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Chapter 6. Wages, Salaries, and Other Earnings

Important Changes

Educational assistance program. The income exclusion for employer-provided
educational assistance is extended through June 30, 1992. Graduate-level
courses can be included as part of an educational assistance program.
See Educational assistance program under Other Fringe Benefits, later.

Group legal services plan. The exclusion from employees' income for
employer-provided group legal services plans is extended through June 30,
1992. See Group legal services plan under Other Fringe Benefits, later.

Introduction

This chapter discusses wages, salaries, fringe benefits, and other
compensation received for services as an employee. The topics include:

∙  Bonuses and awards

∙  Unemployment compensation

∙  Disability income

∙  Special rules for certain employees

∙  Military

The chapter also explains what income is included in the employee's gross
income and what is not included.

Related publications.

This chapter refers to several publications that you may need. For more
information, you may want to order the following:

        Publication 503, Child and Dependent Care Expenses

        Publication 505, Tax Withholding and Estimated Tax

        Publication 525, Taxable and Nontaxable Income

        Publication 917, Business Use of a Car

Employee Compensation

This section explains many types of employee compensation. The subjects are
arranged in alphabetical order followed by Fringe Benefits, Disability Income,
and Pension and Annuity Contributions, which are explained in greater detail.

Advance commissions and other earnings. If you receive advance commissions or
other amounts for services to be performed in the future, and you are a cash
method taxpayer, you must include these amounts in your income in the year
you receive them.

If you repay unearned commissions or other amounts in the same year in
which you received them, reduce the amount to include in your income by the
repayment. However, if you repay the unearned commissions or other amounts
in a later tax year, you can deduct the repayment as an itemized deduction
on your Schedule A (Form 1040), or you may be able to take a credit for that
year. See Repayments in Publication 525.

Back pay awards. Amounts you are awarded in a settlement or judgment for back
pay, including unpaid life insurance premiums and unpaid health insurance
premiums, are included in your gross income. They should be reported to you
by your employer on Form W─2.

Bonuses and awards paid to you for outstanding  work are income shown on your
Form W─2. These include prizes such as vacation trips for meeting sales goals.
If a prize or award is in goods or services, you must include the fair market
value of the goods or services in your income. However, if your employer
merely promises to pay you a bonus or award at some future time, it is not
taxable until you receive it or it is made available to you. If you receive
an award for length of service or safety achievement, see Employee achievement
awards in Chapter 13.

Child-care providers. If you provide child care, either in the child's home or
in your home or other place of business, the pay you receive must be included
in your income. If you provide the care in the child's home, you probably are
an employee. If you provide the care in your home or other place of business,
you may or may not be an employee. You are an employee if you are subject to
the will and control of your employer as to what you are to do and how you
are to do it.

If you are an employee, you should receive a Form W─2, Wage and Tax
Statement, if your pay is subject to social security and Medicare taxes
or would be subject to the withholding of income tax if one exemption
were claimed. Include your pay on line 7 of Form 1040 or Form 1040A,
or on line 1 of Form 1040EZ.

If you are an employee, but do not receive a Form W─2, report your pay as
"other income" on line 22, Form 1040.

If you are not an employee, you are self-employed and must include the
payments you receive on Schedule C (Form 1040), Profit or Loss From Business.
You may be able to use Schedule C-EZ instead of Schedule C. See the
instructions for Schedule C-EZ.

Babysitting. The rules for child-care providers also apply to teenagers who
periodically babysit for relatives or neighborhood children. These teenagers
are normally employees whose pay is below the amount that would require
withholding tax or the issuance of a Form W─2. If this pay, when added to any
earnings, is more than the standard deduction ($3,600 for 1992), a tax return
may have to be filed. If the teenager received unearned income (such as
interest on a savings account), that when combined with the babysitting pay
totals more than $600, a tax return may have to be filed. See Publication 501,
Exemptions, Standard Deduction, and Filing Information, for more information
on when a return must be filed.

Christmas gifts. If your employer gives you a turkey, ham, or other item of
nominal value at Christmas or other holidays, the value of the gift is not
income. However, if your employer gives you cash, a gift certificate, or
similar item that you can easily exchange for cash, the value of the gift
is extra salary or wages regardless of the amount involved.

Government cost-of-living allowances are generally not included in the
income of federal civilian employees, including federal court employees
stationed in Alaska, Hawaii, or outside the 48 contiguous states or the
District of Columbia.

Allowances and differentials that increase your basic pay as an incentive for
taking a less desirable post of duty are part of your compensation and must
be included in your income. For example, your compensation includes Foreign
Post, Foreign Service, and Overseas Tropical salary differentials. For
more information, get Publication 516, Tax Information for U.S. Government
Civilian Employees Stationed Abroad.

Interview expenses. If an employer asks you to appear for an interview and
pays you an allowance, or reimburses you for your transportation and other
travel expenses, you include in your income on line 22, Form 1040, only the
amount you receive that is more than your actual expenses.

Moving expense allowances or reimbursements are included in your salary
or wages for the tax year in which you receive them. See How to Report in
Chapter 27.

Property purchased from employer. If your employer allows you to buy property
below its fair market value as compensation for your services, you must
include in your income as wages the difference between the property's fair
market value and the amount you paid for it.

Property received for services. If you receive property for your services,
you generally must include its value in your gross income as wages. Property
for services includes shares of corporate stock you receive from your
employer. You must include the fair market value of this property in the year
you receive it. However, you may not have to include the value of the property
in your income in the year received, if the property is both nontransferrable
and subject to a substantial risk of forfeiture. For details, see Restricted
Property Received for Services in Publication 525.

Dividends you receive on restricted stock are extra compensation to you.
Restricted stock is stock you received from your employer and did not include
in your income because it was nontransferrable and subject to forfeiture.
Your employer should include these payments on your Form W─2.

Dividends you receive on stock you chose to include in your income in the
year transferred are treated the same as any other dividends. Report them
on line 9, Form 1040. For a discussion of dividends, see Chapter 9.

Get Publication 525 for information on how to treat dividends reported on
both your Form W─2 and Form 1099─DIV.

Severance pay is taxable. A lump-sum payment for cancellation of your
employment contract is income in the tax year you receive it and must be
reported with your other salaries and wages.

Accrued leave payment. If you are a federal employee and receive a lump-sum
payment for accrued annual leave when you retire or resign, this amount will
be included on your Form W─2.

