All the compensation you receive for the work you perform as an employee, whether in the form of wages, salary, tips or other remuneration, must be reported on your annual tax return.  Your employer should send you a Form W-2, Wage and Tax Statement, each year, and the amount reported in box 1 of Form W-2 is your taxable employee compensation for the year.  If you work for more than one employer during the year, you will need to be sure you get a W-2 from each employer and add up the taxable compensation reported on all your W-2s.  If you do not receive a Form W-2, you should contact your employer, but you still have to report the taxable compensation received from that employer on your tax return. 

Types of Employee Compensation

In addition to wages, salaries, and tips, employee compensation includes other amounts such as commissions, bonuses, awards, allowances, and reimbursements.  These amounts should be included in the amount reported in box 1 of your Form W-2, but you should be aware of the taxable employee compensation you have received during the year so that you can properly report it when you file your federal income tax return.  The following are descriptions of some of the components of employee compensation you should take into account.

Allowances and Reimbursements

If your employer pays you an advance, allowance, or reimbursement for travel, transportation, entertainment, or other  expenses, how you report the amount received and the actual expenses incurred will depend on whether the payment was made to you under an accountable plan or non-accountable plan.

Basically, under an accountable plan you must report your actual expenses incurred to your employer, who will in turn reimburse you for the actual amount spent.  In this case, the reimbursement is not included in your compensation and you do not need to report the expenses.

Under a non-accountable plan, you are not required to inform your employer of your actual expenses incurred.  Your employer pays you an allowance and this amount is included in your compensation, in box 1 of your W-2.  You will then need to complete Form 2106 to deduct your business-related travel, transportation and entertainment expenses.

Bonuses and Awards

Performance bonuses and achievement awards, both in monetary form and in the form of goods or services, are included in your taxable employee compensation.  If you receive goods or services, their fair market value must be included in income.  Bonuses and awards are not taxable until you actually receive them or they are available to you.

Employee Achievement Awards

Special tax rules apply to tangible personal property that an employer gives as length-of-service awards or safety achievement awards.  You can exclude the value of these awards up to the amount of their cost to your employer, which cannot be more than $1,600 per year for all the awards you receive.  If the awards are not qualified plan awards, the limit on the amount that can be excluded is $400 per year.  In order to be considered as qualified plan awards, your employer must have an established written plan or program that does not favor highly compensated employees.

The exclusion does not apply for awards of cash or cash equivalents, gift certificates, or intangible property such as vacations, lodging, meals, tickets to cultural or sporting events, or stocks, bonds, or other securities.   

Cost of Living Allowances and Differentials

Cost of living allowances are included in your taxable employee compensation unless you are a federal civilian employee or a federal court employee stationed in Alaska, Hawaii, or outside the United States.  Overseas differentials, which are amounts paid in addition to your base salary or wages as an incentive to take a foreign assignment, for example, are also taxable employee compensation.

Sick Pay

Amounts you receive from your employer for sick pay are included as part of your salary or wages.  This amount is included in box 1 of your W-2.

Any sick pay benefits you receive from any of the following third parties must also be included in your taxable income:

• A welfare fund
• A state sickness or disability fund
• An association of employers or employees
• An insurance company, if your employer paid for the plan

The cost of accident or health insurance coverage paid by your employer is not taxable to you, but the benefits you receive from that insurance may be taxable.

If you receive sick pay benefits from an accident or health insurance policy for which you paid the premiums yourself, the benefits are not taxable.

Stock Appreciation Rights

When, as part of your compensation, your employer grants you a stock appreciation right, you should not include it in your income until you actually exercise the right.  At the time you exercise the right, you will be entitled to a cash payment equal to the fair market value of the corporation’s stock on that date, minus the fair market value of the stock on the date the right was granted.  This cash payment will then be included in your taxable income at that time.

