Correcting an employment tax error that is discovered in the year in which the error occurs is generally a simple process. However, employers often discover such errors after the close of the calendar year in which they paid the wages to an employee. The adjustment process to correct those errors is confusing and often leads to further mistakes.
The mechanical process for making adjustments of wages and related taxes varies depending on whether there is a correction to FICA taxes or to income tax withholding, whether the error is identified before or after the close of the calendar year of the wage payment, and whether there is an overpayment or underpayment of taxes. Many of these mechanical difficulties are products of the statute; unfortunately, even the most recent revised regulations have not resolved these problems (T.D. 9405, amending Regs. Sec. 31.6205-1).
Subtitle C of the Code imposes on an employer liability to withhold and pay over to the government an employee’s income taxes and the employee’s (one-half) share of FICA taxes on the employee’s wages. The employer must also pay the other one-half share of FICA. An employer remains liable for the federal income and FICA tax withholding that it should have made, whether or not the taxes are in fact withheld (Regs. Secs. 31.3403-1 and 31.3102-1(d)).
Underpayments: If an employer fails to withhold and pay over to the government an employee’s FICA taxes, in either a current or a subsequent year the employer can make an adjustment when the error is discovered to the quarter in which the underpayment occurred. Beginning January 1, 2009, Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund, can be used to make the adjustment, generally on an interestfree basis under Sec. 6205. (The employer can make a similar correction for its share of FICA taxes.)
If the employer discovers the error after the calendar year of the wage payment closes, the employer provides the employee and the Social Security Administration (SSA) a corrected Form W-2 (Form W-2c, Corrected Wage and Tax Statement) reflecting additional FICA earnings for the prior year and FICA tax withholding as if the employer had made it correctly (Regs. Secs. 31.6051-2(c)(a)–(c) and 31.6051-1(c)(1)).
This change to FICA wages and FICA tax withholding generally does not affect the employee’s prior year individual tax return. At this point the employer has paid the employee’s taxes. The regulations provide a specific remedy to allow an employer to recover from the employee’s pay the FICA taxes that the employer paid on the employee’s behalf (Regs. Sec. 31.6205- 1(d)(1)). If the employer does not recover the amount from the employee, the payment of the employee share of FICA tax by the employer is current wage compensation, subject to FICA and income tax withholding, and reflected on the employee’s year-end Form W-2.
Overpayments: With respect to an overpayment of FICA taxes, the Code provides that the employer may make an adjustment or seek a credit or refund of the employer’s share of FICA. An employer generally cannot seek the employer’s share of overpaid FICA taxes unless the employer, in its capacity as a fiduciary, also seeks the employee’s share. This adds additional complications for the employer, including a requirement to gain consent from the employee to claim the credit or refund on the employee’s behalf.
In some instances, the employer must solicit from the affected employee a certification that the employee has not sought and will not seek a refund for the same overpayment amount (Sec. 6413; Regs. Secs. 31.6413(a)-3 and 31.6402(a)-1(a) (2)). 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 (Regs. Sec. 31.6413(a)-3).
Underwithholding: The adjustment process differs if an employer fails to withhold and pay over to the government federal income taxes on the wages it paid to the employee in a prior year. In contrast to a FICA adjustment, the employer does not make an interest-free adjustment on Form 941-X. The employer must provide the employee and the SSA with a Form W-2c reflecting additional wages for the year in which the underwithholding occurred. However, because the employer may not withhold income taxes from an employee after the calendar year in which the wages were paid, the federal income tax withholding amount does not change (Regs. Secs. 31.6051-2(c)(a)–(c) and 31.6051-1(c)(2)).
After receiving the Form W-2c with additional wages, the employee generally will file an amended personal income tax return and pay the additional income taxes, if any. At this point, the employee has extinguished his or her personal income tax liability for the prior year. However, as a technical matter, the employer remains liable for its failure to withhold income taxes in the prior year (Sec. 3403; Regs. Sec. 31.3403-1).
The employer can eliminate this liability if it secures a statement from the employee certifying that the employee included the wages on his or her personal income tax return and paid the related income taxes (Sec. 3402(d); Regs. Sec. 31.3402(d)-1). Form 4669, Statement of Payments Received, is used for this certification. While receipt of this form mitigates the employer’s liability for the failed withholding amounts, the employer may still be subject to penalties for having failed to withhold as required (Sec. 3402(d)).
A significant issue arises because the employer remains liable for the taxes unless such certification is received. As a technical matter, the employer should pay the amount of federal income tax that was underwithheld. However, there is no guidance to an employer for making the payment and reporting it as an employer’s payment. Because withholding was not made, the employee does not get credit for the withholding; as a result, the withholding reported on Form W-2 will not reconcile to the withholding taxes paid by the employer. Neither the regulations nor the instructions to Form 941-X address this matter.
Overwithholding: Similarly, in the case of overwithholding, an employer generally may not refund income tax withholding to employees after the calendar year closes (Sec. 6414; Regs. Sec. 31.6414-1). Instead, an employee must resolve the overpayment, if any, with the filing of a personal income tax return.
Typically, employers make income and FICA tax withholding errors at the same time, and these adjustments are undertaken together. While the newly released Form 941-X has improved the adjustment process, employment tax adjustments often remain cumbersome.
Annette Smith is with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington, DC.
Unless otherwise noted, contributors are members of or associated with Pricewater-houseCoopers LLP.
For additional information about these items, contact Ms. Smith at (202) 414-1048 or annette.smith@us.pwc.com.