If you resign from one agency and are reemployed by another agency, you may
have to repay part of your lump-sum annual leave payment to the second agency.
You can reduce gross wages by the amount you repaid in the same tax year in
which you received it. You should attach to your tax return a copy of the
receipt or statement furnished by the agency to which repayment is made to
explain the difference between the wages on the return and the wages on your
Forms W─2.

Sick pay. Amounts you receive from your employer while you are sick or
injured are part of your salary or wages. Report the amount you receive
on line 7, Form 1040; line 7, Form 1040A; or line 1, Form 1040EZ. You
must include in your income payments made by any of the following:

1)  Your employer.

2)  A welfare fund.

3)  A state sickness or disability fund.

4)  An association of employers or employees.

5)  An insurance company, if your employer paid for the plan.

However, if you paid the premiums on an accident or health insurance policy,
the benefits you receive under the policy are not taxable.

Railroad sick pay. If you receive sick pay under the Railroad Unemployment
Insurance Act, these payments are taxable and you must include them in your
income. However, you do not have to include them in your income to the
extent they are for an on-the-job injury.

If you received income because of a disability, see Disability Income, later.

Social security and Medicare taxes paid by employer. If you and your employer
have an agreement that your employer pays your social security and Medicare
taxes without deducting them from your gross wages, you must report the amount
of tax paid for you as taxable wages on your tax return. You must also treat
the payments as wages for figuring your social security and Medicare taxes and
your social security and Medicare benefits. However, these payments are not
treated as social security and Medicare wages if you are a household worker
or a farmworker.

Stock appreciation rights. If your employer grants you a stock appreciation
right, do not include it in your income until you exercise the right. When
you exercise (use) the right, you are entitled to a cash payment equal to the
amount by which the fair market value of the corporation's stock on the date
of exercise has increased over the fair market value on the date the right was
granted. You include the cash payment in your income in the year you exercise
the right.

Stock options. You usually have taxable income when you receive or exercise
a nonstatutory option to buy stock (or other property) as payment for
your services. However, if your option is a statutory stock option - an
incentive stock option or an option granted under an employee stock purchase
plan - special rules generally delay the tax until you sell or exchange your
shares of stock. For details, get Publication 525.

Unemployment compensation. You must include in your income all unemployment
compensation you receive. You may be liable for estimated tax if you receive
unemployment compensation. For more information on estimated tax, get
Publication 505.

Types of unemployment compensation. Unemployment compensation generally
includes any amount received under an unemployment compensation law of the
United States or of a state. It includes:

1)  Benefits paid by a state or the District of Columbia from the Federal
    Unemployment Trust Fund.

2)  Unemployment insurance benefits.

3)  Railroad unemployment compensation benefits.

4)  Disability payments from a government program paid as a substitute for
    unemployment compensation (amounts received as workers' compensation
    for injuries or illness are not unemployment compensation).

5)  Trade readjustment allowances under the Trade Act of 1974.

6)  Benefits under the Airline Deregulation Act of 1978.

7)  Unemployment assistance under the Disaster Relief Act Amendments of 1974.

If you contribute to a governmental unemployment compensation program,
and your contributions are not deductible, amounts you receive under the
program are not included as unemployment compensation until you recover
your contributions.

Supplemental unemployment benefits received from a company-financed fund
(to which the employees did not contribute) are not unemployment compensation.
They are taxable as wages subject to income tax withholding but not subject
to social security, Medicare, or federal unemployment taxes.

You may have to repay some of your supplemental unemployment benefits to
qualify for trade readjustment allowances under the Trade Act of 1974. If
you repay supplemental unemployment benefits in the same year you receive them,
reduce the total benefits by the amount you repay. However, if you repay the
benefits in a later year, you must include the full amount of the benefits you
received in your income for the year you received them.

Deduct the repayment in the later year as an adjustment to gross income.
Include the repayment on line 30, Form 1040, and put "Sub-pay TRA" and the
amount on the dotted line next to line 30. If the amount you repay in a
later year is more than $3,000, you may be able to take a credit against
your tax for the later year instead of deducting the amount repaid. For more
information on this, see the discussion on Repayments in Publication 525.

Private unemployment fund. Unemployment benefit payments from a private
fund to which you voluntarily contribute are taxable only if the amounts you
receive are more than your total payments into the fund. Report the taxable
amount on line 22, Form 1040.

Payments by a union. Benefits paid to you as an unemployed member of a union
out of regular union dues are included in your gross income on line 22, Form
1040.

Guaranteed annual wage. Payments you receive from your employer during periods
of unemployment, under a union agreement that guarantees you full pay during
the year, are taxable as wages.

State employees. Payments can be made by a state to its employees who are
not covered by the state's unemployment compensation law. If the payments
are similar to benefits under that law, they are fully taxable. Report
these payments on line 22, Form 1040.

Fraudulently obtained unemployment compensation is fully taxable and you
report it on line 22, Form 1040.

Repayment of unemployment compensation benefits. If you repaid in 1992
unemployment compensation benefits you received in 1992, subtract the amount
you repaid from the total amount you received and enter the difference on line
20, Form 1040, or on line 12, Form 1040A. Write "Repayment" and the amount you
repaid on the dotted line next to line 20 or next to line 12. If you repaid in
1992 benefits you included in your income in an earlier year, see Repayments
in Chapter 13.

Union benefits and dues. Amounts deducted from your pay for union dues,
assessments, contributions, or other payments to a union cannot be excluded
from your salary or wages. You must include them in your income as wages.

You may be able to deduct some of these payments as a miscellaneous deduction
subject to the 2% limit if they are related to your job and if you itemize
your deductions on Schedule A (Form 1040). You may deduct them whether you
paid them directly to the union or had them deducted from your pay. See Union
Dues and Expenses in Chapter 30.

Strike and lockout benefits paid to you by a union from union dues, including
both cash and the fair market value of other property, are usually included
in your income as wages. You can exclude these benefits from your income
only when the facts show that the union intended them as gifts to you.

Withholding. Amounts withheld from your pay for income tax, social security
tax, Medicare tax, or savings bonds are considered received by you. They will
be included in your wages on Form W─2. The same generally is true of amounts
withheld for taxable fringe benefits, pensions, insurance, union dues, and
other assessments. For more information on withholding, get Publication 505.

