Employees from different sectors endowed with the responsibility of offering personal services to different organizations normally are compensated in a variety of ways. One of the major forms of compensation used by organizations is through wages or salaries. Deferred compensation is also one of the means of compensation which presents an expectation of receiving payment in the future for services rendered at present. Such compensation always come in many forms one of them being in the form of qualified employee plan. Such plan entails pension plan or rather what is known as profit sharing plan and non-qualified deferred compensation plan or rather what is referred to as an annuity. Other forms of compensation involve the use of non-cash such as employee health, death and other welfare benefits. There are fringe benefits which include personal vehicle, meals, lodging, educational benefits, low-interest loans, travel and entertainment and club membership amongst other benefits (Pope et al, 2012).
Principles safeguarding compensation
The first principle is known as the general rule of inclusion where all forms of compensation are subjected to tax unless otherwise specified and excluded by the code. The code is derived from IRC 61(a)(1) which refers to gross income as that form of income obtained from all derived sources including service compensation, commissions, fringe benefits, fees amongst other forms. All payments made as compensation services are subject to tax unless otherwise stated. Payment made by employer to an employee is to some extent not considered to be form of compensation for services. This is always considered as a gift and at the same time all the benefits that employee receives from employer are thus considered compensatory. Hence the general rule of inclusion applies to both money payment and other employee benefits from employers.
Then there is the principle of Receipt which utilizes the use of cash receipts and accounting disbursement methods. In this case all items included in the gross income are governed by IRC 451 and underlying regulations. This provides regulations for cash basis taxpayers where items of gross income are taxed. Then there is the principle of Economic benefit doctrine which deals with taxation of cash compensation and fringe benefits. This principle explains the fact that employees obtain income in different forms from any financial benefit received as compensation (Pope et al, 2012).
Current cash compensation
Cash compensation is always included in the gross income in various forms. Some of the items included within the current cash compensation include wages salaries as well as commissions, termination and other fees. Expense accounts and allowances are treated in a manner such that reimbursement amounts are never considered as part of employee compensation unless it exceeds the employee’s expenses. At the same time compensation income is given on the interest forgone in the circles of below-market loans given.
This is provided as compensation and also include in the employees income unless otherwise specified. Fringe benefit is considered compensation based on its connection with performance services. There are several rules governing treatment of fringe benefits provided within the code regulations. However, some circumstances guarantees exclusion of fringe benefits from gross income, such entails situations where fringe benefits do not exceed specific limits as well as meeting other requirements. IRC 61 rules are enforced in the event where requirements for exclusion are not attained.
Fringe benefit is valuated based on costs and fair market value. This is because fringe benefit is considered to result from income equivalent of the fair market value in excess of amount paid by the employee. This is provided for in the code Reg. 1.61-21(b)(1).
There are many welfare benefits provided by employers some of which include health and death amongst others. These welfare benefits are at times either self-funded or insured and are all included as compensation in the employee’s income. Life insurance can either be a individual issue or taken as a group. Cost attached to group term insurance taken by employee to cover family members is always included in the employee’s income.
Other welfare benefits are normally provided as fringe benefits based on given terms and conditions. These include health benefits which are considered through employer- provided health insurance which also considers satisfaction on non-discrimination rules. Health plan coverage is also considered whereby an employee’s gross income excludes employer-provided coverage. Other benefits considered under fringe benefits include; scholarship and tuition reductions, group legal service plans which have been qualified, transportation, qualified cafeteria plans and assistance programs on education.
The value of meals and lodging provided to the employee by the employer should be included in the employee’s income unless specified otherwise. However, some benefits under this might be excluded and thin includes; meals and lodging provided based on employer’s conveniences, parsonage allowance, eating facilities operated by employers.
The nature of deferred compensation is dependent of the nature of program it takes. The re is also consideration of time of establishment of the program and whether the deferred compensation qualifies to be elective or not. Deferral is normally safeguarded under certain strict rules, such conditions include the fact that the deferral compensation targeted should originate from qualified plans. At the same time employee may decide to defer income after earning which should be equivalent to deferred amount. Under qualifies plans the beneficiaries indicated by the employee is subject to no tax based on the existing trust. However the employee is taxed based on the received distributions related to annuities. Such income include ordinary income, non-taxable return on capital based on employee contributions. This makes clear the fact that income is taxed based on received distributions and not contributions. Beneficiaries of both tax-sheltered annuity program and qualified annuity contract are taxed on a similar basis. However, tax-sheltered annuity are established by qualified employers (Moran & Leon, 2006).
Unfunded deferred compensation plan does not reflect participant’s interests. This means that instances of current financial benefit of the participant may not be covered. Such scenario occurs in the event that an agreement is reached to pay deferred compensation in future. Also it bares the participant from having beneficial interest in money and assets transferred from claims of creditors of the person involved in the transfer issue. This means that the employers have no powers to secure deferred compensations for their employees leading to emergence of varying degrees of security and outcomes on diferring federal tax. Meaning that lack of interest in fund provided through deferred compensation on the side of the employee makes the whole process effective. Such only takes place in the scenario where the employer’s creditors rights supersedes that of the employees (Moran & Leon, 2006).
It is impossible for employers to achieve deferral where funding is done through annuity or insurance, especially when interest of employees are expected on the same. Current compensation can as well be realised through other means such as use of surety bonds. Deferral as discussed earlier becomes effective when those concerned declares no interest in the set contract. In cases where eligible employer’ plans are not regarded as valid deferred compensation plan, the deferred compensation is incorporated as part of income within the first year and bears no risk of termination.
Traditional Individual Retirement Account (IRA)
Traditional individual retirement account is known to be tax-advantaged since it provides room for earnings and deductible contributions to increase on a tax deferred basis. In this case federal income taxes are not charged on the earnings as well as from other contributions until withdrawals are made after retirement. One of its benefits is that contributions are deducted from gross income within the year of contribution. There is age limit to which an individual is allowed to contribute to Traditional IRA (Ben-Zion, 1984).
Annual contributions to Traditional IRA reached upto 100% of individual’s earned income. An individual is allowed to contribute total of $ 4000 with married couple contributing a total of $ 8000. Distribution guidelines may be taken from the age of 59 years and any distribution taken before the stated age is normally subject to taxes and the underlined penalties. Individuals are allowed to take specific distributions in form of systematic payments. However, the rate of annual contribution deducted from federal income taxes fully relies on individuals participation in employer sponsored retirement plan as well as the nature of gross income as indicated on the federal income tax return (Ben-Zion, 1984).
Ben-Zion, U. (1984). Recent Literature on the Impact of Taxation and Inflation on Interest Rates. In V. Tanzi (Eds.), Taxation, Inflation, and Interest Rates (pp. 69-99). Washington: International Monetary Fund.
Moran, E. M. & Leon, M.A. (2006). Surprises in Severance Packages: New Deferred Compensation Rules Limit Flexible Arrangements. Employee Relations Law Journal, 31(4), 2-10. Web.
Pope, T.R., Anderson, K. E., & Kramer, J.L. (2012). Prentice Hall’s Federal Taxation. Prentice Hall: Upper Saddle River.