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Why this topic matters
Taxation and Regulation (REG) tests which employer-provided benefits employees can exclude from income, how payroll taxes are computed for employees and the self-employed, and the rules for classifying workers. Figures are for 2026 unless stated.
Payroll taxes
| Tax | Employee | Employer | Wage base |
|---|---|---|---|
| Social Security (Old-Age, Survivors, and Disability Insurance (OASDI)) | 6.2% | 6.2% | First $184,500 of wages (2026) |
| Medicare (Hospital Insurance) | 1.45% | 1.45% | All wages |
| Additional Medicare Tax | 0.9% | None | Wages above $200,000 (single) / $250,000 (joint) / $125,000 (separate) — employers withhold once wages exceed $200,000, regardless of filing status |
| Federal Unemployment Tax Act (FUTA) tax | None | 6.0%, less a credit of up to 5.4% for state unemployment taxes = 0.6% net | First $7,000 per employee |
Together, Social Security and Medicare are the Federal Insurance Contributions Act (FICA) taxes. An employee with two employers may have excess Social Security withheld; the excess is claimed as a credit on the individual return (each employer still pays its own share).
EXAMPLE: An employer has 10 employees who each earn more than $7,000 and receives the full state credit. FUTA tax = 0.6% × $7,000 × 10 = $420.
Self-employment tax
- Net earnings from self-employment = net self-employment income × 92.35%.
- Rate: 15.3% (12.4% Social Security up to the wage base, reduced by any wages already subject to it, + 2.9% Medicare on all), plus the 0.9% Additional Medicare Tax above the thresholds.
- No tax if net earnings are under $400.
- Half of self-employment tax (excluding the Additional Medicare Tax) is deductible as an adjustment to adjusted gross income.
Employee fringe benefits — what's excluded
| Benefit | Exclusion rule |
|---|---|
| Employer-provided health insurance and payments for medical care | Fully excluded (for more-than-2% S corporation shareholders, included in wages) |
| Group-term life insurance | Cost of the first $50,000 of coverage excluded; cost of coverage above that (from Internal Revenue Service (IRS) tables) is taxable |
| Health flexible spending account (FSA) | Salary reductions up to $3,400 (2026) |
| Health savings account (HSA) contributions by the employer | Excluded within the annual limits ($4,400 / $8,750) |
| Dependent care assistance | Up to $7,500 per year from 2026 (raised from $5,000 by the One Big Beautiful Bill Act (OBBBA)) |
| Educational assistance (Section 127) | Up to $5,250 per year, including payments of the employee's student loans — made permanent by OBBBA and indexed after 2026 |
| No-additional-cost services | Excluded (for example, airline standby seats for airline employees) |
| Qualified employee discounts | Goods: up to the gross profit percentage; services: up to 20% |
| Working condition fringes | Excluded if the employee could have deducted the cost as a business expense (professional dues, business use of a company car, job-related subscriptions) |
| De minimis fringes | Small, infrequent items (holiday gifts of property such as a ham, occasional meals or tickets). Cash and cash equivalents (gift cards) are always taxable. |
| Qualified transportation fringes | Transit passes and parking up to $340 per month each (2026); bicycle commuting reimbursements are taxable |
| Meals and lodging | Excluded if provided on the employer's premises for the convenience of the employer (lodging must also be a condition of employment) |
| On-premises athletic facilities | Excluded |
| Adoption assistance | Excluded up to the adoption credit limit |
EXAMPLE: An employer gives each employee a $50 gift card and a $50 holiday ham. The gift card is taxable wages (a cash equivalent); the ham is an excluded de minimis fringe.
Stock-based compensation
| Incentive stock options | Nonqualified stock options | |
|---|---|---|
| At grant | No income | No income (unless readily valued) |
| At exercise | No regular income — but the bargain element is an alternative minimum tax adjustment | Ordinary income = fair market value − exercise price; employer deducts the same amount |
| At sale | Long-term capital gain if held 2 years from grant and 1 year from exercise; otherwise a disqualifying disposition (ordinary income) | Capital gain or loss on later appreciation |
Restricted stock is taxed when it vests, unless the employee makes a Section 83(b) election within 30 days to be taxed at grant.
Worker classification
Employees receive a Form W-2 and have payroll taxes withheld; independent contractors receive Form 1099-NEC and pay self-employment tax. The Internal Revenue Service weighs:
- Behavioral control — does the business control how, when, and where the work is done, or provide training?
- Financial control — who invests in equipment, bears expenses, and can make a profit or loss?
- Relationship — written contracts, benefits, permanence, and whether the work is a key activity of the business.
Misclassification exposes the employer to back payroll taxes, penalties, and interest. Section 530 relief may apply if the employer had a reasonable basis and treated workers consistently.
Reporting
- Form W-4 (employee withholding certificate); Form W-2 to employees and the Social Security Administration by January 31.
- Form 941 quarterly (income tax withholding and FICA); Form 940 annually (FUTA).
- Form 1099-NEC for nonemployee compensation — the reporting threshold rises from $600 to $2,000 for payments after 2025 under OBBBA (indexed after 2026).
- Household employers report nanny taxes on Schedule H.
How it is tested
- Pick the benefits employees can exclude, and compute taxable group-term life coverage.
- Compute FICA, FUTA, and self-employment tax.
- Apply the Additional Medicare Tax withholding rule.
- Classify a worker as an employee or independent contractor.
EXAM TIP: Cash is never a de minimis fringe — even a small gift card is taxable. And FUTA is paid only by the employer, while the 0.9% Additional Medicare Tax is paid only by the employee.