If your employer uses your wages to pay your debts, or if your wages are
attached or garnisheed, the full amount is considered received by you.
Also included in your wages are fines or penalties withheld from your pay.

Fringe Benefits

The value of fringe benefits you receive from your employer is taxable and
must be included in your income as compensation, unless the benefits are
specifically excluded by law or you pay fair market value for them.

Some of the benefits you must report in your income include your personal use
of an employer-provided car or aircraft or a membership in a country club. For
more information about fringe benefits, get Publication 525.

Certain fringe benefits you receive are specifically excluded by law. These
include:

1)  No-additional-cost service.

2)  Qualified employee discount.

3)  Working condition fringe benefit.

4)  De minimis (minimal) fringe benefit.

No-Additional-Cost Service

If your employer provides you with a service offered for sale to customers
in the ordinary course of your employer's line of business in which you work,
and your employer does not incur any substantial additional cost in providing
this service to you, you will not have to include in your income the value of
the service. Examples of no-additional-cost services are free, or reduced
-price, stand-by flights for airline employees, and free telephone service to
telephone company employees.

Non-excess capacity services are not eligible for exclusion as no-additional
-cost services. For example, an employee's use of a stock brokerage firm to
buy stock, or a mutual fund to buy an interest in the mutual fund, does not
qualify. However, non-excess capacity services can be considered a qualified
employee discount, discussed later.

Reciprocal agreements. You can exclude a no-additional-cost service provided
by a different employer who has a written reciprocal agreement with your
employer if all of the following conditions are met:

∙  The agreement states that employees of each employer who perform
   substantial services in the same line of business can receive
   no-additional-cost services from the other employer.

∙  The service provided to the employees is the same type provided to
   customers in the same line of business in which the employees perform
   substantial services.

∙  Neither employer incurs a substantial additional cost in providing the
   service to the other's employees. If one employer pays a substantial
   amount to the other in connection with the agreement, that employer has
   incurred a substantial additional cost.

Recipient of services. The value of these no-additional-cost services will
not have to be included in your income if the services are offered to:

1)  Any individual who is currently employed by the employer in the line of
    business,

2)  A retired or disabled employee who was formerly employed in the line of
    business,

3)  A surviving spouse of an employee who died while employed in the line of
    business or a surviving spouse of a former employee who could no longer
    work because of retirement or disability,

4)  A spouse or dependent child of an employee (including a child whose
    parents have died and who has not reached age 25), or

5)  Any partner who performs services for the partnership.

For purposes of item (4) above, a child of divorced parents is treated as
a dependent of both parents, if the child can be claimed as a dependent by
either parent. In addition, any use of air transportation by the parent of
an employee of an airline or airline affiliate will be treated as use by
the employee. This does not include the parent of a surviving spouse of
a deceased, retired, or disabled employee.

Note. If these services are generally available only to highly compensated
employees, then the value of the services cannot be excluded from the
income of the highly compensated employees.

Qualified Employee Discount

If your employer allows you to buy qualified property or services (defined
below) at a discount (a price that is less than the price for which it is
sold to customers), you do not have to include in your income the value of
the discount if:

1)  The discount you get on property is not more than the gross profit
    percentage of the price at which the property is offered for sale to
    customers, or

2)  The discount you get on services is not more than 20% of the price at
    which the services are offered for sale to customers.

The value of these qualified employee discounts also does not have to be
included in your income if the discounts are offered to a spouse, a dependent
child, a former employee (if retired or disabled), or to a surviving spouse or
dependent child (if both parents are deceased, the child must be under age 25)
of an employee or former employee who is retired or disabled.

For purposes of these discounts, if your employer leases space in a department
store, you will be treated as an employee of the department store.

Qualified property or services generally means any property (other than real
property and personal property held for investment) or services offered for
sale to customers in the ordinary course of your employer's line of business
in which you work.

Note. If these discounts are generally available only to highly compensated
employees, the value of the discount cannot be excluded from the income of
the highly compensated employees.

Working Condition Fringe Benefit

You will not have to include in your income the value of property or services
provided to you by your employer if you would be allowed to take a business
deduction for them had you paid for them. Examples of working condition fringe
benefits are the business use of a company car and subscriptions to business
periodicals provided to you by your employer.

Parking. You do not have to include in your income the value of free parking
facilities provided to you on or near your employer's business premises.

Demonstration car. If you are a full-time car salesperson and you are provided
a demonstration car to use in the sales area of your car dealer's sales
office, you will not have to include in your income the value of the car if:

1)  The car is provided mainly so you can help your employer,

2)  There are substantial restrictions on your personal use of the car,

3)  The car is currently in the inventory of the automobile dealership, and

4)  The car is available for test drives by customers during your normal
    business hours.

De Minimis (Minimal) Fringe Benefit

You do not have to include in your income a fringe benefit so small in value
(after taking into account how frequently similar benefits are provided) that
it would be unreasonable or administratively impractical for your employer
to account for it. Examples of minimal fringe benefits are occasional typing
of personal letters by a company secretary, occasional personal use of your
employer's copying machine, occasional parties for employees, occasional
tickets to the theater or sporting events, discount transit passes not over
$21 a month, and occasional meal money or taxi fares if you work overtime.

Occasional meal money or local transportation fare. You do not have to include
in your income meals, meal money or local transportation fare provided to you,
if the benefit is reasonable and meets three conditions:

1)  The benefit is only provided to you occasionally,

2)  The benefit is provided because overtime work required you to extend your
    normal working hours, and

3)  In the case of meals or meal money, the benefit is provided to enable you
    to work overtime.

Example. Meg is an accountant who routinely works beyond normal business
hours. Each time she works late, her employer pays a car service to take
her home. Because Meg's employer frequently provides local transportation
to her, the value of these benefits must be included in her income.

Certain eating facilities. If your employer operates an eating facility on
or near the business premises for the benefit of employees, you will not have
to include in your income the difference between the cost of the meals and
their fair market value. In order to qualify as a de minimis fringe benefit,
the yearly income from the facility must equal or be more than the cost of
operating the facility, and the facility must be available to all employees
and not primarily for the benefit of highly paid employees.

If the exclusion for meals at an employer-provided eating facility is not
available, you must include in your income the difference between the value of
the meals and the amount you pay for them. However, you may be able to exclude
the value of meals your employer provides to you for his convenience if
certain conditions are met. See Meals and Lodging, later.

