Practitioners’ questions are answered by a payroll and tax consultant who also is an enrolled agent licensed to practice before the Internal Revenue Service.
Question: With regard to an employee repayment of a wage overpayment, we collect the gross less the withheld Social Security and Medicare taxes. Our company also requires the employee to sign a letter stating that we have refunded the employment taxes to the employee, who will not seek a refund from the IRS. Getting employees to repay an overpayment is hard enough and obtaining the letter delays the process. Is the letter necessary?
Answer: Yes. A signed letter from the employee is required by the IRS to ensure that employers who receive refunds of overwithheld taxes are passing on the refunds to the employees. The reason: Amounts withheld for taxes belong to the employee.
The claim for refund or adjustment is made on Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund.
Part 2 of Form 941-X contains certifications employers must make. Line 3 must always be checked to certify that the employer filed or plans to file Forms W-2, Wage and Tax Statement, or W-2c, Corrected Wage and Tax Statements, which are required because of the changes reported on Form 941-X.
An additional certification must be made on Line 4 if the employer is requesting an adjustment of overreported amounts. Similarly, a certification is required on Line 5 if the employer is requesting a refund or abatement of overreported amounts.
To obtain a refund or adjustment of the employee’s share of the overreported amount, the employer must certify that the employee’s share was refunded or that the employer received written consent from the employee to file a claim for the share. If the claim is for overcollected Social Security or Medicare tax from a prior year, the employer must also certify that a written statement was obtained and the employee has not claimed and does not plan to claim a refund or credit.
The employer may also certify that the request for adjustment or refund is for only the employer’s share of the tax because the claim does not involve withheld employee taxes or the employer was not able to obtain the required statements from the employee.
I suggest that having the employee repay the gross overpayment and the employer refund the Social Security and Medicare taxes on the amount repaid is a better practice from a control standpoint than your current practice of collecting the gross minus the Social Security and Medicare taxes.
This is particularly true with partial repayments because amounts that were not repaid, including taxes, are considered taxable income to the employee. For example, I think it is easier to collect $500 and refund the employment tax on that amount than to determine how much of the tax was included in the refund, which would require a gross-up calculation.
If the repayment is for a prior year, the employee must refund the income tax withheld from the amount overpaid. This is required because the employee will recover the withheld income tax through the employee’s Form 1040, U.S. Individual Income Tax Return, rather than from the employer. To not have the withheld income tax remain taxable income, the employee must repay the funds to the employer.
The collection problem is understandable. However, the employer is supposed to refund the excess taxes to the employee. For its own protection, the employer should document that the money was refunded to the employee.
To facilitate the process, you may want to consider simultaneous checks: The employee writes a check to the company for the amount of the repayment amount and the employer writes a check to the employee for the share of the employment taxes on the amount repaid. The net effect is the same as what you now are doing, but provides the additional benefit of documentation of the refund.
In April 2017, in conjunction with revision of Form 941-X and the accompanying instructions, the IRS released Revenue Procedure 2017-28 in Internal Revenue Bulletin 2017–14.
This revenue procedure provides guidance to employers on the requirements for employee consent used by an employer to support a claim for refund of overpaid taxes and clarifies the basic requirements for both a request for employee consent and for the employee consent. The procedure also allows employee consent to be requested, furnished, and retained electronically.
The Revenue Procedure contains guidance as to what constitutes the reasonable efforts required by the regulations when employee consent has not been obtained. These reasonable efforts allow an employer to claim a refund or allowance for the employer share of the taxes.
The regulations provide that when taxes were withheld from an employee, the employer has a duty to make reasonable efforts to protect the employee’s interests in any employee share of the refund. Code of Federal Regulations, Section 31.6402(a)–2(a)(1)(ii), provides that no refund for the employer share of the overpaid FICA taxes would be allowed unless the employer has first repaid or reimbursed its employee or has secured the employee’s consent to the allowance of the claim for refund and includes a claim for the refund of the employee share.
However, this requirement does not apply to the extent that the taxes were not withheld from the employee or, after the employer makes reasonable efforts to repay or reimburse the employee or secure the employee’s consent, the employer cannot locate the employee or the employee will not provide consent.
By Patrick Haggerty
Do you have a question for Payroll in Practice? Send it to firstname.lastname@example.org