New IRS Tax Ruling for Signing Bonuses
June 28, 2011
Terry Peltz, Director
Performance Advisors LLC
If your company offers bonuses to new employees for signing on, you should know about an IRS ruling that might affect the way you do business. (IRS Revenue Ruling 2004-109) The ruling states that these bonuses are subject to federal employment taxes if they are contingent on future services.
While this specific ruling addressed the signing bonus received by a professional baseball player, it could have implications for a variety of businesses that use this type of payment to entice talent. The ruling is generally effective for payments made after January 12, 2005.
The Ground Rules for Signing Bonuses
For starters, federal employment taxes - meaning FICA, FUTA and federal income tax withholding are generally imposed on wages, which include salary, commissions, and most bonuses.
"Amounts an employer pays as bonuses for signing or ratifying a contract in connection with the establishment of the employer-employee relationship are wages for purposes of FICA, FUTA, and Federal income tax withholding."
- IRS Revenue Ruling 2004-109
In the IRS ruling, a baseball player negotiated a contract that provided a signing bonus if he reported to spring training, even if he didn't play for the team that season. In other words, the bonus wasn't contingent upon the player's future performance of services.
The IRS determined that the player was receiving the bonus in the course of establishing an employer-employee relationship. Therefore, the IRS concluded the bonus represented remuneration for employment and was subject to federal employment taxes the same as garden variety salary payments.
If your business uses signing bonuses or severance packages to lure top talent, they are likely to be subject to employment taxes under the current rules. Consult with your tax adviser and consider the tax ramifications both to the recipient and your company.