Wages: What It Means for Employers

What it means in practice

In everyday payroll, wages are what an employee is paid for work. Federal law gives the word two working definitions. The Fair Labor Standards Act (FLSA) uses it to decide whether an employee received the required minimum wage and overtime. The Internal Revenue Code uses it to decide what is subject to income tax withholding, Social Security and Medicare tax. The two overlap but are not identical. Wages are the starting point for gross pay, and what remains after deductions is net pay.

Wages are paid to employees. The income tax withholding definition covers remuneration "for services performed by an employee for his employer" (26 U.S.C. 3401(a)). Whether a worker is an employee is a separate question; see independent contractor. Treasury regulations say the name given to remuneration is immaterial, so salaries, fees, bonuses and commissions are wages if paid as compensation for employment, and the basis is also immaterial, whether piecework, a percentage of profits, or an hourly, weekly, monthly or annual rate (26 CFR 31.3121(a)-1(c) and (d)). The Social Security Administration uses the same approach for benefit purposes (20 CFR 404.1041).

The FLSA definition: cash first. Standing alone, the minimum wage and overtime sections require payment in cash or a negotiable instrument payable at par; section 3(m) is what permits payment in anything else (29 CFR 531.27). Scrip, tokens and coupons are not proper wage payments (29 CFR 531.34).

Board, lodging and other facilities. Section 3(m) lets the reasonable cost of board, lodging or other facilities count as wages if they are customarily furnished to employees, unless a bona fide collective bargaining agreement excludes them (29 U.S.C. 203(m)(1)). The regulations set "reasonable cost" at not more than the actual cost to the employer, with no profit to the employer or an affiliated person, and never more than fair rental value or fair price (29 CFR 531.3). The employee must actually receive the facility and accept it voluntarily (29 CFR 531.30). Facilities primarily for the employer's benefit cannot be counted at all, including tools of the trade, uniforms and their laundering where the business requires them, and transportation that is necessary to the job, while meals are always regarded as primarily for the employee's benefit (29 CFR 531.3(d) and 531.32). The reasonable cost of facilities furnished in addition to a cash wage is part of the regular rate for overtime (29 CFR 531.37(b); DOL Fact Sheet #23).

Free and clear payment and deductions. Wages are not paid unless they are paid finally and unconditionally. If an employee must buy tools required for the job, there is a violation in any workweek when that cost cuts into the minimum or overtime wages owed (29 CFR 531.35). Deductions for items that are not facilities are lawful only if the employee still receives the minimum wage in cash free and clear, and in an overtime week they cannot exceed what could have been deducted for straight-time hours alone (29 CFR 531.36(b) and 531.37). The Department of Labor's Handy Reference Guide applies the same limit to cash or merchandise shortages, employer-required uniforms and tools of the trade, and Fact Sheet #16 adds that the employer cannot avoid it by having the employee repay the cost in cash.

Payments to others on the employee's behalf. Employee taxes the employer collects and forwards count as wages paid, but no deduction may be made for a tax the law requires the employer to bear (29 CFR 531.38). Sums paid to a third party under a court order, such as a garnishment, count as paid to the employee if the employer gains no profit or benefit, but amounts withheld beyond Consumer Credit Protection Act limits do not (29 CFR 531.39). Voluntary assignments, such as union dues or premiums to an independent insurer, are treated the same way (29 CFR 531.40).

Tipped employees. A tipped employee is one engaged in an occupation in which they customarily and regularly receive more than $30 a month in tips (29 U.S.C. 203(t)). For these employees an employer may count part of the tips toward the wage: the cash wage must be at least $2.13 an hour, and the tip credit cannot exceed the difference between that cash wage and the federal minimum wage or the tips actually received (29 U.S.C. 203(m)(2)(A)). The credit is available only if the employer first informs employees of the cash wage, the credit amount and the rules on retaining tips (29 CFR 531.59(b)). A mandatory service charge is not a tip, although distributed service charges can be used to meet wage obligations (29 CFR 531.55).

Tips belong to employees. An employer may not keep employees' tips for any purpose, including letting managers or supervisors keep a share, whether or not it takes a tip credit (29 U.S.C. 203(m)(2)(B)). An employer that takes a tip credit may require a tip pool only among employees who customarily and regularly receive tips; one that pays the full minimum wage in cash may include cooks and dishwashers (29 CFR 531.54). Collected tips must be fully distributed no later than the regular payday for the workweek, or as soon as practicable after it if amounts cannot be determined in time (29 CFR 531.54(b)(2)). For overtime, the regular rate includes the tip credit taken, but tips above the credit need not be included (29 CFR 531.60), and Fact Sheet #15 says overtime must be calculated on the full minimum wage, not the lower cash wage.

