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.

EY polling shows room for employer improvement in unemployment tax performance

ey-rhf-ui-awareness-month-highlightsDuring Ernst & Young LLP’s 7 August 2014 webcast, “Unemployment insurance: how do you rate?,” participants were given the opportunity to respond to four questions about their management of unemployment insurance tax and whether they have experienced a merger or acquisition activity in this last three years.

Worth noting is that 44% of responders said the tax director requests information concerning the company’s unemployment insurance tax performance, and another 16% believe this is an approach worth considering.

Of concern is the large number of responders (54%) who don’t plan to project the impact of their claims activity on the upcoming year’s unemployment tax rates/costs and another 45% who don’t plan to review the accuracy of unemployment insurance contributions for the prior three years, although 56% of the same responders said they had business acquisition activity in the same period.

These polling results indicate the potential for unemployment tax performance improvement by a significant population of employers not currently embracing leading practices, such as tax director oversight and holistic program oversight.

Read details concerning the 2014 polling results.

Benchmark your unemployment insurance performance with our groundbreaking survey

Businesses interested in benchmarking their unemployment tax performance with others in their states or industries are encouraged to participate in the Ernst & Young LLP national survey.

Watch our introductory video.

Watch out when reimbursing employees for health insurance

Health plan reimbursementsFor various reasons, employees may not be able to take advantage of health insurance benefits offered through their employer’s group plan. Employers may accommodate such employees by agreeing to reimburse them for all or a portion of the cost incurred in purchasing their own individual health insurance policies.

Provided reimbursed employees submit receipts substantiating their out-of-pocket expenses for their health insurance purchases, these reimbursements retain their tax-favored status as a health and welfare benefit.

Although the income tax withholding and employment tax rules have not changed, new rules effective 1 January 1 2014, will cause large employers to think differently about how they offer health insurance benefits to employees who are not participating in the company’s group plan.

The Affordable Care Act

The IRS recently posted a frequently asked questions (FAQ) to its website reminding employers subject to the health market reforms of the Affordable Care Act (ACA) that effective January 1, 2014, reimbursing employees for their purchase of an individual health insurance policy could result in penalties under IRC §4980D of up to $100 per day/$36,500 per year for each employee participating in the employer’s group health plan.

For instance, assume that an employer has 1,000 participants in its group health plan and one of its employees is reimbursed for health insurance that he or she individually purchases. The potential penalty in this case is $100,000 per day.

Income tax withholding and employment tax rules have not directly changed

The federal employment and income tax withholding rules have not changed. It is still the case that if employees substantiate the cost of their individually purchased health insurance, such reimbursement receives tax-favored treatment under IRC §105 as follows:

  • Nondiscriminatory health plans. If the health policy reimbursement is made pursuant to an employer’s nondiscriminatory health plan, it is excluded from wages subject to federal income tax, federal income tax withholding, Social Security/Medicare and federal unemployment insurance.
  • Discriminatory plan. Reimbursements for individually purchased health insurance made to non-highly-compensated employees follow the rules applicable to nondiscriminatory plans (see above). However, reimbursements made to highly compensated employees are subject to federal income tax but are exempt from federal income tax withholding, Social Security, Medicare and federal unemployment insurance tax. (IRC §3401(a)(20); Reg. §31.3401(a)(19)-1; IRC §3121(a)(2)(B); Reg. §31.3121(a)(2)-1(a)(3); IRC §3306(b)(2)(B), (b)(4) and Reg. §31.3306(b)(2)-1(a)(3).)

Extra pay day? Here’s a refresher

Bakers dozen graphicA number of our clients with weekly and biweekly payroll periods have been raising questions about an additional payroll period occurring within their businesses this year. These queries alert us that many employers are dealing with an anomaly in 2014 that comes around every several years thanks to our calendar-year system. For businesses that are now or soon will be dealing with this payday “baker’s dozen,” here are answers to the questions frequently raised.

Income tax withholding

In the year in which there is an additional payroll period, weekly and biweekly payers must be certain to adjust the computer formulas used to compute federal income tax withholding (FITW). (Similar adjustments to the state and local income tax withholding formulas may also be necessary.)

The computer formula used by most automated payroll systems to compute federal income tax withholding is generally based on 26/52 payroll periods and is rarely automatically adjusted when there are 27/53 payroll periods. According to the IRS Office of Chief Counsel, employers using an annual withholding method must base the FITW computation on the actual number of pay periods in the year.

