I† get asked this question every year, so I figured I would get it out for† you all to consider and so you can answer employee questions.
The Question: Are end-of-year paychecks taxable in the year of the work or the† year of the paycheck?
The rule is:† The paycheck is considered as taxable income in the year the paycheck is ISSUED (dated), even if the work was done and the pay was earned in a different year (but read the exception below).
You pay employees on January 2, 2012, for work done in the last week of December 2011.† The gross pay is taxable in 2012, not 2011.† If for some reason you wanted to pay employees on the last day of December for this work, the paycheck date of December 31, 2011, would mean the pay is taxable income in 2011.
An exception to this rule:
If for some reason you make paychecks available to employees before the end of the year, even if dated 2012 -- through direct deposit, for example -- the pay must be considered to be received (and taxable) in 2011.†† This is called "constructive receipt" and it means that the income is taxable if the person receiving it had control over it.
My suggestion: Don't get ahead of yourself; hand out paychecks when they are typically distributed.† Then you won't have any problem figuring out what's what.† And let your CPA or tax advisor help you if you have more questions.
How does this rule affect W-2 forms for employees?
The last paycheck dated in December is included in 2011 W-2 earnings.† That check dated January 3 is included in 2012 W-2 earnings.
More end-of-year tax timing tips for business income and expenses.
More about Preparing W-2 Forms (Remember, these forms must be given to employees by the end of January 2011.)