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Reward star employees: Pick up the tax tab for their raises

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in Small Business Tax,Small Business Tax Deduction Strategies

When you want to reward an up-and-coming star at your company, taxes can substantially dilute that well-deserved raise.

Strategy: Make your employee “whole” after a salary increase. Pay the employee enough to cover the raise plus the taxes he or she owes as a result.

Can’t you just simply pay the employee’s share of income and employment taxes? The IRS says this is a no-no. Under a long-standing ruling, the payment is treated as additional taxable compensation to the employee. (IRS Revenue Procedure 81-48) This creates a pyramid effect where the employee owes “tax on the tax” that is treated as taxable compensation and so on.

Of course, you can keep recomputing the tax that will be due until you arrive at a negligible additional tax liability. But there is a much easier way to do it:

Payment = amount of original increase/1 minus applicable tax rate.

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