Before we begin, please note that this article contains observations about the term “wages”, however, these comments do not constitute legal advice in general or for any specific examples mentioned. For such guidance, contact legal counsel, or, when appropriate, licensed practitioners in the areas of practice mentioned.
Toward the end of each tax year, Payroll professionals often struggle with ensuring proper amounts are included as wages for year-end reporting, reconciliation, and payments. This perennial challenge happens primarily in the Payroll tax realm, but different characterizations about what wages are can extend into other areas of the Payroll practice.
This is because wages make up the backbone of the Payroll process, without which there would be no Payroll.
While the term has a generally accepted definition, “wages” can be an enigma for Payroll; it has become a very complicated word.
Wages for Payroll purposes can mean many things. Some obvious, and some so esoteric (but nevertheless important) as to boggle the mind. The fact remains that there is no uniformity when it comes to defining wages.
It is necessary to provide a breakdown of general distinctions before a more refined meaning of wages for Payroll can be explored.
Income, Earnings, and Compensation
A wage can be a salary, or, how much you make at a job. Once it is received, it generally falls into the category of earned income.
Isn’t it understood that wages are income?
Income can consist of both earned and unearned amounts, and, in many cases, unearned income is not considered wages. While both can be subject to taxes, wage amounts generally are taxed at specific rates at the time of payment, through Payroll, while unearned income amounts, in many cases, can be taxed at different times and at different rates than wages.
Can everything earned and received by workers be considered wages? No, maybe not.
Wages generally are applied as payments to employees for their services. For global tax purposes, tax treaties make the distinction more clearly as the difference between dependent personal services, i.e., working for an employer, and independent personal services.
According to the U.S. Internal Revenue Service webpage Pay for Personal Services Performed, examples of independent personal services include fees charged by accountants, attorneys, doctors, and other professionals. Athletes and entertainers also are mentioned, but they are covered under another section in tax treaties, as are at least some payments made to scholars and teachers.
NonWage Amounts
For those who are not employees but receive payments for work, for the most part, they are not receiving wages. The administration of nonemployee payments generally is treated as an arms-length, contractual arrangement with invoices and this triggers accounts payable procedures outside of the Payroll process.
Payments for contract work, like wage payments, are considered earned income. However, there are few mechanisms or requirements for withholding taxes on such payments at the time of payment in the U.S.
The U.K. and other countries have mechanisms for withholding such pay, but those amounts may still not be considered wages, and some countries address worker status for tax purposes in different ways.
Payroll should know the difference. It is very common to categorize payments to contractors in the U.S., for example, as “compensation” for contract work, and the amounts are reported on a special nonemployee income tax form.
Can nonwage amounts become wages? Yes! In the event that a contract worker performing services for an organization has a connection so close to the paying entity that they are deemed an employee, all those amounts generally need to be recategorized as wages, with all the employment tax programs applied.
Wage Definitions Vary
Beyond these broader distinctions come the more granular determinations Payroll must make as to what constitutes wages. This is where, for employer exposure purposes, the devil is in the details.
Unfortunately, to limit potential legal liability, it is paramount that employers understand these various definitions and apply them properly during the pay cycle. And this task, despite the aid of advances in system applications, is not getting simpler.
This complexity is present on several levels.
The first level has Payroll professionals continuing to grapple with the fact that there are minimums and maximums to be applied before determining, say, a taxable gross. Gross pay for one tax requirement is different for another.
Often, there are wage amounts that get either excluded or included from total amounts, such as the threshold for applying income tax to the wages earned and when a higher rate needs to be applied beyond certain amounts.
Key payroll numbers also include determining whether an employer is meeting a particular government requirement surrounding minimum hourly wages, calculations for gross overtime amounts, thresholds for exempting workers from those requirements, and, now, more recently, pay equity rules.
These examples only scratch the surface of how a particular amount can be wages for one purpose, but another amount is considered wages under a different purpose or requirement. And exceptions are everywhere.
Another level of analysis involves just that: what wages are for one aspect of Payroll operations may not be considered wages for others (or, at least, applicable wages). Labor laws often apply a broader definition of wages to be applied than some tax laws. But in these requirements, there still are carved-out exclusions from wages to be considered.
