Payments by employers to employees made in connection with employment contracts must be treated as wages for purposes of FICA, FUTA, and Federal income tax withholding, according to two rulings published by the Treasury Department and the IRS.

The first ruling, Revenue Ruling 2004-109, clarifies that employment taxes must be paid--and income taxes withheld--on bonuses paid for signing of an employment contract. The ruling addresses situations such as signing bonuses paid in connection with the first contract between a baseball club and a baseball player and payments made upon ratification of a collective bargaining agreement.

The second ruling, Revenue Ruling 2004-110, concerns payments made in connection with the cancellation of an employment contract. The ruling clarifies that, if an employment contract is cancelled before its agreed-upon end and a payment is made in lieu of the remaining period of employment, the payment is treated as wages for purposes of employment taxes and income tax withholding.

Because these rulings revoke or modify prior rulings, the new rulings will not apply to certain payments made before January 12, 2005, such as signing bonuses, sign-on fees or other amounts paid in connection with an employee's initial employment or payments made or agreed to on the cancellation of an employment contract. This relief applies only where the facts and circumstances relating to the payments are substantially the same as the revoked or modified rulings, according to the IRS.