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Irse FileIrse file 2. Irse file Employees' Pay Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Tests for Deducting PayTest 1—Reasonableness Test 2—For Services Performed Kinds of PayAwards Bonuses Education Expenses Fringe Benefits Loans or Advances Property Reimbursements for Business Expenses Sick and Vacation Pay Introduction You can generally deduct the amount you pay your employees for the services they perform. Irse file The pay may be in cash, property, or services. Irse file It may include wages, salaries, bonuses, commissions, or other non-cash compensation such as vacation allowances and fringe benefits. Irse file For information about deducting employment taxes, see chapter 5. Irse file You can claim employment credits, such as the following, if you hire individuals who meet certain requirements. Irse file Empowerment zone employment credit (Form 8844). Irse file Indian employment credit (Form 8845). Irse file Work opportunity credit (Form 5884). Irse file Credit for employer differential wage payments (Form 8932). Irse file Reduce your deduction for employee wages by the amount of employment credits you claim. Irse file For more information about these credits, see the form on which the credit is claimed. Irse file Topics - This chapter discusses: Tests for deducting pay Kinds of pay Useful Items - You may want to see: Publication 15 (Circular E), Employer's Tax Guide 15-A Employer's Supplemental Tax Guide 15-B Employer's Tax Guide to Fringe Benefits See chapter 12 for information about getting publications and forms. Irse file Tests for Deducting Pay To be deductible, your employees' pay must be an ordinary and necessary business expense and you must pay or incur it. Irse file These and other requirements that apply to all business expenses are explained in chapter 1. Irse file In addition, the pay must meet both of the following tests. Irse file Test 1. Irse file It must be reasonable. Irse file Test 2. Irse file It must be for services performed. Irse file The form or method of figuring the pay does not affect its deductibility. Irse file For example, bonuses and commissions based on sales or earnings, and paid under an agreement made before the services were performed, are both deductible. Irse file Test 1—Reasonableness You must be able to prove that the pay is reasonable. Irse file Whether the pay is reasonable depends on the circumstances that existed when you contracted for the services, not those that exist when reasonableness is questioned. Irse file If the pay is excessive, the excess pay is disallowed as a deduction. Irse file Factors to consider. Irse file Determine the reasonableness of pay by the facts and circumstances. Irse file Generally, reasonable pay is the amount that a similar business would pay for the same or similar services. Irse file To determine if pay is reasonable, also consider the following items and any other pertinent facts. Irse file The duties performed by the employee. Irse file The volume of business handled. Irse file The character and amount of responsibility. Irse file The complexities of your business. Irse file The amount of time required. Irse file The cost of living in the locality. Irse file The ability and achievements of the individual employee performing the service. Irse file The pay compared with the gross and net income of the business, as well as with distributions to shareholders if the business is a corporation. Irse file Your policy regarding pay for all your employees. Irse file The history of pay for each employee. Irse file Test 2—For Services Performed You must be able to prove the payment was made for services actually performed. Irse file Employee-shareholder salaries. Irse file If a corporation pays an employee who is also a shareholder a salary that is unreasonably high considering the services actually performed, the excessive part of the salary may be treated as a constructive dividend to the employee-shareholder. Irse file The excessive part of the salary would not be allowed as a salary deduction by the corporation. Irse file For more information on corporate distributions to shareholders, see Publication 542, Corporations. Irse file Kinds of Pay Some of the ways you may provide pay to your employees in addition to regular wages or salaries are discussed next. Irse file For specialized and detailed information on employees' pay and the employment tax treatment of employees' pay, see Publications 15, 15-A, and 15-B. Irse file Awards You can generally deduct amounts you pay to your employees as awards, whether paid in cash or property. Irse file If you give property to an employee as an employee achievement award, your deduction may be limited. Irse file Achievement awards. Irse file An achievement award is an item of tangible personal property that meets all the following requirements. Irse file It is given to an employee for length of service or safety achievement. Irse file It is awarded as part of a meaningful presentation. Irse file It is awarded under conditions and circumstances that do not create a significant likelihood of disguised pay. Irse file Length-of-service award. Irse file An award will qualify as a length-of-service award only if either of the following applies. Irse file The employee receives the award after his or her first 5 years of employment. Irse file The employee did not receive another length-of-service award (other than one of very small value) during the same year or in any of the prior 4 years. Irse file Safety achievement award. Irse file An award for safety achievement will qualify as an achievement award unless one of the following applies. Irse file It is given to a manager, administrator, clerical employee, or other professional employee. Irse