Rules surrounding child support, garnishments, and benefit deductions complicate the gross-to-net calculation because thresholds and amounts to consider as covered wages can vary from jurisdiction to jurisdiction and with the particular circumstance that can impact the deduction amount calculation.
Answers often lie in how the law or rule surrounding the transaction defines the character of the amounts being paid.
Carve Outs and Exclusions
Some employers would like to think chunks of amounts are excludable from wages, especially if ad hoc payments or gifts and services are provided to employees. But there is a general application of tax treatment in the U.S. that essentially says everything of value is taxable unless it is specifically excluded under the tax law.
Those attempting to characterize some payments as not taxable because they are not addressed in the law often are wrong in their assumptions.
But there are exclusions. These carve-outs can be perplexing, and it is important for Payroll professionals to understand the nuances surrounding any type of these payments or awards.
In Australia, amounts paid for meals for workers whose shift extends into overtime are exempt from Pay As You Go tax withholding and are not reportable.
In the U.S., turkeys and hams made available to employees during certain holidays, are not considered wages. Why? Because the tax regulations specifically exclude these items, among other small, tangible gifts, as de minimis fringes, not subject to taxation to the recipient as wages. These fringes do not need to be included in employment tax reports nor is any tax required to be withheld for these tangible items.
However, giving someone a gift card for $50 to buy that turkey or ham? Taxable as wages.
And, unfortunately, in these instances when the answer is “no, the item must be included as wages,” Payroll often is the deliverer of the bad news.
That $100 bill given to an employee by the CEO at a company-wide meeting for being able to recite company core values? It is to be added to gross pay and taxed as wages. In the U.S., it also is added to gross pay for the work period, changing the worker’s regular rate of pay for calculating an overtime rate.
Benefit Exclusions Not Uniform
Amounts deferred under the most common federal tax-qualified retirement plans in the U.S. generally can be tax-free until the amounts are drawn out at retirement time. And then it is generally up to the plan administrator — not Payroll — to follow any withholding and reporting obligations once payments begin. (Attention must be paid to other nontax-free deferral arrangements.)
Most states follow suit, but there always seem to be exceptions. Pennsylvania, for example, generally does not consider the deferred amounts excludable from state tax at the time of deferral. Those deferred amounts are wages for state tax purposes at deferral time, but drawing on those amounts at retirement generally has no state tax requirement. This may be one reason why Pennsylvania is attractive to retirees because as a resident they receive that benefit payment free of state tax.
The list continues and includes personal use of business resources or assets that can also be excluded in some cases. But there are criteria for determining if the amounts qualify for these exclusions, and formulas for ascertaining the taxable value of some programs, such as flights on company-provided airplanes.
Implementing New Compensation Programs
As creative compensation plans continue to be developed, Payroll, in its role as the implementer of the bulk of these plans, must be able to articulate the consequences of particular schemes to attract and retain employees.
Much of that lies in two areas: explaining administrative burdens that could arise when administering payments (or deferring amounts) and outlining any compliance exposure such moves possibly create.
The drivers for most compensation programs generally are to have the right features to attract workers to fill positions and retain such workers over a period of time. When the competition for talent among employers in certain industries is high, HR and compensation planners get more innovative when looking for that edge in the employee market.
Incentive payment programs get a lot of attention. These come in all forms; as bonuses paid at hire or special compensation for remaining employed, and onto continuing education, deferred compensation, stock awards and other equity-based compensation (again, these examples scratch the surface of the totality of programs).
These amounts either are wages at the time paid or are excluded up to a certain amount, with accumulators needed to keep track and ensure amounts exceeding thresholds are then applied as wages.
The pandemic has accelerated the need for using these mechanisms down the salary scale, so that, in some sectors, even unskilled workers are now getting these awards at hire. Policies have changed so that other tax-free or taxable benefits, as well, are being tailored to a broader set of workers.
While some of this is being rolled back as the employment environment continues its post-pandemic adjustments, the challenge to provide the right total rewards package for the right type of worker and demographic continues unabated.