On-Premises Athletic Facilities

If your employer operates a gym or other athletic facility located on the
business premises, you do not have to include in your income the value of
this fringe benefit. To qualify, substantially all the use of this facility
must generally be by employees, spouses, and dependent children.

Group Life Insurance Premiums

Group-permanent life insurance premiums paid by your employer for you are
ordinary income to you and must be reported as part of your wages.

Bought for employees. Generally, the cost of up to $50,000 of group-term
life insurance coverage that is provided to you by your employer is not
included in your income. You must include in your income the cost of insurance
that is more than the cost of $50,000 of insurance, reduced by the amount you
pay towards the purchase of the insurance.

Form W─2. The amount included in your income is reported as part of your wages
on Form W─2 and is shown separately on the form. If you paid any part of the
cost of the insurance and the payment qualifies to reduce the amount otherwise
included in your income, the reduced amount would be shown on Form W─2. See If
you pay any part, later.

Retired employees must generally include in income the cost of payments
for insurance coverage that is more than $50,000. However, certain retired
employees do not have to include these amounts in income. For more
information, get Publication 525.

Group-term life insurance is term life insurance protection (insurance for a
fixed period of time) that:

1)  Provides a general death benefit that is excluded from income,

2)  Is provided to a group of employees,

3)  Is provided under a policy carried by the employer, and

4)  Provides an amount of insurance for each employee based on a formula that
    prevents individual selection.

If you pay any part of the cost of the insurance, your entire payment reduces,
dollar for dollar, the amount your employer would otherwise include in your
income. However, you cannot reduce the amount to include in your income by:

1)  Payments for coverage in a different tax year, or

2)  Payments not taxed to you because of the exceptions discussed below.

Permanent benefits. If your group-term life insurance policy includes
permanent benefits, such as a paid-up or cash surrender value, you must
include in your income, as wages, the cost of the permanent benefits,
reduced by the amount you pay for them. Your employer should be able to
tell you the amount to include in your income.

Accidental or other death benefits in policies that do not provide general
death benefits (travel insurance, for example) are not included as group-term
life insurance coverage.

Exceptions. You are not taxed on the cost of group-term life insurance if any
of the following apply:

1)  You are disabled and have ended your employment;

2)  Your employer is the beneficiary of the policy for the entire period the
    insurance is in force during the tax year; and

3)  The only beneficiary is a qualified charitable organization (defined in
    Chapter 25) for the entire period the insurance is in force during
    the tax year. You are not entitled to a deduction for a charitable
    contribution by naming a charitable organization as the beneficiary
    of your policy.

You are taxed on the entire cost of group-term life insurance protection
provided by your employer through a qualified employees' trust, such as
a pension trust or a qualified annuity plan.

You are also taxed on the entire cost of the group-term life insurance
coverage if you are a key employee and your employer's plan discriminates
in favor of key employees.

Full-time life insurance agents who are considered employees for social
security and Medicare tax withholding purposes are treated as employees in
applying the provisions relating to group-term life insurance under a policy
carried by their employer.

If you have only one employer and you were insured at any time during the
tax year for more than $50,000 under a group-term life insurance policy, your
income from this source is shown as other compensation on the Form W─2 you
receive.

If two or more employers provide you group-term life insurance coverage
totaling more than $50,000, you must figure how much to include in your income
for the cost of all coverage that is more than $50,000. You must include the
cost of life insurance provided to you during the tax year, regardless of when
your employers paid the premiums.

You figure the cost for each month of coverage by multiplying the number of
thousands of dollars of insurance coverage, less $50,000 of insurance (both
figured to the nearest tenth), by the cost from the following table. You
must prorate the cost if less than a full month of coverage is involved.

                  COST PER $1,000 OF PROTECTION
                          FOR ONE MONTH
         Age                                          Cost
     Under 30 ....................................   8 cents
     30 through 34 ...............................   9 cents
     35 through 39 ...............................  11 cents
     40 through 44 ...............................  17 cents
     45 through 49 ...............................  29 cents
     50 through 54 ...............................  48 cents
     55 through 59 ...............................  75 cents
     60 through 64 ...............................  $1.17
     65 through 69 ...............................  $2.10
     70 and older ................................  $3.76

Example. You are 51 years old and work for Employers A and B. Both employers
provide group-term life insurance coverage for you. Your coverage with
Employer A is $35,000, and your coverage with Employer B is $45,000. You pay
premiums of $50 a year under the Employer B group plan. You figure the amount
to include in your income as follows:

     Employer A coverage (in thousands) ............  $     35
     Employer B coverage (in thousands) ............        45
                                                     __________
     Total coverage (in thousands) .................  $     80
     Minus: Exclusion (in thousands) ...............        50
                                                     __________
     Excess amount (in thousands) ..................  $     30
     Multiply by cost per $1,000 per month,
     age 51 (from table) ...........................       .48
                                                     __________
     Cost of excess insurance for 1 month ..........    $14.40
     Multiply by number of full months coverage
     at this cost ..................................        12
                                                     __________
     Cost of excess insurance for tax year .........   $172.80
     Minus: Premiums you paid ......................     50.00
                                                     __________
     Cost to include in your income as wages ...       $122.80
                                                     ==========

For information on employer payments for group-term life insurance,
get Publication 535, Business Expenses.

Meals and Lodging

You do not include in your income the value of meals and lodging provided to
you and your family by your employer at no charge if the following conditions
are met:

1)  The meals are:

    a)  Furnished on the business premises of your employer, and

    b)  Furnished for the convenience of your employer.

2)  The lodging is:

    a)  Furnished on the business premises of your employer,

    b)  Furnished for the convenience of your employer, and

    c)  You are required to accept the lodging as a condition of your
        employment.

Your family, for this purpose, includes only your spouse and dependents.

Lodging includes the cost of heat, electricity, gas, water, sewer service,
and similar items that are needed to make the lodging habitable.

Meals. Generally, you can exclude from your income the value of meals provided
to you during working hours so that you can be available for emergency calls,
or because your employer's business restricts you to a short meal period (30
to 45 minutes). For more details on meals and lodging, get Publication 525.

Faculty housing. If you are employed by an educational institution and you (or
your spouse and dependents) are provided qualified campus lodging for use as a
residence, you must include in your income the excess of the fair rental value
over the amount of rent you pay. Get Publication 525 for more information.