file During the tax year, more than 10% of your employees, excluding those listed in (1), have already received a safety achievement award (other than one of very small value). Irse file Deduction limit. Irse file Your deduction for the cost of employee achievement awards given to any one employee during the tax year is limited to the following. Irse file $400 for awards that are not qualified plan awards. Irse file $1,600 for all awards, whether or not qualified plan awards. Irse file A qualified plan award is an achievement award given as part of an established written plan or program that does not favor highly compensated employees as to eligibility or benefits. Irse file A highly compensated employee is an employee who meets either of the following tests. Irse file The employee was a 5% owner at any time during the year or the preceding year. Irse file The employee received more than $115,000 in pay for the preceding year. Irse file You can choose to ignore test (2) if the employee was not also in the top 20% of employees ranked by pay for the preceding year. Irse file An award is not a qualified plan award if the average cost of all the employee achievement awards given during the tax year (that would be qualified plan awards except for this limit) is more than $400. Irse file To figure this average cost, ignore awards of nominal value. Irse file Deduct achievement awards as a nonwage business expense on your return or business schedule. Irse file You may not owe employment taxes on the value of some achievement awards you provide to an employee. Irse file See Publication 15-B. Irse file Bonuses You can generally deduct a bonus paid to an employee if you intended the bonus as additional pay for services, not as a gift, and the services were performed. Irse file However, the total bonuses, salaries, and other pay must be reasonable for the services performed. Irse file If the bonus is paid in property, see Property , later. Irse file Gifts of nominal value. Irse file If, to promote employee goodwill, you distribute food or merchandise of nominal value to your employees at holidays, you can deduct the cost of these items as a nonwage business expense. Irse file Your deduction for de minimis gifts of food or drink are not subject to the 50% deduction limit that generally applies to meals. Irse file For more information on this deduction limit, see Meals and lodging , later. Irse file Education Expenses If you pay or reimburse education expenses for an employee, you can deduct the payments if they are part of a qualified educational assistance program. Irse file Deduct them on the “Employee benefit programs” or other appropriate line of your tax return. Irse file For information on educational assistance programs, see Educational Assistance in section 2 of Publication 15-B. Irse file Fringe Benefits A fringe benefit is a form of pay for the performance of services. Irse file You can generally deduct the cost of fringe benefits. Irse file You may be able to exclude all or part of the value of some fringe benefits from your employees' pay. Irse file You also may not owe employment taxes on the value of the fringe benefits. Irse file See Table 2-1, Special Rules for Various Types of Fringe Benefits, in Publication 15-B for details. Irse file Your deduction for the cost of fringe benefits for activities generally considered entertainment, amusement, or recreation, or for a facility used in connection with such an activity (for example, a company aircraft) for certain officers, directors, and more-than-10% shareholders is limited. Irse file Certain fringe benefits are discussed next. Irse file See Publication 15-B for more details on these and other fringe benefits. Irse file Meals and lodging. Irse file You can usually deduct the cost of furnishing meals and lodging to your employees. Irse file Deduct the cost in whatever category the expense falls. Irse file For example, if you operate a restaurant, deduct the cost of the meals you furnish to employees as part of the cost of goods sold. Irse file If you operate a nursing home, motel, or rental property, deduct the cost of furnishing lodging to an employee as expenses for utilities, linen service, salaries, depreciation, etc. Irse file Deduction limit on meals. Irse file You can generally deduct only 50% of the cost of furnishing meals to your employees. Irse file However, you can deduct the full cost of the following meals. Irse file Meals whose value you include in an employee's wages. Irse file Meals that qualify as a de minimis fringe benefit as discussed in section 2 of Publication 15-B. Irse file This generally includes meals you furnish to employees at your place of business if more than half of these employees are provided the meals for your convenience. Irse file Meals you furnish to your employees at the work site when you operate a restaurant or catering service. Irse file Meals you furnish to your employees as part of the expense of providing recreational or social activities, such as a company picnic. Irse file Meals you are required by federal law to furnish to crew members of certain commercial vessels (or would be required to furnish if the vessels were operated at sea). Irse file This does not include meals you furnish on vessels primarily providing luxury water transportation. Irse file Meals you furnish on an oil or gas platform or drilling rig located offshore or in Alaska. Irse file This includes meals you furnish at a support camp that is near and integral to an oil or gas drilling rig located in Alaska. Irse file Employee benefit programs. Irse file Employee benefit programs include the following. Irse file Accident and health plans. Irse file Adoption assistance. Irse file Cafeteria plans. Irse file Dependent care assistance. Irse