Payroll needs to be a supportive part of the discussion surrounding these more creative programs, especially to determine how to value or handle any wage or wage-like component, and provide information on any associated administrative burdens that may raise costs for the employer.
The Evolving Regulatory Environment
Governments have two driving motivations for their payroll-related requirements: economic and social.
They are equally creative as HR and compensation teams in setting up plans to not only raise revenue through taxation and ensure living wages but also require employers to provide certain benefits to workers and reports about wage amounts.
Changes to address myriad issues cross into Payroll, even when it is not obvious to the policymakers considering a new program. There may be a need to address particular welfare programs, such as nationalized health care, or to raise revenue such as the not-so-recent effort in France to tax companies that pay over a threshold wage to chief executives.
There are too many troubling examples of laws being passed impacting wages that could have been thought through a bit further in relation to employer burden, ability to implement, and whether the approach in the legislation effectively addresses the problem that needs to be addressed.
A recent example in the U.S. state of Alabama calls for overtime wage amounts (that exceed 40 hours of work in a work week) paid to hourly workers to not be taxed under state law. Reportedly, this came about because of problems employers were having with shift coverage and staffing in general.
Alabama employers, their Payroll teams, and service providers are scrambling to retool systems to account for this change, which is extremely complicated to implement.
The overtime wage amounts are considered wages for federal (U.S.) tax purposes, social tax purposes, unemployment, and in figuring the regular pay rate for labor law purposes. The overtime payments also are wages to be considered for determining child support and garnishment amounts.
But for Alabama’s state tax, these amounts are to be excluded from wages. The law lapses in mid-2025, and then, if Alabama does not choose to extend the law, the overtime payment amounts will once again be wages for Alabama tax purposes.
Will this, in the end, be an effective tool for incentivizing workers to work longer hours?
Unfortunately, Alabama’s law is only a recent example of many well-intentioned requirements across the globe that force Payroll teams to adjust processes, adding burden and cost to operations.
Payroll professionals should be called on to respond to these initiatives with effective communication about any implementation issues, as well as the exposure employers may face for failing to comply.
Advance systems coming from payroll services strive to consider all the appropriate deductions and inclusions to what are considered wage amounts, and this helps. But the systems are works in progress, constantly adjusting to changes in regulatory requirements and employer policy wants and needs.
Situations requiring a nuanced approach – of which there are many -- often can fall outside of a programmed solution, even with the use of artificial intelligence. Accounting for these circumstances can be time-consuming and costly.
Simplifying Wage Definitions
A federal and state multiagency effort in the early 1990s attempted to address the disparities surrounding wage definitions under various U.S. laws. The officials had heard employer concerns about having to adjust to changes that affected the definition of wages, and started to explore ways to improve the lot of Payroll reporting.
For several years they met to potentially hammer out some standards that could be applied across the country for what should be included as wages, and how to lay out consistent formats for reporting amounts. It was to be called the Simplified Tax and Wage Reporting System.
By the late 1990s, the effort was disbanded. Getting agreement across jurisdictions to harmonize laws covering wages and the manner in which amounts were to be reported was perhaps too much to ask of these government officials all while they had obligations to their regular duties.
Jurisdictions, particularly states in the scenarios contemplated, would have to give up a certain amount of flexibility and autonomy to conform with such standards being discussed. [The Alabama law likely would not come to pass under this regime.]
It soon became clear that the most that could be done was possibly standardize some aspects of reporting across the entities, but not the wage definitions. Even with that, there was little headway made.
Some 30 years on, accounting for wages in Payroll operations is not getting simpler. It is only getting more complex. The likelihood that governments and others will recognize the burden placed on employers and Payroll to comply and allocate some resources to simplify their systems remains remote.
At year-end, Payroll teams will continue to take time to identify wage amounts that were originally misapplied, and struggle to accumulate accurate wage numbers for reporting and reconciliation purposes by the due dates set, with no end in sight.
Author: Michael Baer
Michael Baer is president of Baer Unlimited, LLC, an independent research, analysis, and communications provider that helps Payroll modernize operations, stay compliant, and improve the use and security of their payroll data. For more on the issue of wages and Payroll, book Michael as a mentor through the GPA Mentor page.