In other words, in the year of an additional payroll period, pay period wages are multiplied by 27/53 rather than 26/52, and the annual tax is divided by 27/53 rather than 26/52. Failure to make this modification in the FITW computation can result in the underwithholding of federal income tax (see the example below). Such errors can result in adverse consequences (e.g., tax liability, interest and penalty).

Example: Employee Angela earns $1,260 each biweekly pay period in 2014. She claims single with no allowances. She will receive 27 paychecks in the year. If her employer uses 26 payroll periods to compute her federal income tax withholding, the FITW for the year will be $189 less than it should be ($4,311.75 – $4,122.75), as shown in the calculations below.

  1. Annual withholding based on a normal 26-pay-period year:

$1,260 × 26 = $32,760

2014 FITW on $32,760 = $4,122.75

[($32,760 −$11,325) × 15% + $907.50]

  1. Annual withholding based on a 27-pay-period year:

$1,260 × 27 = $34,020

2014 FITW on $34,020 = $4,311.75

[($34,020 − $11,325) × 15% + $907.50]

Don’t forget to readjust calculations in the subsequent year. Employers must be sure to count the number of pay periods in each tax year to determine if an adjustment in the FITW computation (as previously described) is necessary. If there was an additional pay period in one tax year, and the computer formula was modified to take into account the additional pay period, be sure to change the computation back to a pay period wage multiplication of 26/52 and a division of the annual tax by 26/52 for the subsequent tax year.

Budgetary considerations

The additional payroll period will generally always result in higher-than-normal annual wages for nonexempt employees; however, whether the same is true of exempt-salaried employees depends on how their payroll period wages are determined.

There are three approaches for computing the weekly/biweekly pay of exempt-salaried employees, each having a different budgetary result.

1.  Recompute the annual salary in the year of an additional payroll period. The agreed-upon annual regular salary of exempt employees is divided by the actual number of payroll periods in the year. Hence, the biweekly pay of a salaried employee is 26 or 27 in the year having an additional payroll period. (See Example 1.)

Example 1. John’s employer agrees to pay him $50,000 per year. John is paid biweekly. In those years in which there are 26 payroll periods, John’s biweekly pay is $1,923.08 ($50,000/26). In the year in which there are 27 payroll periods, John’s biweekly pay is $1,851.85 ($50,000/27).

Budgetary result. In all years, including the year of the additional payroll period, John’s annual compensation is close to the agreed-upon regular salary of $50,000.

2.  Do not recompute the annual salary in the year of an additional payroll period. The agreed-upon annual regular salary of exempt employees is divided by 26 or 52 payroll periods and is not adjusted in those years with an additional payroll period. The result is a windfall in pay in the year of an additional payroll period. (See Example 2.)

Example 2. Mark’s employer agrees to pay him $50,000 per year. Mark is paid biweekly. His biweekly pay is computed as $1,923.08 ($50,000/26). In those years with 26 payroll periods, Mark is paid $50,000.08. In the year in which there are 27 payroll periods, Mark is paid $51,923.16 ($1,923.08 x 27).

Budgetary result. In the year of the additional payroll period, Mark receives excess compensation of $1,923.16 ($51,923.16 – $50,000). In all other years, Mark’s annual salary is close to the agreed-upon amount of $50,000.

3. Use the exact calendar-year divisor of 26.0893 or 52.1786. The agreed-upon annual regular salary is divided by 26.0893 for those paid biweekly and 52.1786 for those paid weekly. (See Example 3.)

Example 3. Ruth’s employer agrees to pay her $50,000 per year. Ruth is paid biweekly. Her biweekly pay is computed as $1,916.49 ($50,000/26.0893).

Budgetary result. In those years with 26 pay periods, Ruth is paid $49,828.74, which is $171.26 less than her agreed-upon annual regular salary of $50,000. In the year in which there are 27 payroll periods, Ruth is paid $51,745.23, an excess of $1,745.23 over the agreed-upon regular salary of $50,000.

Ernst & Young LLP insights

To eliminate complications in paying the correct annual salary to exempt employees, it is not uncommon that businesses pay their salaried exempt employees on a semimonthly basis (where allowed by state law) while paying hourly and salaried non-exempt employees on a weekly/biweekly basis. Always consult with a competent labor law advisor before making a change in the amount or frequency at which you pay salaried employees.