Payroll in Practice: 4.13.21

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: We hired an employee with a military spouse who is stationed in California at a base near our location. If our employee chooses to decline California personal income tax withholding under the Military Spouses Residency Relief Act, are we required to withhold state disability insurance?

Answer: The Military Spouses Residency Relief Act, as applied to California, allows a military spouse to keep a tax domicile outside of California for income tax purposes throughout the marriage. This is true even if the spouse moves to California, provided the spouse moves to California to be with the service member who is in the state because of military orders.

To request exemption from withholding for personal income tax (PIT) under the law, the military spouse should check the box on Line 4 of California Form DE 4, Employee’s Withholding Allowance Certificate, and sign the form.

However, the wages of the service member’s spouse still are subject to California unemployment insurance and disability insurance taxes because the services were performed in California. The Military Spouses Residency Relief Act applies only to state income tax.

The employer is to report the total subject wages for an exempt military spouse on Forms DE 9, Quarterly Contribution Return and Report of Wages, and DE 9C, Quarterly Contribution Return and Report of Wages (Continuation), along with any other subject wages. Subject wages generally are reportable for federal and state unemployment insurance purposes.

On Form DE 9C, the employer is to include the military spouse’s wages in Line F, Total Subject Wages, but enters zero for Line G, PIT wages, and Line H, PIT withheld.

On Form DE 9, the employer should include the service member spouse’s subject wages in Line C, Total Subject Wages Paid This Quarter; subject unemployment insurance wages in Line D, UI Taxable Wages for the Quarter; and subject state disability insurance wages in Line F, SDI Taxable Wages for the Quarter.

Question: An employee took two days of qualified family leave in the third quarter of 2020, but the payments were coded incorrectly in our system as exempt from Social Security and Medicare taxes for the employee share as well as the employer share. The mistake was not detected until after we filed 2020 W-2s. We know how to correct the wages, but how do we correct and recover the additional tax, which amounts to less than $10?

Answer: Unwithheld Social Security and Medicare taxes may be recovered from the employee after the end of the year. Income tax and Additional Medicare tax withholding are the withholding amounts that cannot be adjusted after the end of the end of the year except in the case of administrative errors. These withholding amounts are estimates of the employee’s tax liability and are applied as a credit against the tax liability on the employee’s individual income tax return, which allows employee to recover excess withholding as an income tax refund.

Withheld Social Security and Medicare is the actual amount of tax. These taxes are to be withheld in the year the related wages were paid. On that basis, the amounts can be adjusted so that the correct amount for each year is withheld and paid. For benefits determination purposes, it is important that the employee’s accounts at the Social Security Administration show the correct amounts for each year.

Because the coding error only affected Federal Insurance Contributions Act (FICA) wages and taxes, the income tax wages were reported correctly. However, the employee received money that should have been deposited with the Internal Revenue Service. That is, the amount of compensation to the employee was correct, but the amounts reported and deposited were incorrect. Correction of the information returns, deposit of the taxes, and recovery the funds from the employee resolves the situation.

If the funds are not recovered, the employer still is responsible for remitting them to the IRS. This payment creates an actual wage overpayment in the amount of the employer paid tax plus any gross up of tax on the amount paid by the employer. FICA taxes are deemed withheld when the underlying wages are paid and are to be reported on the employee’s Form W-2, Wage and Tax Statement, regardless of actual withholding or when the employer deposits the taxes.

Whether resolution occurs by recovery from the employee or by employer payment of the tax, there will be no effect on payroll for any year subsequent to the year that the error occurred.

To make the correction, prepare a Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, for each affected quarter. Because there is an underreported amount, the adjustment method is to be used on Form 941-X rather than a claim for refund. Report the correct amounts and corresponding originally reported amounts then enter the amount of the changes for Social Security wages, Social Security taxes, Medicare wages, and Medicare taxes and complete the computations, explanation, and signature sections of the form.

To take advantage of the interest-free adjustment for the correction, file Form 941-X by the due date of the Form 941, Employer’s Quarterly Federal Tax Return, for the quarter that the error was discovered. In this case, it would be the due date for the first quarter 2021 Form 941. Deposit the tax due by the date the Form 941-X is filed.

Correct the W-2 information by preparing Form W-2c, Corrected Wage and Tax Statement, by filling in the employer and employee information and the previously reported and correct information for only the amounts being corrected. Be sure to indicate the year being corrected. File the Form with the Social Security Administration and provide the employee copies to the employee. If you recover the tax from the employee, the employee should not have to file an amended income tax return.

By Patrick Haggerty

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