Other Fringe Benefits

Other fringe benefits you receive may be excluded from your income.

Cafeteria plans. Cafeteria plans are separate written plans that allow
participants (who must be employees) to choose among two or more benefits
consisting of cash and qualified benefits. A "qualified benefit" includes any
benefit that is not currently taxable to the participant upon receipt (such as
group-term life insurance up to $50,000, coverage under an accident or health
plan, and coverage under a dependent-care assistance program).

The only taxable benefit that a cafeteria plan can offer is cash. Any
qualified (nontaxable) benefit can be used in a cafeteria plan, other
than scholarship and fellowship grants, educational assistance programs,
and the fringe benefits (other than Meals and Lodging) previously discussed.
Nontaxable benefits include group-term life insurance that is included in
gross income only because the amount of the cost of the insurance is more than
$50,000 or the insurance is on the life of the employee's spouse or children.

A participant is not considered to have received a taxable benefit from a
cafeteria plan simply because the participant can choose among the benefits
of the plan.

Nondiscrimination rules. A cafeteria plan cannot discriminate in favor of
highly compensated participants as to eligibility to participate in the plan
or as to contributions or benefits. If the plan does discriminate, highly
compensated participants must include in their income the value of the
benefits that could have been elected.

If qualified benefits provided to key employees are more than 25% of the
total of these benefits provided for all employees under the plan, key
employees must include in their income the value of the benefits that could
have been elected.

The taxable benefits are treated as having been received or accrued in the
tax year of the highly compensated participant or key employee in which the
plan year ends.

Dependent care assistance. If your employer provided you with child care or
disabled dependent care services to allow you to work, you can exclude (within
certain limits) the amount of this benefit. The amount you can exclude is
limited to the smaller of your earned income, your spouse's earned income,
or $5,000 ($2,500 if you are married filing a separate return). To exclude
this benefit from your income (and include any amount that exceeds the limit),
see How to report, later.

Note. Overnight camp expenses paid by your employer from a qualified plan
cannot be excluded as dependent care assistance. Also, the amount you can
exclude from your income reduces the dollar limit on work-related expenses
you can use to figure your child and dependent care credit. For more
information, get Publication 503.

For purposes of the earned income limit, if your spouse is a full-time student
or incapable of self-care, your spouse will be considered to have earned $200
a month if you receive care for one dependent, or $400 a month if you receive
care for two or more dependents.

If your dependent is cared for at your employer's place of business, the
amount you can exclude from income is based on how often you use the
facility and the value of the services.

The dependent care assistance must be provided under a separate written plan
of your employer that does not favor highly compensated employees and that
meets other qualifications. Your employer can tell you if the plan qualifies
for the exclusion.

How to report. To exclude the correct amount of dependent care benefits you
received and include in your income any taxable part of the benefits, complete
and attach to your return the appropriate form for Child and Dependent Care
Expenses. Attach Form 2441 to Form 1040 or Schedule 2 to Form 1040A. Do not
file Form 1040EZ to report dependent care amounts.

When you complete the child and dependent care expenses form, be sure to
give the dependent care provider's name, address, and identification number.

Educational assistance. You generally must include in your income, as wages,
any amount your employer paid for educational expenses for you.

Exception. If the educational courses are required by your employer or are
job-related, and your employer either pays the expenses directly to the
educational organization or reimburses you for the expenses after you make
a full accounting, you may not have to include in your income the amount paid
by your employer.

In other cases, you may be able to deduct the expenses under the rules
explained in Chapter 29. You must include in your income stipends paid
by your employer when you are on educational leave.

Educational assistance program. Your employer should have excluded the first
$5,250 of any qualified educational assistance that your employer paid for
you through June 30, 1992. This exclusion does not apply to educational
assistance paid for you after June 30, 1992.

Beginning in 1991, graduate-level courses can be included as part of an
educational assistance program.

Qualified tuition reductions. If you receive a qualified tuition reduction
(QTR), it is not included in your income. A QTR is the amount of reduction in
tuition for education (below the graduate level) furnished by an educational
institution to an employee (or a person treated as an employee or certain
other individuals) provided certain requirements are met. See Qualified
tuition reductions under Scholarship and Fellowship Grants in Chapter 13.

Employer-provided transportation. The value of employer-provided
transportation, such as a vanpool or similar shared-usage arrangement,
must be included in the gross income of each employee, including the
driver, who commutes in the employer-provided vehicle.

Executive health program. Amounts an employer pays for a fitness program
provided to one of its executives at an off-site resort hotel or athletic
club are included in the executive's compensation.

Financial counseling fees paid by a corporation for its executives are
included in the executives' gross incomes and must be reported as part of
their wages. If the fees are for tax or investment counseling, they can
be deducted by the executive as a miscellaneous deduction subject to the
2%-of-adjusted-gross-income limit on Schedule A (Form 1040).

Group legal services plan. Your employer may have excluded up to $70 of the
amount that your employer paid for your coverage under a qualified group legal
services plan. This exclusion is no longer available after June 30, 1992.
After that date, the value of any coverage that your employer paid for on your
behalf must be included in your income.

Medical insurance premiums paid for you, your spouse, and your dependents by
your employer (former employer if you are retired) under an accident or health
plan are not included in your income. This includes supplemental medical
insurance (Medicare). You continue to be an employee during a layoff period
for purposes of this benefit.

If your employer reimburses you for health insurance premiums after you verify
that you paid the premiums, the reimbursement is not included in your income.
Premiums paid by an employer for the benefit of a deceased employee's
surviving spouse and dependents are also not included in income.

How To Report Fringe Benefits

The amount of your taxable fringe benefits is shown on your Form W─2.

Employer-provided car. If your employer provides a car (or other highway motor
vehicle) to you, your personal use of the car is a taxable noncash fringe
benefit.

Your employer must determine the actual value of this fringe benefit to
include in your income. Your employer determines this value by either of
the following methods:

1)  The actual value of your personal use of the car, or

2)  The actual value of the car as if you used it entirely for personal
    purposes (100% income inclusion).

If your employer includes 100% of the value in your income, you may deduct the
value of your business use of the car as long as you itemize your deductions.
You figure the value of this business use on Form 2106, Employee Business
Expenses. For more information, get Publication 917, Business Use of a Car.

