When preparing your taxes or doing any paperwork that concerns income, you may see the term taxable wages or taxable income. As the term implies, not all your wages may be taxable. So the amount of income to be reported can actually be less than your total income. As an employer, you will need to understand the concept of taxable wages for tax purposes.
Taxable wages from an employer’s perspective
To an employer, an employee’s taxable wages include all of the income from which the employer must withhold income tax. This can include more than just your employee’s paycheck. It may also include bonuses, advances, back pay, severance pay, fringe benefits, cash gifts from an employer, and unemployment compensation. The IRS has specific guidelines about some of these types of income.
For example, perhaps you pay a commission to your employee upfront, but then the commission is unearned.
- If the commission is repaid during the same tax year, the amount of taxable wages is reduced by the amount repaid.
- If it’s repaid in a different tax year, it may be included as an itemized deduction on Schedule A of Form 1040.
It’s best that you and/or your employee check with the IRS to make certain you’re treating the commission as the proper type of wage in this situation.
Taxable wages from an employee’s perspective
Taxable wages from a personal perspective actually include more than just what your employee makes in a year. Taxable wages is often synonymous with taxable income. While it does include your employee’s salary or other income, the IRS also includes all of the following:
- Lottery winnings
- Winnings from any type of betting or gambling on races
- Casino winnings (including money won internationally)
- Stock pay outs
- Real estate sales
- Interest received on accounts
- Rental income
- The cash value of any items bartered/traded with others
- Virtual currency
Note that virtual currency is a recent addition to the list. It was added in 2014 to cover such currencies as Bitcoin. The fair market value of these virtual currencies must be reported on tax returns and is subject to federal income tax, FICA, and FUTA tax.
Non-taxable wages per IRS
To clarify the concept of taxable wages, it is helpful to look at their counterpart, non-taxable wages. There are also some types of payments that are specifically listed by the IRS as non-taxable income. They include the following:
- Child support
- Any money received from a life insurance policy
- Any inherited money
- Payments made from workers’ compensation
- Compensation received due to physical injury
While these types of income are not considered a part of a person’s taxable income, they are considered part of their gross income.
It depends …
There are some types of income that may or may not be taxable depending on the circumstances in which they are received. For example …
… If a student receives scholarships or educational grants that go directly to pay for tuition, they are considered non-taxable wages. However, if the student uses a scholarship to pay for room and board, it is considered a taxable wage.
… Income from a 401(k) or an IRA may also be taxable. When a person receives a pre-retirement payment from a retirement fund, that income is usually taxable. However, if it is rolled over into another retirement plan, the pre-retirement payment is non-taxable until it’s withdrawn from the new plan.
… Sick pay may also be taxable or non-taxable depending on where the income comes from. If the employer is paying an employee sick pay, that money is taxable. Sick pay is also taxable if it comes from a state disability fund, employee association, welfare fund, or an insurance company if the employer paid the premiums. If the employee paid the insurance premiums, then the payments are not taxable.
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