Depending on your source of information, the definition of “gross” can be extremely good, extremely bad, or an acronym for a club in an old cartoon. In tax-speak, gross is a total before expenses (or taxes) are deducted.
In a legal advice memo issued to program managers (PMTA 2018-15), an auditor asked if the IRS could gross up an employment tax adjustment.
1. During an examination of an employer’s quarterly federal tax returns for 2016, an IRS auditor found that the employer had paid $10,000 of taxable fringe benefits to an employee. The benefits were not included in the employee’s wages in 2016, nor reported on Form W-2, the annual wage and tax statement, for that year.
The auditor said the $10,000 was additional wages in 2016 and the total employment tax due from the employer on the additional wages was $4,030.
Note: The additional medicare tax of 0.9% did not apply to this employee.
2. Under the internal revenue code, the employer is required to withhold income taxes and the employee’s half of the FICA taxes on employee wages. The employer is required to pay those amounts plus the employer’s half of the FICA taxes to the government. That’s true whether or not the taxes are withheld from the employee (internal revenue regulation 31.3403-1).
In this case, the FICA and income taxes on the $10,000 fringe benefit were supposed to be withheld and paid in 2016 and were not. Instead, the employer paid the taxes (both the employee and employer share plus withholding) in 2018 when the IRS found the error.
The IRS said the payment of the $4,030 by the employer satisfies the employer’s FICA obligations under internal revenue code sections 3102 and 3111, and income tax withholding liability under section 3403.
You might be wondering if the fact that the employer paid the employee’s share of tax as well as its own share means the employee received additional wages (of that amount) in 2016. After all, the employee got a benefit from the payment (the employee didn’t have to pay the FICA or the withholding tax).
The IRS said no. The $4,030 of tax the employer paid in 2018 is not additional compensation or wages to the employee in 2016.
And that means the answer to the auditor’s question about “grossing up” the assessment is no. The auditor can’t assess an additional FICA tax and income tax withholding amount on the employer with respect to the unreported fringe benefit income for 2016.
3. What about the $10,000 of unreported taxable fringe benefits that were not included on the employee’s Form W-2 for 2016?
Since those were actual wages, the employer is required to prepare a corrected W-2 (Form W-2c) for 2016, reporting the additional $10,000 of income.
Should the employer include the $2,500 of federal income tax paid on the corrected form?
Should the employer include the employee’s portion of the FICA tax that the employer paid on the corrected form W-2?
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This information should not be considered legal, investment, or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment, or tax advice. Always consult your legal, investment, and/or tax advisor regarding your personal situation.
When income tax withholding is involved and the rate determined under internal revenue code section 3509 (determination of employer’s liability for certain employment taxes) is not applicable, the withholding is either computed under ordinary income tax withholding requirements or by using the supplemental withholding rate in treasury regulation 31.3402(g)-1. (See internal revenue manual section 18.104.22.168.)
The supplemental withholding rate in 2016 is 25%.
Note: This rate was changed to 22% for taxable years 2018 through 2025 in Notice 2018-14.
The payment of the assessment by the employer satisfies the employer’s FICA obligations under sections 3102 and 3111, and income tax withholding liability under section 3403. The payment of the taxes by the employer in 2018, in satisfaction of its own liability, does not result in additional compensation or wages to the employee in 2016.
In other words, the employer’s payment in a subsequent year of taxes that should have been withheld from wages paid in the prior year does not create additional compensation or wages to the employee for the prior year.
Accordingly, the employer’s payment of the assessment does not provide a basis for the auditor to assess an additional FICA tax and income tax withholding amount on the employer with respect to the $10,000 payment for the prior year.
To the extent the $10,000 payment creates any income tax liability for the employee, section 6201 does not provide a basis for assessing the employee’s income tax liability against the employer.
Because the income tax withholding assessed in 2018 was not tax actually withheld from the employee in 2016, the employee gets no credit for the income tax withholding liability paid by the employer as a result of the audit.
Accordingly, no amount should be reported by the employer in box 2, federal income tax withheld, of the 2016 Form W-2c for the income tax withholding assessed and paid by the employer in 2018.
In addition, the employee does not get credit for the employer’s payment of its assessed income tax withholding liability under section 3403 on any 2016 Form 1040X filed by the employee.
Furthermore, the employment tax regulations do not authorize the employer to recover the amount paid in 2018 as its income tax withholding liability for 2016 from the employee. See section 31.6205-1(d)(2).
NOTE: If the employee files Form 1040X and pays his or her income tax liability on the additional wages reported on the corrected W-2, the employer can receive an abatement of the $2,500 it paid as income tax withholding in 2018.
To do this, the employer must get Form 4669, Statement of Payments Received, from the employee.
The abatement can be made prior to the completion of the audit by submitting Forms 4669 and 4670, Request for Relief of Payment of Certain Withholding Taxes, to the auditor.
If the audit is closed, the employer can file the Forms 4669 and 4670 with a claim for refund.
Abatement of income tax withholding would not result in abatement of any applicable penalties.
There are no tax ramifications to the employee if the employer receives an abatement of income tax withholding.
Unlike the federal income tax withholding liability of section 3402 that is only imposed on the employer, the employee FICA tax is a tax imposed on the employee under section 3101. The employer is required to withhold the employee FICA tax under section 3102 and is liable for the payment of such tax whether or not it withholds the tax from the employee.
The employee also is liable for the tax until it is collected from the employee.
Accordingly, while both the employer and employee are liable for the tax, the employee is ultimately liable for the tax imposed by section 3101 regardless of whether it is the employer or the government who collects it from the employee.
Once the employee FICA is paid by the employer or employee, the employee receives credit for the employee FICA tax.
In this case the $10,000 should be added by the employer to the corrected wages on the 2016 Form W-2c in box 1, wages, tips other compensation, box 3, social security wages, and box 5, medicare wages and tips, and the additional employee FICA tax paid by the employer should be reported in box 4, social security tax withheld, and box 6, medicare tax withheld, as applicable.
Section 31.3401(a)-1(b)(6) of the employment tax regulations provides that the term “wages” for income tax withholding purposes includes amounts paid by an employer on behalf of an employee (without deduction from the remuneration of, or other reimbursement from, the employee) on account of any tax imposed on the employee, including the tax imposed by section 3101 (the employee portion of FICA taxes).
If an employer collects less than the correct amount of FICA tax from an employee, the employer must collect the amount of the under-collection by deducting the amount from remuneration of the employee, if any, paid after the employer ascertains the error.
The correct amount of employee tax must be reported and paid whether or not the under-collection is corrected by a deduction and even if the deduction is made after the return on which the employee tax must be reported is due.
If such deduction is not made, the obligation of the employee to the employer is a matter for settlement between the employee and the employer.
If the employer deducts the employee FICA tax from other remuneration paid to the employee or otherwise collects the amount from the employee, the payment of employee FICA tax by the employer is not additional compensation to the employee in 2018.
However, if the employer does not seek repayment of the employee FICA tax from the employee, the $765 of employee FICA tax paid by the employer in 2018 without collecting the amount from the employee is additional wages to the employee when paid in 2018 and is subject to employment taxes.
The employer may either withhold the employee’s FICA tax and income tax on such additional wages in 2018 from other wages or via payment by the employee or may calculate the applicable employment taxes on such additional wages in 2018 by grossing up the employee FICA tax and income tax withholding under the procedures of revenue procedure 81-48 and revenue ruling 86-14.