Accounting period. You must use the same accounting period your employer uses
to report your taxable fringe benefits. Your employer has the option to report
taxable fringe benefits by using either of the following rules:

1)  The general rule: value the benefit for a full calendar year (January
    1─December 31), or

2)  The special accounting period rule: treat the value of benefits provided
    during the last two months of the calendar year (or any shorter period)
    as paid during the following calendar year.

    a)  Under this rule, each year your employer includes the value of
        benefits provided the last 2 months of the prior year and the first
        10 months of the current year.

    b)  If your employer uses this rule to determine the amount to include
        in your income, you must use the same accounting period to claim an
        employee business deduction (for use of a car, for example).

Your employer does not have to use the same accounting period for each
fringe benefit, but is required to use the same period for all employees who
receive a particular benefit. For more information, get Publication 917 and
Publication 525.

Form W─2. Your employer reports your taxable fringe benefits in Box 10 (Wages,
tips, other compensation) and, if applicable, Box 12 (Social security wages)
and Box 14 (Medicare wages) of Form W─2, Wage and Tax Statement. The total
value of your fringe benefits should also be shown in Box 23. The value of
your fringe benefits may be added to your other compensation on one Form W─2,
or you may receive a separate Form W─2 showing just the value of your fringe
benefits in Box 10 with a notation in Box 23.

Disability Income

Generally, if you retire on disability you must report your pension or annuity
as income. There is a tax credit for people who are permanently and totally
disabled. For information on this credit and the definition of permanent and
total disability, see Chapter 34.

Disability pensions. Generally, you must report as income any amount you
receive for your disability through an accident or health insurance plan paid
for by your employer. If both you and your employer pay for the plan, only the
amount you receive for your disability that is due to your employer's payments
is reported as income. However, certain payments may not be taxable. Your
employer should be able to give you specific details about your pension plan
and tell you the amount you paid for your disability pension. In addition to
disability pensions and annuities, you may be receiving other payments for
sickness and injury. See Other Sickness and Injury Benefits in Chapter 13.

If you pay the entire cost of a health or accident insurance plan, do not
include any amounts you receive for your disability as income on your tax
return. If your plan reimbursed you for medical expenses you deducted in an
earlier year, you may have to include some, or all, of the reimbursement
in your income. See Reimbursement in a later year in Chapter 22.

Accrued leave payment. If you retire on disability, any lump-sum payment
you receive for accrued annual leave is a salary payment. The payment is not
a disability payment. You must report it as wages in the tax year you receive
it.

Retirement and profit-sharing plans. Any payments you receive from a
retirement or profit-sharing plan that does not provide for disability
retirement are not payments from an accident or health plan. Therefore, do
not report them as disability income. The payments are taxable and should be
reported as a pension or annuity. See Disability Income in Chapter 11.

Military disability pensions. Generally, you must report these disability
pensions as income. But certain military and government disability pensions
are not taxable. For more information, see Military and Certain Government
Disability Pensions in Chapter 11.

How to report. If you retired on disability, payments you receive are taxed as
wages until you reach minimum retirement age. Minimum retirement age generally
is the age at which you can first receive a pension or annuity were you not
disabled. You must report your taxable disability payments on line 7, Form
1040, or on line 7, Form 1040A, until you reach minimum retirement age.

Beginning on the day after you reach minimum retirement age, payments you
receive are taxable as a pension. Report the payments on line 17, Form 1040,
or on line 11, Form 1040A. The rules for reporting pensions are explained
in How to Report in Chapter 11.

Pension and Annuity Contributions

Generally, you cannot exclude from income amounts you pay into a pension plan
through payroll deductions.

Contributions to Federal Thrift Savings Fund. Federal employees can choose to
make contributions, from their salaries, to the Federal Thrift Savings Fund.
Contributions are not included in income. Your salary before contributions
are taken out is used for purposes of social security and Medicare taxes
and benefits. Payments from the fund are taxable as a distribution from a
qualified pension or annuity plan.

Employer's contributions to qualified plan. Generally, your employer's
contributions to a qualified pension plan for you are not included in income
at the time contributed. However, employer contributions that are made out
of funds that would otherwise have been paid to you as salary, except that
you entered into a salary reduction agreement with your employer (elective
deferral), are excluded from income only up to a limit.

For 1992, you cannot set aside more than a total of $8,728 for all elective
deferrals. If you set aside more than $8,728, the excess is included in your
gross income that year. Contributions to tax-sheltered annuities are subject
to a higher limit. Get Publication 571, Tax-Sheltered Annuity Programs for
Employees of Public Schools and Certain Tax-Exempt Organizations, for more
information.

The cost of life insurance coverage included in an employer's plan may be
income if the proceeds of the policy are payable directly or indirectly to
your beneficiary. See Group Life Insurance Premiums, earlier, under Fringe
Benefits.

Amounts actually distributed or made available to you generally are
taxable, unless they are eligible for a tax-free rollover and are rolled
over (normally, within 60 days after receipt) to another qualified plan or to
an individual retirement account or annuity. Your employer can tell you how
the amount you received is taxed. See Chapters 11 and 18.

Employer's contributions to nonqualified plan. If your employer pays into
a nonqualified plan for you, you generally must include the contributions
in your income as wages for the tax year in which the contributions are made.
Report this income on line 7 of Form 1040 or Form 1040A, or on line 1 of Form
1040EZ. However, if your interest is not transferrable and is subject to a
substantial risk of forfeiture (you have a good chance of losing it), you need
not include the amount of the contribution or premium in your income. When
your interest becomes transferrable or is no longer subject to a substantial
risk of forfeiture, you must include the value in your income.

Railroad retirement annuities. If you received railroad retirement tier 1
benefits that are more than the "social security equivalent benefit," or tier
2 or vested dual benefits, these payments are treated as pension or annuity
income and are taxable under the rules explained in Chapter 11.

Special Rules for Certain Employees

This section deals with special rules for people in certain types of
employment. It includes members of the clergy, people working for foreign
employers, military personnel, veterans, ACTION and Peace Corps volunteers,
and statutory employees.

Clergy

If you are a member of the clergy, you must include in your income offerings
and fees you receive for marriages, baptisms, funerals, masses, etc., in
addition to your salary. If the offering is made to the religious institution,
it is not taxable to you.