Before we begin, please note that this article contains observations about the term “wages”, however, these comments do not constitute legal advice in general or for any specific examples mentioned. For such guidance, contact legal counsel, or, when appropriate, licensed practitioners in the areas of practice mentioned.
Toward the end of each tax year, Payroll professionals often struggle with ensuring proper amounts are included as wages for year-end reporting, reconciliation, and payments. This perennial challenge happens primarily in the Payroll tax realm, but different characterizations about what wages are can extend into other areas of the Payroll practice.
This is because wages make up the backbone of the Payroll process, without which there would be no Payroll.
While the term has a generally accepted definition, “wages” can be an enigma for Payroll; it has become a very complicated word.
Wages for Payroll purposes can mean many things. Some obvious, and some so esoteric (but nevertheless important) as to boggle the mind. The fact remains that there is no uniformity when it comes to defining wages.
It is necessary to provide a breakdown of general distinctions before a more refined meaning of wages for Payroll can be explored.
Income, Earnings, and Compensation
A wage can be a salary, or, how much you make at a job. Once it is received, it generally falls into the category of earned income.
Isn’t it understood that wages are income?
Income can consist of both earned and unearned amounts, and, in many cases, unearned income is not considered wages. While both can be subject to taxes, wage amounts generally are taxed at specific rates at the time of payment, through Payroll, while unearned income amounts, in many cases, can be taxed at different times and at different rates than wages.
Can everything earned and received by workers be considered wages? No, maybe not.
Wages generally are applied as payments to employees for their services. For global tax purposes, tax treaties make the distinction more clearly as the difference between dependent personal services, i.e., working for an employer, and independent personal services.
According to the U.S. Internal Revenue Service webpage Pay for Personal Services Performed, examples of independent personal services include fees charged by accountants, attorneys, doctors, and other professionals. Athletes and entertainers also are mentioned, but they are covered under another section in tax treaties, as are at least some payments made to scholars and teachers.
NonWage Amounts
For those who are not employees but receive payments for work, for the most part, they are not receiving wages. The administration of nonemployee payments generally is treated as an arms-length, contractual arrangement with invoices and this triggers accounts payable procedures outside of the Payroll process.
Payments for contract work, like wage payments, are considered earned income. However, there are few mechanisms or requirements for withholding taxes on such payments at the time of payment in the U.S.
The U.K. and other countries have mechanisms for withholding such pay, but those amounts may still not be considered wages, and some countries address worker status for tax purposes in different ways.
Payroll should know the difference. It is very common to categorize payments to contractors in the U.S., for example, as “compensation” for contract work, and the amounts are reported on a special nonemployee income tax form.
Can nonwage amounts become wages? Yes! In the event that a contract worker performing services for an organization has a connection so close to the paying entity that they are deemed an employee, all those amounts generally need to be recategorized as wages, with all the employment tax programs applied.
Wage Definitions Vary
Beyond these broader distinctions come the more granular determinations Payroll must make as to what constitutes wages. This is where, for employer exposure purposes, the devil is in the details.
Unfortunately, to limit potential legal liability, it is paramount that employers understand these various definitions and apply them properly during the pay cycle. And this task, despite the aid of advances in system applications, is not getting simpler.
This complexity is present on several levels.
The first level has Payroll professionals continuing to grapple with the fact that there are minimums and maximums to be applied before determining, say, a taxable gross. Gross pay for one tax requirement is different for another.
Often, there are wage amounts that get either excluded or included from total amounts, such as the threshold for applying income tax to the wages earned and when a higher rate needs to be applied beyond certain amounts.
Key payroll numbers also include determining whether an employer is meeting a particular government requirement surrounding minimum hourly wages, calculations for gross overtime amounts, thresholds for exempting workers from those requirements, and, now, more recently, pay equity rules.
These examples only scratch the surface of how a particular amount can be wages for one purpose, but another amount is considered wages under a different purpose or requirement. And exceptions are everywhere.
Another level of analysis involves just that: what wages are for one aspect of Payroll operations may not be considered wages for others (or, at least, applicable wages). Labor laws often apply a broader definition of wages to be applied than some tax laws. But in these requirements, there still are carved-out exclusions from wages to be considered.