file Education assistance. Irse file Life insurance coverage. Irse file Welfare benefit funds. Irse file You can generally deduct amounts you spend on employee benefit programs on the applicable line of your tax return. Irse file For example, if you provide dependent care by operating a dependent care facility for your employees, deduct your costs in whatever categories they fall (utilities, salaries, etc. Irse file ). Irse file Life insurance coverage. Irse file You cannot deduct the cost of life insurance coverage for you, an employee, or any person with a financial interest in your business, if you are directly or indirectly the beneficiary of the policy. Irse file See Regulations section 1. Irse file 264-1 for more information. Irse file Welfare benefit funds. Irse file A welfare benefit fund is a funded plan (or a funded arrangement having the effect of a plan) that provides welfare benefits to your employees, independent contractors, or their beneficiaries. Irse file Welfare benefits are any benefits other than deferred compensation or transfers of restricted property. Irse file Your deduction for contributions to a welfare benefit fund is limited to the fund's qualified cost for the tax year. Irse file If your contributions to the fund are more than its qualified cost, carry the excess over to the next tax year. Irse file Generally, the fund's “qualified cost” is the total of the following amounts, reduced by the after-tax income of the fund. Irse file The cost you would have been able to deduct using the cash method of accounting if you had paid for the benefits directly. Irse file The contributions added to a reserve account that are needed to fund claims incurred but not paid as of the end of the year. Irse file These claims can be for supplemental unemployment benefits, severance pay, or disability, medical, or life insurance benefits. Irse file For more information, see sections 419(c) and 419A of the Internal Revenue Code and the related regulations. Irse file Loans or Advances You generally can deduct as wages an advance you make to an employee for services performed if you do not expect the employee to repay the advance. Irse file However, if the employee performs no services, treat the amount you advanced as a loan. Irse file If the employee does not repay the loan, treat it as income to the employee. Irse file Below-market interest rate loans. Irse file On certain loans you make to an employee or shareholder, you are treated as having received interest income and as having paid compensation or dividends equal to that interest. Irse file See Below-Market Loans in chapter 4. Irse file Property If you transfer property (including your company's stock) to an employee as payment for services, you can generally deduct it as wages. Irse file The amount you can deduct is the property's fair market value on the date of the transfer less any amount the employee paid for the property. Irse file You can claim the deduction only for the tax year in which your employee includes the property's value in income. Irse file Your employee is deemed to have included the value in income if you report it on Form W-2, Wage and Tax Statement, in a timely manner. Irse file You treat the deductible amount as received in exchange for the property, and you must recognize any gain or loss realized on the transfer, unless it is the company's stock transferred as payment for services. Irse file Your gain or loss is the difference between the fair market value of the property and its adjusted basis on the date of transfer. Irse file These rules also apply to property transferred to an independent contractor for services, generally reported on Form 1099-MISC, Miscellaneous Income. Irse file Restricted property. Irse file If the property you transfer for services is subject to restrictions that affect its value, you generally cannot deduct it and do not report gain or loss until it is substantially vested in the recipient. Irse file However, if the recipient pays for the property, you must report any gain at the time of the transfer up to the amount paid. Irse file “Substantially vested” means the property is not subject to a substantial risk of forfeiture. Irse file This means that the recipient is not likely to have to give up his or her rights in the property in the future. Irse file Reimbursements for Business Expenses You can generally deduct the amount you pay or reimburse employees for business expenses incurred for your business. Irse file However, your deduction may be limited. Irse file If you make the payment under an accountable plan, deduct it in the category of the expense paid. Irse file For example, if you pay an employee for travel expenses incurred on your behalf, deduct this payment as a travel expense. Irse file If you make the payment under a nonaccountable plan, deduct it as wages and include it in the employee's Form W-2. Irse file See Reimbursement of Travel, Meals, and Entertainment in chapter 11 for more information about deducting reimbursements and an explanation of accountable and nonaccountable plans. Irse file Sick and Vacation Pay Sick pay. Irse file You can deduct amounts you pay to your employees for sickness and injury, including lump-sum amounts, as wages. Irse file However, your deduction is limited to amounts not compensated by insurance or other means. Irse file Vacation pay. Irse file Vacation pay is an employee benefit. Irse file It includes amounts paid for unused vacation leave. Irse file You can deduct vacation pay only in the tax year in which the employee actually receives it. Irse file This rule applies regardless of whether you use the cash or accrual method of accounting. Irse file Prev Up Next Home More Online Publications
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