If you are a member of a religious organization and you give your outside
earnings to the organization, you still must include the earnings in your
income. However, you may be entitled to a charitable contribution deduction
for the amount paid to the organization.

Rental value of a home. You do not have to include in your income the rental
value of a home (or utility expenses) provided to you as part of your pay for
your duties as an ordained, licensed, or commissioned minister. However, you
must include the rental value of the home, and related allowances, as earnings
from self-employment on Schedule SE (Form 1040) for purposes of the social
security self-employment tax.

A housing allowance paid to you as part of your salary is not income to the
extent you use it, in the year received, to provide a home or to pay utilities
for a home with which you are provided. The amount of the housing allowance
that you can exclude from your income cannot be more than the reasonable
compensation for your services as a minister. The church or organization
that employs you must officially designate the payment as a housing allowance
before the payment is made. A definite amount must be designated; the
amount of the housing allowance cannot be determined at a later date.

If you are employed and paid by a local congregation, a resolution by a
national church agency of your denomination does not effectively designate a
housing allowance for you. The local congregation must officially designate
the part of your salary that is to be a housing allowance. However, a
resolution of a national church agency can designate your housing allowance
if you are directly employed by the agency. If no part has been officially
designated, you must include your total salary in your income.

Expenses of providing a home include rent, house payments, furniture payments,
costs for a garage, and utilities. They do not include the cost of food or
servants.

If you own your home, or are buying it, you can exclude your housing allowance
from your income if you spend it for the downpayment on the home, for mortgage
payments, or for interest, taxes, utilities, repairs, etc. However, you cannot
exclude more than the fair rental value of the home plus the cost of utilities,
even if a larger amount is designated as a housing allowance. Fair rental value
of a home includes the fair rental value of furnishings in it.

You can deduct the mortgage interest and real estate taxes you pay on your
home even if you use nontaxable housing allowance funds to make the payments.
See Chapters 23 and 24.

Teachers or administrators. If you are a minister employed as a teacher
or administrator by a church school, college, or university, you are, for
purposes of the housing exclusion, performing ministerial services. However,
if you perform services as the head of a religious department, or as a teacher
or administrator on the faculty of a nonchurch college, and if your specific
duties involve no religious functions, you cannot exclude from your income
a housing allowance or the value of a home that is provided to you.

If you live in qualified campus housing as an employee of an educational
institution, you do not have to include the value of that housing in your
income if you pay rent equal to or greater than the fair rental value of
the housing.

If you serve as a "minister of music" or "minister of education," or serve in
an administrative or other function of your religious organization, but are
not authorized to perform all of the religious duties of an ordained minister
in your church, even though you are commissioned as a "minister of the gospel,"
you cannot exclude from your income a housing allowance or the value of a home
provided to you.

Theological students. You cannot exclude a housing allowance from your income
if you are a theological student serving a required internship as an assistant
pastor, unless you are ordained, commissioned, or licensed as a minister.

Traveling evangelists. You can exclude amounts received from out-of-town
churches for evangelistic services if you are an ordained minister, if those
amounts are designated as housing allowance, and you actually use them to
maintain your permanent home.

Retired members of the clergy. The rental value of a home provided rent free
by your church for your past services is not income if you are a retired
minister. In addition, a housing allowance paid to you is not income to the
extent you spend it for utilities, maintenance, repairs, and similar expenses
that are directly related to providing a home.

The general convention of a national religious denomination can designate a
housing allowance for retired ministers, if the local congregations authorize
the general convention to establish and maintain a unified pension system for
all retired clergy members of the denomination for their past services to the
local churches.

A surviving spouse of a retired minister cannot exclude a housing allowance
from income. It must be reported on line 17 of Form 1040 or on line 11 of
Form 1040A.

A pension or retirement pay for a member of the clergy is usually treated as
any other pension or annuity. (See Chapter 11.) If you are not expected to
perform any further services, payments from the congregation may be gifts.
They are not taxable if they are based solely on your financial needs and the
financial capacity of the congregation. If these payments are made under a
legal agreement, an established plan, or because of past practice, they do
not qualify as nontaxable gifts.

Members of religious orders. If you are a member of a religious order who has
taken a vow of poverty, the amounts you earn for services you perform which
you renounce and turn over to the order may or may not be included in your
income.

Services performed for the order. If you are performing the services as an
agent of the order in the exercise of duties required by the order, you do
not include in your income the amounts you turn over to the order.

If your order directs you to perform services for another agency of the
supervising church or an associated institution, you are considered to be
performing the services as an agent of the order. Any wages you earn as an
agent of an order that you turn over to the order are not included in your
gross income.

Example. You are a member of a church order and have taken a vow of poverty.
You renounce any claims to your earnings and turn over to the order any
salaries or wages you earn. You are a registered nurse, so your order assigns
you to work in a hospital that is an associated institution of the church.
However, you remain under the general direction and control of the order. You
are considered to be an agent of the order and, therefore, any wages you earn
at the hospital that you turn over to your order are not included in your
gross income.

Services performed outside the order. If you are directed to work outside the
order, the work will not constitute the exercise of duties required by the
order unless the services you perform meet both of the following requirements:

1)  The services are the kind that are ordinarily the duties of members of
    the order, and

2)  The services are part of the duties that are required to be exercised
    for, or on behalf of, the religious order as its agent.

If the legal relationship of employer and employee exists between you and
a third party, the services you perform for the third party will not be
considered directed or required of you by the order. Amounts you receive for
these services are included in your gross income, even if you have taken a vow
of poverty.

Example. Mark Brown is a member of a religious order and has taken a vow of
poverty. He renounces all claims to his earnings and turns over his earnings
to the order.

Mark is a school teacher. He was instructed by the superiors of the order to
get a job with a private tax-exempt school. Mark became an employee of the
school, and, at his request, the school made the salary payments directly
to the order.

Because Mark is an employee of the school, he is performing services for the
school rather than as an agent of the order. Therefore, the wages Mark earns
working for the school are included in his gross income.

Foreign Employer

Special rules apply if you work for a foreign employer.

U.S. citizen. If you are a U.S. citizen who works for a foreign government, an
international organization, a foreign embassy, or any foreign employer, you
must include your salary in your income.

