Defining employee compensation and taxable wages

Deciding how much a new employee is paid can be one of your tougher challenges as a small business owner. You want the best candidate you can find and attract that individual with a number that will get their attention.

You’ll need to find the sweet spot – the salary that will appeal to someone with your desired qualifications, yet leaves some room for negotiation. But, before you make the decision to hire, you should brush up on common tax-related concepts related to employee compensation so you can better determine what that final salary will be.

Here are common questions and answers related to the tax aspects of setting employee compensation:

What are taxable wages?

The first and one of the most common questions related to employee compensation and taxes is “what are taxable wages?” Taxable wages are the salaries and hourly wages paid to your employees. Not sure what type of payments apply? The following employee payments are considered taxable:

determining employee compensation
  • Commissions
  • Employee wages, including overtime   
  • Certain stock options, such as stock options exercised under a nonstatutory stock option plan
  • Tips  

There are also non-taxable wages not subject to tax withholding, like:

  • Expense reimbursement under an accountable plan
  • Holiday or birthday gifts, other than cash, with a low fair market value
  • Payments in the nature of workers’ compensation
  • Health insurance provided by the employer

You might be wondering if it’s possible to provide a tax-free employee bonus. This answer is no, a bonus is always taxable to the employee.

What are payroll tax expenses?

The next common question is “what are payroll expenses?”

Payroll expenses is the sum you pay to employees for their labor, as well as associated expenses such as employee benefits and payroll taxes. This is an important definition to note because you should consider your overall payroll expense when hiring a new employee. Long story short, your employee’s salary is just one part of that overall number—taxes, commissions, stock options and more all play into the total sum.

Payroll taxes-deductible amounts

Payroll taxes and deductible amounts for various benefits all affect your employee’s take home pay amount. If your new employee is new to the working world, this may be news to them. If you think this might be a first job for your employee, it may help to mention this concept. These types of payroll deductions include:

  • Income tax withholding
  • Social Security tax withholding
  • 401(k) plan retirement contributions
  • Court ordered wage garnishments
  • Court ordered child support payments

Are employee advances taxable?

Employee advances are sometimes provided to employees to give them access to their paycheck before the normal payday. So, “are employee advances taxable?” Here’s the answer… Because a salary advance is money that would normally be part of an employee’s wages, you must withhold appropriate taxes; and your employee must pax tax on the advance.

What else should you consider while determining employee compensation levels?

Here are some things for you to ponder while you’re making this decision about how much to compensate a new employee:

1 – Assess your actual needs carefully and realistically

Hire an applicant who is an ideal fit, and who demonstrates skills from previous positions. But, before you can begin to shape that job and its pay, you need to be very clear on what your company or department needs, and whether you have the budget for it.

Consider if you’re hiring an independent contractor vs. a full-time employee where you may have additional costs (e.g., medical/dental benefits). If you do go the employee route, you’ll need to collect a Form W-4 from each employee.

2 – Include intangible benefits in job listings

If you’re hoping to interview the very best-qualified and most-motivated applicants for any position, factors other than compensation are important. Advancement opportunities, a welcoming company culture and work/life balance benefits like flexible hours, family-related time off and other perks can make all the difference to the most desirable potential hires. Mention these prominently in your listings.

3 – Be creative

Today’s workers are looking for extras more than they were even 20 years ago, when the “big” benefits were more generous – and economically possible. If an applicant is considering two comparable jobs, even a minor difference can tip the scales. You never know what’s going to be important to prospective employees.

4 – Consider your competition

Spend some time researching what other companies in your market area are offering for similar positions. Your compensation package should compare well with other local employers. If competition for outstanding applicants is fierce in your market, additional stimulants – like hiring bonuses, use of a company car, and a spacious office — may give you an edge over your competitors.

Employees are a cost center for you, but the right ones can have enormous impact on your profits, too. Having highly productive and talented employees at every level directly and positively affects your bottom line.

Get help with new-hire tax matters

If you’re considering hiring a new employee or multiple employees this year, it might serve you well to consult a Block Advisors small business certified tax pro. While they can’t advise you on human resource-type questions, they can help you when it comes to taxes. Plus, if you need help with bookkeeping and payroll, you’ll find we offer services year-round, so you can get back to doing more of what you love!

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