Some payroll adjustments can’t wait until year-end

Wash bucket and spongeIf you have taxable noncash fringes and similar adjustments that you are holding until December, now may be a good time to rid your year-end bucket list of most of them.

The fact that wages are subject to withholding at the time they are made available to employees (the “constructive receipt doctrine”) is second nature to payroll professionals and the fundamental logic on which payroll systems are based. (IRC §451.)

Compliance is fairly straightforward as well, except when the compensation isn’t a cash wage driven by the usual parameters of the payroll system. Noncash fringes, stock awards, taxable “expense” reimbursements, third-party payments and other similar items that require withholding and reporting after the fact frequently challenge the status quo and raise critical questions concerning the correct timing for wage and tax reporting.

It’s easy to understand how certain types of wages are pushed into an adjustment folder for some later time. Compliance issues arise, however, when the list of year-end adjustments includes items of compensation that were required to be accounted for at the time employees received them.

Exceptions to the constructive receipt rule are limited

In consideration of the difficulties that businesses may encounter in identifying compensable items and determining their cash value, the IRS offers a limited number of exceptions to the general timing rule.

  • Special accounting rule. The most well-known of these exceptions or “rules of convenience” is the special accounting rule that allows employers to defer accounting for certain noncash fringe benefits received in November and December until the following year.
  • Annual taxation specifically allowed. The IRS also specifies that certain noncash fringe benefits, such as the fair market value of group-term life over $50,000 and the personal use of company cars, may be accounted for on an annual basis.

Because the IRS extends these rules of convenience, it is sometimes assumed that they apply to all special wage payments. The fact is, the constructive receipt doctrine applies unless the taxpayer can demonstrate that a rule of convenience is expressly allowed by law, regulation or other substantial authority. Hence, when reviewing compensatory items that are deferred to the end of the year (or the end of the month or quarter), it is important to keep in mind that the IRS will generally assume that the rule of constructive receipt governs, leaving you with the burden to refute its position.

For more information on the fringes and special wage payments that can wait until the end of the year, and those that can’t, see our special report, Why some payroll adjustments can’t wait until year-end

Consider these 2014 Form W-2 reporting changes

Income Tax FormsFor 2014, a few important Form W-2 reporting changes may require some advance preparation to implement, including revised “Third-Party Sick Pay Recap” reporting procedures, automatic rejection of certain incorrect forms and revisions in providing contact information on Form W-3.

“Third-Party Sick Pay Recap” now filed with IRS on Form 8922

Effective January 2015, the Social Security Administration (SSA) will no longer process the “Third-Party Sick Pay Recap,” which is required in order to reconcile Forms W-2 to Form 941 when insurance companies and plan administrators share employment tax responsibilities with their client employers for disability payments.

Under the new procedures, applicable insurance companies, administrators and employers will be required to file Form 8922, Third-Party Sick Pay Recap, with the IRS by 28 February (or 31 March if filed electronically).

The IRS expects to release the final Form 8922 by December 2014. The draft form is available here.

SSA will now return certain invalid Forms W-2

The SSA announced that beginning with tax year 2014, it will reject for correction Forms W-2 that are filed with the following errors:

All employers

  • Medicare wages and tips are less than the sum of Social Security wages and Social Security tips.
  • Social Security tax is greater than zero, but Social Security wages and Social Security tips are equal to zero.
  • Medicare tax is greater than zero, but Medicare wages and tips are equal to zero.

Household employers

  • Sum of Social Security wages and Social Security tips is less than the minimum yearly earnings subject to Social Security and Medicare tax withholding for a household employee.
  • Medicare wages and tips are less than the minimum yearly earnings subject to Social Security and Medicare tax withholding for a household employee.

To avoid having their Form W-2 files returned, household employers should keep in mind that Social Security/Medicare tax does not apply to household employees if:

  • An employee’s wages are $1,900 or less in 2014.
  • Wages are paid to an individual who is under 18 at any time during the year and household work is not his/her principal occupation.
  • Wares are paid to a regular student.
  • An employee was paid less than $100 in the year by an exempt organization.

