Payroll in Practice: 3.30.21

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: Our Forms W-2 were filed with the IRS without reporting 401(k) deductions in Box 12 (Code D). We are reissuing the forms as corrected to the affected employees. Do we also need to file them with the IRS?

Answer: Reissued Forms W-2, Wage and Tax State, generally may be sent to employees before filing the original W-2s with the Social Security Administration. The employee copies are marked “Reissued Statement” so that employee knows which copies to use for filing with an individual tax return. In this case, the employer files the correct W-2 with the SSA; the incorrect W-2 is not filed.

Reissued forms may also be used after the original forms were filed with the SSA to replace original employee copies or to change the employee’s address on an original W-2 Form that was mailed to the employee but not delivered because the address was incorrect. The employer does not file such reissued statements with the SSA or the IRS.

An incorrect employee address is treated as an inconsequential error with respect to the SSA or IRS. An inconsequential error or omission is not considered a failure to include correct information since it does not prevent or hinder the SSA or the IRS in terms of processing the form, correlating required information with information reported on the employee’s tax return or otherwise putting the form to its intended use.

However, an incorrect address may be consequential with regard to furnishing the W-2 to the employee because the employee needs that information to prepare a complete and accurate tax return.

The situation described in the question involves W-2 Forms that have already been filed with the SSA, but the employer did not include information about Section 401(k) deductions that is required to be reported with a Code D in box 12. This information is not considered inconsequential and must be corrected by filing Forms W-2c, Corrected Wage and Tax Statement, with the SSA and furnishing the employee copies of the W-2c to the employees. Forms W-2c are not sent to the IRS.

The information is consequential because of the overall limitations on salary reduction contributions. For 2020 the contribution limit for employees who participate in Section 401(k), 403(b), most 457 plans, and the federal Thrift Savings Plan is $19,500. The catch-up contribution limit for employees 50 and older who participate in these plans is $6,500.

The limit applies to all salary reduction contributions and elective deferrals. If in conjunction with other plans the deferral limit is exceeded, the difference is included in the employee’s gross income.

Sometimes the limit is exceeded when an employee has plans with more than one employer during the year, however, this can also happen when an employee participates in more than one plan with a single employer.

Knowing the amount of the deferrals is important information for the employee in preparing an accurate tax return and for the IRS so that it can tell if there were excess deferrals that needed to be corrected or included in income.

In this case, any excess deferral is included in the employee’s gross income for 2020. If the employee removes the excess deferral by April 15, 2021, it is not reported again by including it in the employee’s gross income for 2021. However, any income earned in 2020 on the excess deferral taken out is taxable in the tax year in which it is removed. The distribution is not subject to the additional 10% tax on early distributions. If the employee takes out part of the excess deferral and the income on it, the distribution is treated as made proportionately from the excess deferral and the income.

If the employee does not remove the excess deferral by April 15, 2021, the excess does not increase the employee’s cost basis in figuring the taxable amount of any eventual distributions under the plan even though it was included in the employee’s gross income for 2020. That means any excess deferrals left in the plan are taxed twice—once when contributed and again when distributed.

For the employer, the plan can be disqualified if the employee’s excess deferral is allowed to stay in the plan and the employee participates in no other employer’s plan.

By Patrick Haggerty

Do you have a question for Payroll in Practice? Send it to phaggerty@prodigy.net.