensation."
A municipality has a group-term life insurance plan. The employer pays for the cost of insurance coverage under $50,000. The employee may purchase additional insurance which may exceed $50,000. Is any part of the premium taxable?
An employer can exclude up to $50,000 of group-term life insurance coverage from income and FICA taxes. The employee is taxed on the cost of coverage in excess of $50,000 (reduced by any amounts paid by the employee toward the cost of the coverage), but only if the insurance is “provided under a policy carried directly or indirectly by the employer” (as defined below). The cost of the insurance must be computed using the premiums prescribed in Table I of the Regulations under Internal Revenue Code section 79. To determine the amount to be included in an employee’s income, total the coverage provided under all policies carried directly or indirectly by the employer and reduce that coverage by $50,000. Next, go to Table I to determine the cost of the insurance and then reduce that cost by any premium amounts paid by the employee.
A policy is carried directly or indirectly by the employer if either of the following is true: (1) The employer pays any cost of the life insurance; or (2) The employer arranges for the premium payments and the premiums paid by at least one employee subsidize those paid by at least one other employee. The test for determining whether some employees are subsidizing other employees is found in section 1.79-0 of the regulations. Under that test, there is employee subsidization if at least one employee is charged less than the cost of his or her insurance (as determined under Table I) and at least one other employee is charged more than the cost of his or her insurance (as determined under Table I). This is sometimes referred to as the straddle rule. That is, if the premiums charged the employees “straddle” the Table I premium rates, the insurance is “carried directly or indirectly by the employer.” Each policy must be tested separately to determine if it is carried directly or indirectly by the employer. As a general rule, all insurance coverage provided by the same insurance company (or any of its subsidiaries) is considered one policy.
If the insurance is purchased from different insurers, the employer-paid coverage is “carried directly or indirectly by the employer.” The optional insurance, even though it is paid for entirely by employee after-tax dollars, must also be included in the calculations for group-term insurance if the premiums charged to the employees “straddle” the Table I rates. If the premiums charged to employees for the optional insurance do not “straddle” the Table I rates, only the cost of the employer-paid coverage is subject to inclusion in income–and because you do not pay for more than $50,000 of coverage, no amounts would be taxable.
For more information, see Publication 15-B or the Regulations under section 79.
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A town official pursues a master’s degree in public administration. The town pays the cost of the tuition for the courses and treats these payments as a taxable fringe benefit. The courses are job-related for the most part. Is the town treating this benefit correctly?
Educational expenses paid by an employer may qualify for exclusion under two different sections of the Internal Revenue Code: under section 132 as a working condition fringe, or under section 127 as an educational assistance program.
Working Condition Fringe
Employer-paid tuition is excludable under section 132(a)(3) as a working condition fringe. A working condition fringe is any property or services provided to an employee to the extent that, if the employee paid for them, the payment would be allowable as a deduction by the employee under section 162 or 167.
Educational expenses are deductible if they maintain or improve skills required by the individual in his employment or if they meet the express requirements of the employer. The expenses are deductible if the educational requirements are imposed as a condition to retention of employment, status, or pay level, and also if new requirements are imposed after the employee is hired. See section 1.162-5(c), Income Tax Regulations.
Educational expenses are not deductible if the courses are required to satisfy the minimum educational requirements to qualify for employment. For instance, if a bachelor's degree is a minimum requirement for a teacher, none of the costs of a bachelor's degree would be deductible, even if an individual was hired provisionally as a teacher, with the understanding that he would complete his bachelor's degree.
Educational expenses are not deductible if they qualify the individual for a new trade or business. Thus, if an employer requires an employee to pursue a law degree in order to continue her current non-legal employment, the expenditures of attending law school are not deductible. See section 1.165-2(b)(3) of the Regulations.
If the employee is reimbursed for expenditures, the reimbursement arrangement must be an accountable plan within the meaning of section 62(c) and regulations. If the employer includes the benefit in the employee’s wages, the employee can take a deduction for the expenses on his or her individual income tax return if the tests are met.
Educational Assistance Program
Code section 127 provides an exclusion for an educational assistance program under a separate written plan for employees. This provision allows an individual an exclusion of up to $5,250 in a calendar year. For tax years beginning before 2002, it does not apply to graduate level courses leading to a law, business, medical, or other advanced academic or professional degree. The Economic Growth and Tax Relief Reconciliation Act of 2001 made this provision permanent and extended the exclusion to graduate level courses after December 21, 2001.
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A municipality reimburses its retirees for the cost of Medicare B premiums. Is this a taxable fringe benefit?
Section 106 of the Code excludes from gross income employer-provided insurance coverage under an accident or health plan. Retirees are treated like employees for this purpose.
Reimbursement for the cost of Medicare B premiums can be excluded from a retiree's income. The reimbursements have to be handled so as to ensure that they are for actual premiums paid. The employer can reimburse the employee after receiving proof of prior payment of the premiums by the employee. It can also issue the employee a check payable to Medicare. The Medicare B premium reimbursements in this case would not be a taxable fringe benefit.
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A school district has no health insurance plan. It gives employees cash from accounts payable to pay for their own health insurance. Is this benefit taxable and subject to FICA?
Generally, any plan that provides for payment of health insurance or medical expenses of employees is an excludable benefit under sections 105 or 106. However, cash given to employees in lieu of health insurance is taxable and should be reported as income and FICA wages on Form W-2. If an employer issues a check to an employee to pay for health insurance without requiring proof of payment of premiums, the amount is a taxable fringe benefit.
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Is payment received for jury duty subject to income tax? What if jurors are paid for mileage from home to the courthouse?
Jury fees received as compensation for services are includible in gross income. See section 1.61-2(a)(1), Income Tax Regulations. However, amounts received separately as reimbursements or allowances for travel to and from the courthouse, meals, and lodging during jury duty are not included in gross income.
Some employers pay employees their regular wages on days that the employees perform jury duty. In exchange for these wages, the employer may require the employees to pay to the employer the jury fees that the employees receive as compensation for jury service. If an employee must pay these jury fees to his or her employer, the employee may claim an above-the-line deduction on Form 1040 for the amount of the fees paid to the employer.
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