Rules surrounding child support, garnishments, and benefit deductions complicate the gross-to-net calculation because thresholds and amounts to consider as covered wages can vary from jurisdiction to jurisdiction and with the particular circumstance that can impact the deduction amount calculation.
Answers often lie in how the law or rule surrounding the transaction defines the character of the amounts being paid.
Carve Outs and Exclusions
Some employers would like to think chunks of amounts are excludable from wages, especially if ad hoc payments or gifts and services are provided to employees. But there is a general application of tax treatment in the U.S. that essentially says everything of value is taxable unless it is specifically excluded under the tax law.
Those attempting to characterize some payments as not taxable because they are not addressed in the law often are wrong in their assumptions.
But there are exclusions. These carve-outs can be perplexing, and it is important for Payroll professionals to understand the nuances surrounding any type of these payments or awards.
In Australia, amounts paid for meals for workers whose shift extends into overtime are exempt from Pay As You Go tax withholding and are not reportable.
In the U.S., turkeys and hams made available to employees during certain holidays, are not considered wages. Why? Because the tax regulations specifically exclude these items, among other small, tangible gifts, as de minimis fringes, not subject to taxation to the recipient as wages. These fringes do not need to be included in employment tax reports nor is any tax required to be withheld for these tangible items.
However, giving someone a gift card for $50 to buy that turkey or ham? Taxable as wages.
And, unfortunately, in these instances when the answer is “no, the item must be included as wages,” Payroll often is the deliverer of the bad news.
That $100 bill given to an employee by the CEO at a company-wide meeting for being able to recite company core values? It is to be added to gross pay and taxed as wages. In the U.S., it also is added to gross pay for the work period, changing the worker’s regular rate of pay for calculating an overtime rate.
Benefit Exclusions Not Uniform
Amounts deferred under the most common federal tax-qualified retirement plans in the U.S. generally can be tax-free until the amounts are drawn out at retirement time. And then it is generally up to the plan administrator — not Payroll — to follow any withholding and reporting obligations once payments begin. (Attention must be paid to other nontax-free deferral arrangements.)
Most states follow suit, but there always seem to be exceptions. Pennsylvania, for example, generally does not consider the deferred amounts excludable from state tax at the time of deferral. Those deferred amounts are wages for state tax purposes at deferral time, but drawing on those amounts at retirement generally has no state tax requirement. This may be one reason why Pennsylvania is attractive to retirees because as a resident they receive that benefit payment free of state tax.
The list continues and includes personal use of business resources or assets that can also be excluded in some cases. But there are criteria for determining if the amounts qualify for these exclusions, and formulas for ascertaining the taxable value of some programs, such as flights on company-provided airplanes.
Implementing New Compensation Programs
As creative compensation plans continue to be developed, Payroll, in its role as the implementer of the bulk of these plans, must be able to articulate the consequences of particular schemes to attract and retain employees.
Much of that lies in two areas: explaining administrative burdens that could arise when administering payments (or deferring amounts) and outlining any compliance exposure such moves possibly create.
The drivers for most compensation programs generally are to have the right features to attract workers to fill positions and retain such workers over a period of time. When the competition for talent among employers in certain industries is high, HR and compensation planners get more innovative when looking for that edge in the employee market.
Incentive payment programs get a lot of attention. These come in all forms; as bonuses paid at hire or special compensation for remaining employed, and onto continuing education, deferred compensation, stock awards and other equity-based compensation (again, these examples scratch the surface of the totality of programs).
These amounts either are wages at the time paid or are excluded up to a certain amount, with accumulators needed to keep track and ensure amounts exceeding thresholds are then applied as wages.
The pandemic has accelerated the need for using these mechanisms down the salary scale, so that, in some sectors, even unskilled workers are now getting these awards at hire. Policies have changed so that other tax-free or taxable benefits, as well, are being tailored to a broader set of workers.
While some of this is being rolled back as the employment environment continues its post-pandemic adjustments, the challenge to provide the right total rewards package for the right type of worker and demographic continues unabated.