Social security and Medicare taxes. You are exempt from social security
and Medicare employee taxes if you are employed in the United States by an
international organization or a foreign government. However, you must pay
social security self-employment tax on your earnings from services performed
in the United States, even though you are not self-employed. This rule also
applies if you are an employee of a qualifying wholly-owned instrumentality
of a foreign government.

Non-U.S. citizen. If you are not a U.S. citizen, or if you are a U.S. citizen
but also a citizen of the Philippines, and you work for an international
organization in the United States, your salary from that source is exempt from
tax. If you work for a foreign government in the United States, your salary
from that source is exempt from tax if your work is like the work done by an
employee of the United States in that foreign country and if the foreign
government gives an equal exemption for the salary of the U.S. employee.

Alien status. If you are an alien and give up your right to this exemption
(by filing a waiver under section 247(b) of the Immigration and Nationality
Act to keep your immigrant status), you are not entitled to the exemption from
the date you give it up, unless you get the exemption from a treaty, consular
agreement, or international agreement.

Pensions. This exemption applies only to employees' wages, salaries, and fees.
Pensions received by former employees living in this country do not qualify
for this exemption.

Employment abroad. For information on income earned abroad, get Publication
54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.

Military

Payments you receive as a member of a military service generally are taxable
except for certain allowances. Report them as wages.

Taxable Income

Taxable income includes the following items.

Wages. Military pay taxed as wages includes:

∙  Active duty pay

∙  Reserve training pay

∙  Reenlistment bonus

∙  Armed services academy pay

∙  Amounts received by retired personnel serving as instructors in junior
   ROTC programs

∙  Lump-sum payments upon separation or release from active duty

∙  Student loan repayments from the General Educational Loan Repayment
   Program

Military retirement pay based on age or length of service is taxable and must
be included on line 17, Form 1040, or on line 11, Form 1040A.

Nontaxable Income

Qualified military benefits you receive are not taxable. The following amounts
are nontaxable.

∙  Annual round trip for dependent students

∙  Burial and death services (interment allowances)

∙  Combat zone compensation and combat-related benefits

∙  Death gratuities

∙  Defense counseling

∙  Dental care for military dependents

∙  Dependent education

∙  Disability benefits

∙  Educational assistance

∙  Emergency assistance

∙  Evacuation allowances

∙  Family counseling

∙  Family separation allowances

∙  Group-term life insurance

∙  Housing allowances

∙  Medical benefits

∙  Moving and storage

∙  Overseas cost-of-living allowances

∙  Premiums for survivor and retirement protection plans

∙  Professional education

∙  Quarters allowances

∙  Subsistence allowances

∙  Temporary lodging in conjunction with certain orders

∙  Travel for consecutive overseas tours

∙  Travel for consecutive overseas tours for dependents

∙  Travel in lieu of moving dependents during ship overhaul or inactivation

∙  Travel of dependents to a burial site

∙  Travel to a designated place in conjunction with reassignment in a
   dependent-restricted status

∙  Uniform allowance

Note. Personal use of a vehicle cannot be excluded from income as a qualified
military benefit.

Veterans

Benefits paid under any law administered by the Department of Veterans Affairs
(VA) are not included in gross income. The following amounts paid to veterans
or their families are not taxable:

∙  Education, training, or subsistence allowances

∙  Disability compensation and pension payments for disabilities

∙  Grants for homes designed for wheelchair living

∙  Grants for motor vehicles for veterans who lost their sight or the use of
   their limbs

∙  Veterans' pensions paid either to the veterans or to their families

∙  Interest on dividends you leave on deposit with the VA

Veterans' insurance proceeds and dividends are not taxable either to the
veterans or to their beneficiaries. This is also true of the proceeds of
a veteran's endowment policy paid before death.

Rehabilitative program payments. VA payments to hospital patients and resident
veterans for their services under the VA's therapeutic or rehabilitative
programs are included as income other than wages on line 22, Form 1040.

Volunteers

The tax treatment of amounts you receive as a volunteer worker for the Peace
Corps, ACTION, or similar agency is covered in the following discussions.

Peace Corps

If you are a Peace Corps volunteer or volunteer leader, some amounts you
receive may be exempt from tax.

Taxable allowances must be included in your income and reported as wages.
These include:

∙  Cash allowances received during training.

∙  Allowances paid to your spouse and minor children while you are training
   in the United States.

∙  The part of living allowances designated by the President, under the
   Peace Corps Act, as basic compensation.

∙  Allowances for personal items such as domestic help, laundry and clothing
   maintenance, entertainment and recreation, transportation, and other
   miscellaneous expenses.

∙  Leave allowances.

∙  Readjustment allowances or "termination payments." These are considered
   received by you when credited to your account.

Example. Gary Carpenter, a Peace Corps volunteer, gets $175 a month during
his period of service, to be paid to him in a lump sum at the end of his
tour of duty. Although the allowance is not available to him until the end
of his service, Gary must include it in his income on a monthly basis as it
is credited to his account.

Nontaxable allowances include travel and living allowances for basic
necessities, such as housing, utilities, food, clothing, and household
supplies.

ACTION

ACTION participants perform services in antipoverty programs and Older
American volunteer programs. Some amounts these participants receive are
taxable and others are exempt from tax.

VISTA. If you are a VISTA volunteer, you must include meals and lodging
allowances paid to you in your income as wages.

University Year for Action program. If you receive a stipend as a full-time
student for service in the University Year for Action program, you must
include the stipend in your income as wages.

Older American programs. Do not include in your income amounts you receive
for supportive services or reimbursements for out-of-pocket expenses from
the following programs:

∙  Retired Senior Volunteer Program (RSVP)

∙  Foster Grandparent Program

∙  Senior Companion Program

Other Volunteer Programs

If you receive amounts for supportive services or are reimbursed for
out-of-pocket expenses under either of the following volunteer programs,
you do not include these amounts in your gross income:

∙  Service Corps of Retired Executives (SCORE)

∙  Active Corps of Executives (ACE)

Volunteer tax counseling. You do not include in your income any reimbursements
you receive for transportation, meals, and other expenses you have in training
for, or actually providing, volunteer federal income tax counseling for the
elderly (TCE).

You can deduct as a charitable contribution your unreimbursed out-of-pocket
expenses in taking part in the volunteer income tax assistance (VITA) program.

Statutory Employees

Statutory employees are considered self-employed independent contractors for
purposes of reporting income and expenses on their tax returns. If you are a
statutory employee, get Publication 525, for more information.