What Compensation Is Taxable?

Once you've identified the workers for whom you have payroll tax obligations, the next step is to determine what portion of the compensation you pay those workers is actually taxable.

"Wages" defined. The federal and state payroll tax laws generally identify taxable compensation as being an employee's wages. Furthermore, they broadly define "wages" to encompass almost every payment you make to an employee for services. The label you give a payment (salary, fee, commission, etc.) is unimportant in determining whether it constitutes wages. Nor does it matter that a payment is designed to supplement an employee's basic salary or that it is not made in cash. Also immaterial is the basis on which the payment is made (hours worked, percentage of profits, etc.). Rather, whenever you transfer something of value to an employee as compensation for the employee's services, you've potentially made a taxable wage payment.

However, the laws do provide for a number of exceptions. There are some types of compensation and fringe benefits that are not always considered taxable wages, for some or all payroll tax purposes:

Wage caps. The definition of taxable wages is basically the same for each of the different payroll taxes. In other words, a specific type of compensation or benefit generally will either be taxable or nontaxable for purposes of all of the taxes. In contrast, the dollar amount of wages that is subject to each of the taxes will not necessarily be the same, because there is a maximum amount of wages beyond which certain of the taxes will not apply. Specifically, wage caps apply to the FICA social security tax, to federal (FUTA) and state unemployment taxes, and to state disability insurance taxes.