Advance Commissions

Advance commissions and other payments for services to be performed in the future are reported for tax purposes when you receive them, if you are on the cash basis.  If you later have to repay any of the commissions or other advance payments in the same year, you would reduce the amount you report as income.  If you make a repayment in a subsequent tax year, you may be able to claim the repayment as a miscellaneous itemized deduction.  Repayments of up to $3,000 are miscellaneous deductions subject to the 2% of adjusted-gross-income limit (line 22 of Schedule A).  If the amount of the repayment is over $3,000, you can deduct the excess as a miscellaneous deduction not subject to the 2% of adjusted-gross-income limit (line 27 of Schedule A), or you can claim a tax credit.  The credit would be the decrease in your tax for the year you reported the income, had you calculated your tax excluding the income.

Back-Pay

Amounts you are awarded for a settlement or judgment for back pay must be included in your employee compensation in the year you receive them.  These amounts should be included in your W-2 and in addition to back pay, they include damages, unpaid life insurance premiums and unpaid health insurance premiums.

Foreign Employer

If you are a U.S. citizen or resident, you have to report income from all sources, including foreign employers, unless the income is exempt by U.S. law.  If you work outside the U.S. for a U.S. employer, you should receive a W-2.  But if you work for a foreign employer and do not receive a W-2, you still need to include that compensation in the wages, salaries, tips, etc. line of your tax return.  If you reside outside the U.S., you may be able to exclude your foreign earned income up to a certain maximum amount.  You can exclude income earned outside the U.S. by filing Form 2555 – Foreign Earned Income, or the simplified Form 2555-EZ, Foreign Earned Income Exclusion, if you qualify.

Severance Pay

Severance pay, or any lump-sum payment to terminate your employment contract, is taxable and must be included in your income in the year you receive it.

Outplacement Services

If you accept a reduced amount of severance pay so that you can receive outplacement services, you must include the unreduced amount of severance pay in your income.  The value of the outplacement services can be deducted as a miscellaneous deduction (subject to the 2% limit) on Schedule A.

Childcare and Babysitting

If you provide childcare or babysitting services, either in the child’s home, your own home, or in a place of business, the pay you receive is taxable compensation.  If you are not an employee, you are probably self-employed and would have to report your income on Schedule C, Profit or Loss from Business, or Schedule C-EZ, Net Profit from Business.  You may also be subject to self-employment tax if you had net earnings of $400 or more for the year.  In this case, you would also have to file Schedule SE, Self-Employment Tax.

Elective Salary Deferrals

If you are covered by certain kinds of qualified retirement plans, such as a 401(k) plan, you can reduce your income tax for the current year by having part of your salary paid tax-free into the retirement account rather than being paid to you.  While the amount contributed is not subject to federal income tax, it is subject to social security and Medicare taxes.  Your employer reports the deferred amount in box 12 of your W-2 and the "Retirement plan" box 13 should be checked.

Qualified Retirement Plans

Elective deferrals include contributions to the following types of qualified retirement plans:

1. Cash or deferred arrangements (section 401(k) plans).
2. The Thrift Savings Plan for federal employees.
3. Salary reduction simplified employee pension plans (SARSEP).
4. Savings incentive match plans for employees (SIMPLE plans).
5. Tax-sheltered annuity plans (403(b) plans).
6. Section 501(c)(18)(D) plans.
7. Section 457 plans.

Limit on Deferrals

There are annual limits on the amount of salary you can defer under each type of retirement plan.  And there is a limit on your total deferrals to all your retirement plans.  You should not have deferred more than a certain total fixed dollar amount per year to the plans indicated in numbers (1) through (6) above.  This annual limit can be found in the instructions and publications issued by the Internal Revenue Service.  For section 457 plans (number 7 above), the annual limit on the amount you can defer is the lesser of the fixed dollar amount limit that applies for plans 1 through 6, or your includible compensation.  Includible compensation, for purposes of the limit on salary deferrals to a section 457 plan,  is basically all the pay you received from the employer who maintains the plan.

If you are over age 50, you can contribute additional amounts called catch-up deferrals.  And a higher limit may apply for the 3 years before retirement age.  The limits on catch-up deferrals and the higher limits for the last 3 years before retirement are defined according to the type of retirement plan.  You may be able to increase the normal limit by amounts you could have contributed in prior years but did not (the limit for prior years minus your actual deferrals for those years).