Your obligation to withhold and pay payroll taxes primarily arises upon your payment of wages to your employees. For this purpose, virtually anything of value that you transfer to your employees as compensation for their services constitutes taxable wages. In other words, except in the cases of tips and payments for casual labor, wages in the form of property are subject to payroll taxes to the same extent as cash wages.

Payments made in the form of food or lodging are generally taxable to the employee, unless they are made in that form for the convenience of the employer, and: (a) in the case of meals, they are taken on the business premises, and (b) in the case of lodging, the employee is required to accept lodging on the business premises as a condition of employment. 1998 tax legislation clarified that when meals are provided on the business premises to at least half the employees for the convenience of the employer, the value of the meals is not taxable to any of the employees who receive meals.

One of the first problems you'll encounter when you choose to compensate employees with food, lodging, equipment, or other noncash items is determining how much you paid. For noncash payments, the general valuation rule is that the amount of taxable wages is the fair market value of the benefits or property at the time of payment. In general, "fair market value" is the amount an individual would pay an unrelated third party to obtain comparable benefits and property. So, although you and your employee may agree on an appropriate value for the noncash payment, that agreed-upon value will not necessarily be accepted by the IRS and your other tax authorities.

There are exceptions to the general valuation rule for certain nonexempt fringe benefits subject to special rules (for example, the automobile lease valuation rule, the vehicle cents-per-mile valuation rule, the commuting valuation rule). Most state unemployment agencies have regulations stating the minimum values that can be used for room and/or board, for state unemployment tax purposes. Consult your state department of labor for more details.

Perhaps the biggest problem with paying an employee noncash wages is that you must see to it that the income taxes and FICA taxes that you're required to withhold on these items are available for collection. If you also pay the employee cash wages, you can withhold all the required taxes from the cash remuneration. If you don't pay any cash wages or if the cash wages you pay are insufficient to cover all of the withholding taxes, you must try to get the necessary funds from the employee. Unfortunately, this is frequently easier said than done.