Contact information

The Form W-3 (and W-3c, W-3SS) now specify that the employer’s contact information is requested and not simply the contact name, telephone number, fax number and email address.

Additionally, the placement of the boxes for fax number and email address is reversed in order to make additional space for a longer email address.

For more information about covered employment and wages for Social Security and Medicare, see IRS Publication 15. For more information about what’s new in 2014, read here.

Ernst & Young LLP insights

Employers should keep in mind that having the SSA reject Forms W-2 puts them at risk of incurring penalties of up to $100 per form (with an annual maximum penalty of $1.5 million). The same penalties also apply to the employee statements.

Employers can prevent these kinds of Form W-2 filing errors by making sure that they or their vendors test Form W-2 files using SSA’s AccuWage software.

AccuWage has been updated for tax year 2014.

Check out our year-end payroll planning resources.

Employee or independent contractor? State audits to heat up

umbrella and business suitThe U.S. Department of Labor’s Employment and Training Administration (ETA) recently notified state workforce agencies of $10 million in supplemental funding available to them to address worker misclassification within the federal-state unemployment insurance (UI) program. (UIPL #18-14.)

At the same time, two high-profile cases  involving California and Oregon employers show a trend of the courts ruling against employers when they assert their workers are independent contractors and not employees.

With much more focus on the underground economy and “wage theft,” businesses should re-evaluate the population of workers they treat as independent contractors with an eye to the state guidelines that are sometimes more stringent than the IRS common-law test.

For more about the different tests states use in determining if workers are employees and how they enforcing those rules, read our special report.

 

Illinois tax refunds may apply to same-gender married couples

IRSDuring the IRS payroll industry telephone conference, Scott Mezistrano, IRS Industry Stakeholder Engagement, announced on 7 August 2014, that Illinois same-gender partners who elect to convert their Illinois civil unions to marriage will be deemed married according to the retroactive date applicable under Illinois law.

Background

Illinois allowed same-gender couples to enter into a civil union effective 1 June 2011 (Public Act 096-1513). Effective 1 June 2014, same-gender couples were granted the lawful right to marry. Accordingly, civil union partners are given the choice to convert their civil unions to marriage, the date of such marriage recorded as the date of the original civil union (Public Act 098-0597).

Income tax refunds

Individuals who have converted their civil unions to marriage may have an opportunity to file for federal income tax refunds if the original date of the civil union was on or before 31 December 2013.

In contrast to federal law, Illinois provides that civil union partners may choose to file as “married filing jointly” or as “married filing separately” when preparing their Illinois Individual Income Tax forms. (Illinois Income Tax news.)

FICA refunds

Subsequent to the Supreme Court decision in Windsor, the Treasury Department and the IRS ruled in Revenue Ruling 2013-17 that same-gender couples who are legally married in state and foreign jurisdictions recognizing same-gender marriages will be treated as married for US federal tax purposes.

The IRS issued Notice 2013-61 to provide guidance for employers and employees making claims for refund or adjustments of FICA taxes and income tax withholding resulting from Windsor and the holdings of the Revenue Ruling 2013-17. That guidance includes a special administrative procedure allowing employers to file one Form 941-X for each tax year (rather than one Form 941-X for each quarter, which is the normal rule).

FICA refunds may be claimed for all open years and quarters, currently (and pursuant to Illinois taxpayers affected by its law change), for periods beginning 1 June 2011.

Ernst & Young LLP insights

Upon enacting legislation to allow same-gender couples to marry, a few states with civil union provisions automatically converted those civil unions to marriage (e.g., Connecticut, effective 1 October 2010; Delaware, effective 1 July 2014; and New Hampshire, effective 1 January 2011).

Illinois’ provision is unique in that individuals must choose to convert their civil unions to marriage, and in doing so, the marriage date is retroactive to the original civil union date.

For questions contact Debby Salam at debera.salam@ey.com.