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, 2013, for work done in the last week of December 2012. The gross pay is taxable in 2013, not 2012. If you pay employees on the last day of December for this work, the paycheck date of December 31, 2012, would mean the pay is taxable income in 2012.
An exception to this rule:
If you make paychecks available to employees before the end of the year, even if dated 2013 -- through direct deposit, for example -- the pay must be considered to be received (and taxable) in 2012. The IRS says employees must have access to the paycheck "without substantial limitation or restriction." 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.
If you are confused, you can get help from your CPA or other tax professional. If you are REALLY confused, you might want to consider getting a payroll service to help with these kinds of issues. Read more about selecting a payroll service.
How does this rule affect W-2 forms for employees?
The last paycheck dated in December is included in 2012 w-2 earnings. The first paycheck in January is included in 2013 W-2 earnings. Read more about Preparing w-2 Forms (Remember, these forms must be given to employees by the end of January 2013, for 2012 wages.)