The tax definition. For Social Security and Medicare (FICA) taxes, "wages" means all remuneration for employment, including the cash value of all remuneration, including benefits, paid in any medium other than cash, except listed exclusions (26 U.S.C. 3121(a)); the income tax withholding definition is parallel (26 U.S.C. 3401(a)). IRS Publication 15 says wages subject to federal employment taxes generally include all pay given to an employee for services, in cash or other forms, including salaries, vacation allowances, bonuses, commissions and taxable fringe benefits, and that pay to a former employee for services performed while employed is still wages. Payments in kind, such as goods, lodging or food, are generally taxed at fair market value.

Common tax exclusions. Publication 15 lists several. Amounts paid under an accountable plan for substantiated business expenses are not wages, but payments under a nonaccountable plan are wages and are treated as supplemental wages. Employer payments for accident or health insurance are not wages. Meals are excluded if furnished for the employer's convenience on its premises, and lodging if also furnished as a condition of employment. Back pay, including retroactive increases but not liquidated damages, is taxed as wages in the year paid. These amounts are reported on the employee's Form W-2, and withholding follows the employee's Form W-4.

Tips and supplemental pay for tax purposes. Cash tips of $20 or more in a calendar month are wages; tips paid in any medium other than cash, and cash tips under $20 in a month, are excluded (26 U.S.C. 3121(a)(12)). Employees report cash tips, including card tips, by the 10th of the following month (IRS Publication 15). Bonuses, commissions, back pay, severance and similar payments that are not regular wages are supplemental wages, with an optional flat 22% federal withholding rate and mandatory 37% withholding on supplemental wages over $1 million in a year (IRS Publication 15, 2026).

When the two definitions differ. Lodging is a clear case. Under the FLSA, the reasonable cost of lodging customarily furnished can count toward the minimum wage (29 CFR 531.29). For tax purposes, lodging furnished for the employer's convenience, on its premises and as a condition of employment is excluded from wages (IRS Publication 15). Expense reimbursements, by contrast, fall outside both: Fact Sheet #23 excludes them from the regular rate, and accountable plan payments are not taxable wages.

When wages are due. The Department of Labor says wages required by the FLSA are due on the regular payday for the pay period covered. The FLSA does not require immediate payment of final wages to terminated employees, and it provides no wage collection procedure for promised wages above what it requires, although the Department notes that some states do. Pay frequency and final pay are mainly state questions; see pay period.

Where states differ. Two examples from official state sources. The Texas Payday Law (Texas Labor Code Chapter 61, published by the Texas Workforce Commission) counts vacation, holiday, sick or severance pay owed under a written agreement or policy as wages; requires FLSA-exempt employees to be paid at least monthly and others at least twice a month; requires final pay by the sixth day after a discharge and by the next regular payday after a resignation; and allows deductions only by court order, by law or with written authorization. The California Department of Industrial Relations says most wages must be paid at least twice each calendar month; a discharged employee must be paid immediately, and one who quits without 72 hours' notice within 72 hours, with waiting time penalties of up to 30 days of pay for willful delay. Other states differ, so check your own state agency through the Department of Labor list of state labor offices.

Recordkeeping. For each non-exempt employee, employers must keep the basis of pay, hours worked each workday and workweek, straight-time earnings, overtime premium pay, total additions to and deductions from wages each pay period, total wages paid, and the date of payment and pay period covered (29 CFR 516.2). Tip credit employers must also keep reported tips, the credit taken and hours in tipped and non-tipped work (29 CFR 516.28), and employers counting facilities must substantiate their cost (29 CFR 516.27). Fact Sheet #21 says payroll records are kept at least three years and wage computation records two years. These records are produced in payroll.

What is at stake. An employer that fails to pay minimum wage or overtime is liable for the unpaid amount plus an equal amount as liquidated damages, and one that unlawfully keeps tips is liable for any tip credit taken plus the tips kept, doubled the same way; inflation-adjusted civil money penalties can also apply (29 U.S.C. 216(b) and (e)). Confirm specifics with the Department of Labor, the IRS, your state labor department or a qualified professional.

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