Payroll needs to be a supportive part of the discussion surrounding these more creative programs, especially to determine how to value or handle any wage or wage-like component, and provide information on any associated administrative burdens that may raise costs for the employer.
The Evolving Regulatory Environment
Governments have two driving motivations for their payroll-related requirements: economic and social.
They are equally creative as HR and compensation teams in setting up plans to not only raise revenue through taxation and ensure living wages but also require employers to provide certain benefits to workers and reports about wage amounts.
Changes to address myriad issues cross into Payroll, even when it is not obvious to the policymakers considering a new program. There may be a need to address particular welfare programs, such as nationalized health care, or to raise revenue such as the not-so-recent effort in France to tax companies that pay over a threshold wage to chief executives.
There are too many troubling examples of laws being passed impacting wages that could have been thought through a bit further in relation to employer burden, ability to implement, and whether the approach in the legislation effectively addresses the problem that needs to be addressed.
A recent example in the U.S. state of Alabama calls for overtime wage amounts (that exceed 40 hours of work in a work week) paid to hourly workers to not be taxed under state law. Reportedly, this came about because of problems employers were having with shift coverage and staffing in general.
Alabama employers, their Payroll teams, and service providers are scrambling to retool systems to account for this change, which is extremely complicated to implement.
The overtime wage amounts are considered wages for federal (U.S.) tax purposes, social tax purposes, unemployment, and in figuring the regular pay rate for labor law purposes. The overtime payments also are wages to be considered for determining child support and garnishment amounts.
But for Alabama’s state tax, these amounts are to be excluded from wages. The law lapses in mid-2025, and then, if Alabama does not choose to extend the law, the overtime payment amounts will once again be wages for Alabama tax purposes.
Will this, in the end, be an effective tool for incentivizing workers to work longer hours?
Unfortunately, Alabama’s law is only a recent example of many well-intentioned requirements across the globe that force Payroll teams to adjust processes, adding burden and cost to operations.
Payroll professionals should be called on to respond to these initiatives with effective communication about any implementation issues, as well as the exposure employers may face for failing to comply.
Advance systems coming from payroll services strive to consider all the appropriate deductions and inclusions to what are considered wage amounts, and this helps. But the systems are works in progress, constantly adjusting to changes in regulatory requirements and employer policy wants and needs.
Situations requiring a nuanced approach – of which there are many -- often can fall outside of a programmed solution, even with the use of artificial intelligence. Accounting for these circumstances can be time-consuming and costly.
Simplifying Wage Definitions
A federal and state multiagency effort in the early 1990s attempted to address the disparities surrounding wage definitions under various U.S. laws. The officials had heard employer concerns about having to adjust to changes that affected the definition of wages, and started to explore ways to improve the lot of Payroll reporting.
For several years they met to potentially hammer out some standards that could be applied across the country for what should be included as wages, and how to lay out consistent formats for reporting amounts. It was to be called the Simplified Tax and Wage Reporting System.
By the late 1990s, the effort was disbanded. Getting agreement across jurisdictions to harmonize laws covering wages and the manner in which amounts were to be reported was perhaps too much to ask of these government officials all while they had obligations to their regular duties.
Jurisdictions, particularly states in the scenarios contemplated, would have to give up a certain amount of flexibility and autonomy to conform with such standards being discussed. [The Alabama law likely would not come to pass under this regime.]
It soon became clear that the most that could be done was possibly standardize some aspects of reporting across the entities, but not the wage definitions. Even with that, there was little headway made.
Some 30 years on, accounting for wages in Payroll operations is not getting simpler. It is only getting more complex. The likelihood that governments and others will recognize the burden placed on employers and Payroll to comply and allocate some resources to simplify their systems remains remote.
At year-end, Payroll teams will continue to take time to identify wage amounts that were originally misapplied, and struggle to accumulate accurate wage numbers for reporting and reconciliation purposes by the due dates set, with no end in sight.
Author: Michael Baer
Michael Baer is president of Baer Unlimited, LLC, an independent research, analysis, and communications provider that helps Payroll modernize operations, stay compliant, and improve the use and security of their payroll data. For more on the issue of wages and Payroll, book Michael as a mentor through the GPA Mentor page.