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: What effect does the 2020 Form W-4 have on existing prior-year IRS lock-in letters for employees?
Answer: When the IRS has determined that a taxpayer has compliance issues regarding tax returns or income tax withholding, the agency may send a lock-in letter to the taxpayer’s employer. The lock-in letter specifies the employee’s allowed filing status and provides withholding instructions that the employer is required to follow and the date that the employer is to start withholding according to those instructions.
The employee has an opportunity to contest the notice with the IRS and the lock-in letter includes a copy the employer is to provide to the employee that details the process by which the employee can provide additional information to the IRS to aid in determining the appropriate amount of withholding or modify the filing status. The time between the date the employer is to have delivered the letter to the employee and the date the employer is to start withholding per the letter instructions is to allow the employee to contact the IRS.
If the employee provides the employer with a new Form W-4, Employee’s Withholding Certificate, after a lock-in letter or a modification notice, the letter or notice remains effective unless the new W-4 results in more income tax withholding than the amount listed in the letter or notice. That is, if the employee submits a Form W-4 that would result in less withholding than required under the letter or notice, the employer is to disregard the new W-4.
If the employee submits a new W-4 that results in more withholding than required under the letter or notice, the W-4 is treated as valid. However, the letter or notice remains in effect and the employee still cannot submit a subsequent W-4 that results in less withholding than required under the letter or notice.
For lock-in letters or modification notices issued before 2020, the employer is to continue to use the same withholding restrictions specified in the letter or notice until the IRS issues a new letter or modification notice. However, if the employee submits a 2020 W-4 that results in more tax withholding than would be withheld under the lock-in letter or modification notice, the employer must honor the new withholding certificate.
Unless the IRS issues a modification notice that specifies withholding restrictions for that employee based on the 2020 W-4 filing status and additional withholding rather than the prior year instructions using filing status and allowances, the existing lock-in letter or modification notice remains effective with regard to calculating the minimum amount to withhold. That is, the changes to the 2020 W-4 do not have any effect on the withholding procedure to be used under an existing lock-in letter or modification notice issued before 2020.
Question: We have a problem involving a wage overpayment made to an employee in 2019, and an underpayment to another employee in 2019 that was not included in her W-2. Both now are former employees. How should this situation be corrected?
Answer: To correct the overpayment, the employee must repay the gross amount of the overpayment, including tax deductions. The employer must refund the Social Security and Medicare taxes that were withheld and obtain the required receipt and statement from the employee. The employer can file Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, for the first quarter of 2019 to make an adjustment or refund claim for the overpaid FICA taxes.
The employer also may be required to file Form W-2c, Corrected Wage and Tax Statement, for Social Security and Medicare wages and taxes, but not income tax wages or income tax withholding, for the overpaid employee. The income tax wages remain taxable income to the employee for 2019 because the employee had use of the money during 2019 and the employee may claim the withholding as a credit against the employee’s 2019 income tax liability.
Because the amount involved is less than $3,000, the overpaid employee cannot recover the tax paid on the overpayment despite refunding the overpayment. Under the tax code overhaul (Pub. L. 115-97) that took effect Jan. 1, 2018, the employee may not take the repaid amount as an itemized deduction and may not claim a credit in 2020 for the tax paid in 2019.
An option the employer might consider, given the amount involved, would be to not seek recovery of the payment for the overpaid employee. In that case, corrections to Form 941 or the W-2 issued to the employee is necessary because the amount paid remains wages to that employee.
For the other employee, the issue involved is a wage underpayment. Because the employee is to be paid in 2020, there is no need to adjust payroll records, filings, or deposits for 2019. The amount paid is reported as any other wage payment made in 2020. Withhold based on the employee’s most recent valid Form W-4. Even though this is a payment to a former employee, it is still wages and is treated as if the worker is still employed. However, it may be wise to check with legal counsel regarding potential wage and hour issues related to late payment of wages.
By Patrick Haggerty
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