|Employee compensation includes
not only direct payments made to employees for work performed but
also any benefits indirectly paid on behalf of the employee. The
employee's compensation includes not only cash paid to employees
but basically anything of value.
As a general rule all types of
compensation paid directly or indirectly to an employee is subject
to withholding and employment taxes. The IRS does allow an
employer to provide some benefits that do provide
favorable tax treatment to the business as well as to the
individual. In other words, the employer can deduct the expense and
the employee doesn't have to include the compensation in his/her
Note: Rules, laws, and
regulations pertaining to fringe benefits are constantly changing.
Your type of business organization (sole proprietorship,
partnership, LLC, or corporation) may affect the tax treatment of
In this lesson, I've grouped an
employee's total compensation into four
- Employer Provided
- Benefits Provided By
This is what the employer and employee agreed would be the
employee's "regular" pay for the services they provide. Common
types of regular compensation are:
- Salaries-compensation based on a
fixed amount and paid to an employee for management, professional,
administrative, or similar services (exempt type of jobs). A salary
is usually stated in terms of a weekly, monthly, or yearly amount.
Note: Although salaries are normally used to pay for the so called
exempt types of jobs, they may also be used as the payment method
for skilled or unskilled employees in non management or supervisory
jobs , the so called nonexempt types of jobs. With a "true"
salaried position the employee is paid the same amount regardless
of how many hours the employee actually works during the pay
- Wages-compensation based on an
hourly or piece work rate for either skilled or unskilled
- Commissions-compensation based on
the employee's productivity usually stated as an amount per sale or
as a percentage of each sale. Most commissions are related to
- Overtime-premium pay for working
more hours than "normal" during a pay period. Normally overtime is
paid for all hours worked over 40 in a weekly period. The extra
hours are paid at time and a half or in some instances double time.
Working on holidays would be an instance when double time might be
paid. This type of compensation is not normally paid to management
type employees. The government has rules and regulations that apply
to this type of compensation.
- Shift differentials-incentive
used to attract employees to work during hours that employees would
normally prefer not to work. An example would be paying an extra 50
cents an hour to employees who work the midnight shift.
- Paid Breaks-employer pays the
employee for the time spent on breaks or rest periods.
Note: Although I
differentiated between the terms salary and wages, they are often
used interchangeably when discussing pay. In addition, when someone
asks the question "what do you make ?" , the answer given normally
only includes their regular compensation. As you will see later,
fringe benefits can also be a substantial part of an
employee's total earnings.
Compensation that may or may not
be paid to employees based on goals, rules, and regulations
determined by the employer or as a customary practice of the
- Tips-extra earnings normally
voluntarily contributed by customers. In other instances, the
business may have a policy of automatically adding a percentage of
the total customer's bill to his/her bill.
- Bonuses and Profit Sharing-extra
compensation usually based on meeting or surpassing some company
set goals. Normally, but not necessarily, reserved for
management type employees. The employer determines the goals, rules
and policies that govern the payment of the bonuses.
Note: Bonuses and Profit
Share payments are not mandatory payments. The payment of
bonuses and profit sharing payments depends on the rules and
policies governing the bonus or profit sharing plan.
Often called fringe benefits or perks.
These type of benefits are
normally not paid in cash or included in the employees pay check;
however, they are a major cost for most employers (businesses).
They can easily amount to 25-30% of an employee's regular
wages. Fringe Benefits are not required by law and a business is
left to determine what if any benefits they will provide for their
||Why Pay Them ?
Good employees are one of a
business's key assets. Hiring and retaining good employees is a
constant challenge. Many businesses "fool" themselves by adopting a
philosophy of I don't have to offer much because I can always
recruit and hire another body to replace the one that quit. Granted
for some low skill jobs they might be right. On the other hand, if
this philosophy is used for jobs that require some skill or
training provided by your company, you may need to change your
philosophy. Turnover is a hidden cost and can "eat your lunch".
Work interruptions and slow downs due to untrained or not enough
employees can have a drastic effect on a business.
Due to the competition from other
businesses also wanting to hire and maintain good employees, a
business would be wise to investigate and at least offer benefits
similar to other businesses in their industry or
What are some of these Other
Some Common Provided
- Vacation â€“
days off provided to employees to relax and get away from work. The
employee is normally allowed so many days off with pay during the
year usually based on their length of service (how long they've
worked for the company). The longer a person works for the company
the more vacation time they normally are provided.
Note: Most businesses allow the employee to select the days;
however, some types of businesses may require all the employees to
take vacation at the same time.
- Holidays â€“
days off for special occasions that the employer provides to
employees. The days off can be with or without pay. Normally, the
employee gets paid for the holiday after working for the business
for a stipulated period of time.
- Sick and personal time
â€“ time allowed due to sickness or illness,
funerals, jury duty, doctor or dentist appointment, military
obligations, etc. This benefit can be with or without pay. Normally
sick and personal days are also tied to how long the employee has
worked for the company. The employer may or may not require the
employee to provide documentation.
- Health insurance
â€“ provides coverage (payments) for the employee
and/or his or her family for medical expenses when a person is sick
or injured. The employer can cover the full cost or require the
employee to also contribute to the cost of providing this benefit.
Normally one of the most wanted benefits by employees. The IRS has
some special rules regarding this type of benefit.
