Payroll in Practice: 4.26.21

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 are an accounting firm. One of our clients is a household employee who received a 2019 W-2 that reported $53,060 income tax wages in Box 1, and Social Security and Medicare wages of $50,000 in boxes 3 and 5. The W-2 reported $0 in boxes 2, 4, and 6 for the respective tax amounts. The additional $3,060 is the employee share of Social Security and Medicare taxes for 2018 paid by the employer in 2019 with the employer’s 2018 tax return. That amount was not withheld or recovered from the employee.

The Social Security Administration has not credited the 2018 earnings to the employee’s Social Security and Medicare accounts stating that the W-2 Form is invalid. Should we amend our client’s 2018 tax return to report the earnings as self-employment income?

Answer: This worker is an employee and not an independent contractor. The income should not be reported as self-employment income. The employer already has paid the full amount of the taxes and the worker should get credit for the wages and taxes. The problem is that the 2019 Form W-2, Wage and Tax Statement, was not accepted by the Social Security Administration and the employer should file Form W-2c, Corrected Wage and Tax Statement. Additionally, the 2018 Form W-2 is likely to be incorrect and should be corrected with Form W-2c.

Social Security and Medicare taxes paid by the employer are considered to have been withheld from the employee’s income tax wages. On that basis the taxes are included in the income tax wages for the year the wages were paid. As with any other withheld taxes, they are considered withheld when the wages are paid regardless of when the employer paid them to the government. These taxes are included on the W-2 for the year the associated wages were paid.

In contrast to most situations when the employer pays employee taxes, household employee wages are not grossed up for employer paid Social Security and Medicare taxes.

This special treatment does not apply for employee income tax. Where the employer pays income tax on behalf of a household worker, the employer paid amount increases wages for all tax purposes. That is, employer paid employee income tax is treated as cash wages.

The 2019 W-2 should report the amount of the employee’s share of the 2019 Social Security and Medicare taxes in boxes 4 and 6 of whether the employer actually paid the taxes in 2020 with the employer’s 2019 income tax return. The amount of cash wages actually paid to the employee, not including the employer paid Social Security and Medicare taxes, is reported in box 3 to the extent the amount does not exceed the Social Security wage base, and in box 5.

For W-2 Box 1, income tax wages, the amounts reported in boxes 4 and 6 are added to the cash wages paid to the employee and the total is reported in Box 1. When no income tax is withheld and there is no employer paid income tax, Box 2 is left blank.

In the client’s situation, the 2019 W-2 should show wages of $50,000 in boxes 3 and 5, Social Security tax of $3,100 in Box 4, $725 Medicare tax in Box 6, and income tax wages of $53,825 ($50,000 + $3,100 + $725) in Box 1.

Working backward, the 2018 W-2 probably should have reported $43,060 in Box 1, $40,000 in boxes 3 and 5, $2,480 in Box 4 and $580 in Box 6.

The client needs to amend the 2018 and possibly the 2019 income tax returns to report the correct amount of income tax income due to the employer paid taxes. If the employer refuses to correct the W-2s, the amended returns may be supported with Form 4852, Substitute for Form W-2, Wage and Tax Statement, or Form 1099R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRA’s Insurance Contracts, Etc.

Ask the employer to correct the Forms W-2 before using Form 4852, which should only be filed if the employer does not provide the corrections. Form 4852 should cause the IRS to contact the employer for a corrected W-2. After filing the returns, the client should contact the Social Security Administration to ensure the client’s account gets the proper wage credits.

By Patrick Haggerty

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