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3-3 SECTION 3: TAXABLE AND NONTAXABLE COMPENSATION In general, the Internal Revenue Code (IRC) provides that all compensation an employee receives from an employer, no matter what form it takes, constitutes wages subject to federal income and employment taxes. Such compensation is excluded from wages and exempt from taxation only where the IRC provides a specific exclusion. This section pro- vides an explanation of many different types of compensation an employee may receive beyond cash wages and salary and whether they are classified as taxable wages under the IRC. The methods by which these different types of com- pensation are calculated, taxed, and reported are also discussed so that a clear picture of the rules regarding employee compensation is provided. 3.1 Gross Income and Wages Under the IRC The IRC uses the term “gross income” as the starting point for determining a taxpayer’s federal tax bill, and in §61 it broadly defines the term as including “compensation for services, including fees, commissions, fringe benefits, and sim- ilar items.”1 The individual withholding and employment tax sections of the IRC are also worded broadly, in that they define wages as “all remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.”2 What this means is that wages and benefits (whether they are called fringe benefits or “perks” or something else) are generally included in income and subject to income and employment tax withholding, deposit, and reporting require- ments unless the IRC says otherwise. The Code does not define the term “fringe benefit,” although the Code and the IRS Regulations include several examples of both included and excluded fringe benefits: • Employer-provided cars • Flights on employer-provided aircraft • Free or discounted commercial flights • Vacations • Discounts on property or services • Employer-paid memberships in country clubs or other social clubs • Tickets to entertainment or sporting events • Qualified tuition reductions • Dependent care assistance • No-additional-cost services • Working condition fringes • Qualified transportation fringes • Qualified moving expense reimbursements • De minimis fringes3 3.1-1 Income and Employment Taxes Defined In general, when employee compensation is described as “taxable,” this means: • It is subject to federal income tax and the employer must withhold the tax from the employee’s pay and remit it to the Internal Revenue Service. 1. IRC §61(a)(1). 2. IRC §3121(a) IRC §3306(b) IRC §3401(a). 3. IRS Reg. §1.61-21(a). The Payroll Source®