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Individual Tax

No “gross up” where employer pays taxes on prior year’s unreported income to employee

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

Program Manager Technical Advice 2018-015

In Program Manager Technical Advice (PMTA), IRS has determined that an employer’s payment of taxes that should have been withheld in a prior year, on taxable fringe benefit income provided to an employee but not timely reported to IRS, does not create additional wages to the employee for that prior year. IRS also explained the reporting requirements associated with the unreported income and the tax payment.

Background. Employers and employees are subject to employment taxes under the Federal Insurance Contributions Act (FICA; referred to throughout as the employer share of FICA and the employee share of FICA), which imposes Social Security taxes and Medicare taxes on both employers and employees with respect to wages paid to employees. (Code Sec. 3101(a)Code Sec. 3111(a))

Employers are required to withhold, and are liable for the payment of, the employee share of FICA tax and the Federal income tax on wage payments that they make to their employees. (Code Sec. 3102(a)Code Sec. 3402(a)Code Sec. 3102(b)Code Sec. 3403) This liability applies regardless of whether the employer actually collects the tax from the employee. (Reg. § 31.3102-1(d)Reg. § 31.3403-1) The employee is also liable for the employee share of FICA.

Code Sec. 3402(d) provides that “if the employer… fails to deduct and withhold the tax… and thereafter the tax against which such tax may be credited is paid, the tax so required to be deducted and withheld shall not be collected from the employer.” (See also Reg. § 31.3402(d)-1)

Under Code Sec. 31, the amount withheld as income tax during any calendar year is allowed as a credit against the income tax of the income’s recipient for the tax year beginning in such calendar year. Reg. § 1.31-1(a) provides that the tax deducted and withheld at the source upon wages is allowable as a credit against the tax imposed upon the recipient of the income. If the tax has actually been withheld at the source, credit or refund is made to the recipient of the income even if the employer failed to pay over such tax to the Government.

If an employer pays the employee share of FICA without deducting that payment from the employee’s pay, the employer must generally increase the amount of the employee’s wages by the amount of this employer payment, referred to as a “gross up.” (Code Sec. 3121(a)(6))

Every person required to deduct and withhold tax from an employee under Code Sec. 3101 or Code Sec. 3402 is required by Code Sec. 6051(a) to furnish to each employee a written statement including the total amounts of wages and the total amounts deducted and withheld as tax. Under Reg. § 31.6051-1(c)(1), for FICA tax purposes, if the amount of wages or tax entered on a statement to an employee for a prior year was incorrect, the employer must furnish a corrected statement for the prior year to the employee.

Facts. In 2018, IRS employment tax exam (Exam) examined an employer’s Forms 941, Employer’s QUARTERLY Federal Tax Return, for all quarters of tax year 2016, and identified $10,000 of taxable fringe benefits provided by the employer to an employee that weren’t included in wages in 2016 or reported on a Form W-2, Wage and Tax Statement, or Form 1099-MISC, Miscellaneous Income, provided to the employee.

Exam correctly characterized the $10,000 fringe benefit amount as additional wages in 2016 and computed that the employer owed an additional $4,030 in income tax withholding, employer share of FICA, and employee share of FICA tax on the additional wages. The employer paid the full $4,030 assessment in 2018.

Issues.  The issues raised in the PMTA were whether the employer’s payment of the tax assessment created additional wages to the employee for 2016, and if not, what the information return reporting implications are for the employer for the exam year (2016) and the year in which the additional taxes were paid (2018).

No gross-up. The PMTA concluded that the taxes paid by the employer in 2018 with respect to the unreported 2016 income can’t be added to the employee’s 2016 wages.

The PMTA reasoned that the employer’s payment of taxes that should have been withheld in a prior year—and for which the employer was liable—does not create additional wages to the employee for that prior year.

The employer was required to prepare a Form W-2c for 2016 reporting the $10,000 in fringe benefit income, furnish a copy to the employee, and file a copy with the Social Security Administration.

The employee will get no credit for the income tax withholding liability that the employer paid in 2018 because it was not “actually withheld” from the employee in 2016. The PMTA noted that the withholding liability in this case was not paid on the employee’s behalf, but rather was paid to satisfy the employer’s own liability. So, no amount should be reported by the employer in box 2, Federal income tax withheld, of the 2016 Form W-2c, and the employee gets no credit for the payment on his or her 2016 amended return.

However, with respect to the employer’s payment of the employee share of FICA, the employee will receive credit, and the employer should reflect the payment in Form W-2c, apportioning it appropriately between box 4, Social security tax withheld, and box 6, Medicare tax withheld.

References: For FICA tax, see FTC 2d/FIN ¶ H-4545United States Tax Reporter ¶ 31,114. For withholding by employers, see FTC 2d/FIN ¶ H-4220 et seq.; United States Tax Reporter ¶ 34,024.

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