- Group Term Life Insurance and/or
Disability Insurance â€“ provides payments to the
employee or surviving family if the employee dies or becomes
disabled. The IRS has some special rules related to this type of
- Retirement â€“
provides a plan to help employees accumulate savings for
retirement. Plans may or may not require the business (employer) to
contribute to the plan. Most retirement plans are required to
follow strict rules and regulations pertaining to eligibility,
discrimination, and limits on benefits, and amounts
Note: Although at one time only thought of as a benefit
provided by large companies, more and more small businesses are
starting to provide these benefits to their employees. In addition,
the laws, rules, and regulations have been simplified in order to
encourage small businesses to provide some form of retirement
Some Other Fringes an Employer
- Dependent Care
- Continuing Education
- Employee Discounts
- Stock Options
- Athletic Facilities
- Meals provided for employer
- Cafeteria Plans
A cafeteria plan is a written plan that allows your employees to
choose between cash or non-taxable (qualified) benefits. The IRS
has guidelines on what benefits may be offered using these
Note: I have not listed all
the benefits imaginable a business has an option to provide as
perks to their employees or the resulting tax effects. For an in
depth discussion of these and the prior benefits I discussed, refer
to IRS Publication 15-B that I asked you to download in the
Introduction. Another useful publication for determining the tax
treatment of fringe benefits is IRS
(this publication as well as others requires free Adobe Reader)
Other Benefits Provided By Law
These benefits are provided by the employer or a combination of
employee and employer contributions.
Worker's Compensation Insurance -
a benefit that provides payments to employees for injuries suffered
on the job. Only the employer is required to contribute premiums
for this coverage. State and federal regulations require most
businesses to provide this benefit.
Unemployment Compensation - a
benefit that provides payments to laid off or ex-employees during
times when they are not employed. The employer is normally required
by law to make payments not only to their state but also to the
Note:Employees may also be
eligible for partial unemployment benefits if working less than
Many employees or for that matter
employers don't understand exactly what those FICA and Medicare
deductions are and what they do and don't provide to covered
employees. Basically, social security deductions (FICA) are for
providing some employee retirement benefits and the medicare
deduction is used to provide future medical benefits.
Social Security (FICA) and
Medicareâ€“ a certain percentage is deducted from
an employee's pay for FICA (Federal Insurance Contribution
Act) and Medicare taxes. The employer is required to pay the
same amount as the amount deducted from the employee's wages for
these two taxes. In other words, the employer pays half and the
employee pays half of these employment taxes.
Note:Earnings from self
employment from "flow thru" types of business organizations are
subject to special IRS rules pertaining to social security and
medicare (Lesson 6 discusses these rules).
The money from social security and
medicare deductions goes toward providing the following
- Retirement â€“
Full benefits are payable at what is called full retirement age
(FRA) (with reduced benefits available as early as 62) to anyone
with enough Social Security credits.
- Disability â€“
Benefits are payable at any age to people who have enough Social
Security credits and who have a severe physical or mental
impairment that prevents them from working or who have a condition
that is expected to result in death.
- SSI (Supplemental Security
Income) is a benefit paid to people who are over 65 and/or disabled
and have low incomes and few resources.
- Family Benefits
â€“ If an employee is eligible for retirement or
disability benefits and dies, other members of their family might
qualify and receive benefits.
- Medicare â€“
Medicare is our countryâ€™s health insurance
program for people age 65 or older. Certain people younger than age
65 can qualify for Medicare, too, including those who have
disabilities and those who have permanent kidney
||You Be The
Let's look at a simple example and
see which employer you'd rather work for. We'll call them Company A
and Company B. We'll use the information and assumptions in the
following table to base our decision on.
|Rate Per Hour
||80 hours (2 weeks)
||40 hours (1 week)
||80 hours (10 days)
||40 hours (5 days)
||80 hours (10 days)
||40 hours (5 days)
||$4,200 annual premium
|Group Life Insurance
||$600 annual premium
We'll calculate an equivalent
hourly rate based on actual hours worked in order to see which
company is offering the best deal.
|Let's calculate our
actual hours worked.
|Total Hours In Year
|Holiday Hours Allowed
|Sick Hours Allowed
|Actual Work Hours
||Now let's total up
our total annual compensation.
|Hourly Pay For Hours Worked
|Group Life Premium
And lastly, calculate our
equivalent rates per hour.
|Actual Work Hours
|Equivalent Rate Per
I know which company I want to
work for do you ? I'm going to work for Company
A. Fringe Benefits made a big difference.
HR-Guide Home Page
HR-Guide is a rapidly growing website containing hundreds of pages
of information related to Human Resources.
Explains the different types of employee compensation available for
Small Business Retirement
As mentioned earlier, setting up and offering an employee
retirement plan is not the hassle that it once was and may just be
the edge you need to keep your good employees. Most mutual fund
companies, brokerage firms, banks and insurance companies offer
small business plans. The IRS even provides you with a
Do-It-Yourself Kit. For more information check out some of the
An online version of the Retirement Plans portion of the 2005 Small
Business Resource Guide CD. This extract (with updates) contains
information useful in choosing an appropriate retirement
Publication 3998 - Choosing a Retirement Solution for your Small
Business - PDF
Starting a small business retirement savings plan can be easier
than most business people think. What's more, there are a number of
retirement programs that provide tax advantages for both employers
Publication 560 Retirement Plans For Small Business -
Department Of Labor Guide - PDF
Handy retirement plan reference ebook.
||Hopefully, in this lesson you
learned that an employee's total compensation "package" is made up
of more than just their regular salary and wages. I grouped
employee compensation into four main categories -regular
compensation, additional compensation, employer provided benefits,
and benefits required by law.
I hope I didn't over tax your
brain. The pun was intended. In a future lesson, we'll learn that
some benefits receive favorable income tax treatment. So far so
good ( I hope) , so we'll move right along to Lesson 2 - Types of