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