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Is It a Wage? The IRS Says "Yes"

Although the IRS view of meal and rest break premium pay will not control the current debate headed to the California Supreme Court regarding its characterization as a wage or a penalty, it is still important to know how the IRS views such pay. For example, employers often like to pay settlements of meal and rest break pay by issuing lump sum payments, without withholding, and later reporting the expense with a form 1099. Then they ask the employees to agree to indemnify the employer if the IRS later assesses penalties. Thus, it is important for employees' counsel to know if the IRS would find fault with such an arrangement. So how do the feds see it?

It is a wage.

In a March 2005 opinion letter, an assistant chief counsel for the IRS provided this analysis:

You have asked whether a payment required to be made under section 226.7 of the California
Labor Code (Labor Code) is a wage payment subject to the Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA), and income tax withholding provisions of the Internal Revenue Code (Code).

Under a proposed regulation promulgated by the California Division of Labor Standards Enforcement (DLSE), any amount paid or owed by an employer to an employee under Labor Code section 226.7(b) for failing to provide the employee a meal period or rest period is a penalty and not a wage. Thus, the employer is not required to include the additional hour of pay required by section 226.7(b) in calculating wages for state employment tax purposes.

Generally, for FICA and FUTA purposes, the term “wages” means all remuneration for employment, unless specifically excepted. The provisions relating to the withholding of income tax contain a similar definition. None of the exceptions to the definition of wages for purposes of FICA, FUTA and income tax withholding are applicable to the additional hour of pay authorized by section 226.7(b) of the Labor Code. Additionally, the regulations that implement the Code provide that the name by which the remuneration for employment is designated is immaterial. See Employment Tax Regulations sections 31 .3121 (a)-1 (c), 31 .3306(b)-I (C), and 31 .3401(a)-i (a)(2). Thus, the characterization of the additional hour of pay as a penalty by the proposed DLSE regulation has no bearing on whether the payment is wages for purposes of FICA, FUTA or income tax withholding.

Although the employees in this case may not perform services directly related to receipt of the additional hour of pay, the payment arises from the employment relationship and is analogous to the “idle time” payments made by the employer in Rev. Rul. 76-217, 1976-1 C.B. 310. Under the facts of that ruling, an employer paid its employees for a minimum number of hours each pay period whether the employees worked less than the minimum number of hours or performed no services at all. The ruling concluded that the idle time payments made to employees are remuneration for employment and are wages for purposes of FICA, FUTA and income tax withholding.

Thus, for at least some purposes, such pay is a wage. This opinion does not address whether sums allocated to interest or other penalties should be treated as wages.

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