WHEN WAGES BECOME TAXABLE - AIPB

1 S ection 8. when WAGES B ECOME TAXAB LE. In trod u ction Th er e is oft en a la pse of a t lea st a week bet ween t h e t im e wa ges a r e ea r n ed a n d t h e t im e t h ey a r e a ct u a lly pa id. F or in st a n ce, a n em ployee wh o is pa id biweekly wor ks du r in g week 1 a n d week 2 bu t is n ot pa id u n t il week 3. Un der IRS r egu la t ion s, wa ges a r e t a xa ble wh en con stru ctively received by (a ct u a lly m a de a va ila ble t o) em ployees, r ega r dless of wh en ea r n ed. Th is is kn own a s t h e pr in ciple of con st r u ct ive r eceipt .. P ROB LEM 1: Accou n t Cor p pa ys em ployees weekly. E m ployees wh o wor k fr om F ebr u a r y 5 t h r ou gh F ebr u a r y 9 a r e pa id for t h is wor k on F ebr u a r y 13.

2 Wh en a r e t h ese wa ges su bject t o feder a l in com e t a x wit h h oldin g (F ITW) a n d F ICA wit h h oldin g? S OLU TION 1: On F ebr u a r y 13. Th ese wa ges a r e su bject t o F ITW. a n d F ICA on t h e da y t h a t t h ey a r e pa id. Th u s, t a xes a r e wit h h eld on F ebr u a r y 13. Th e em ployer 's F ICA t a x lia bilit y a lso is in cu r r ed on F ebr u a r y 13, t h e da y t h a t wa ges a r e a ct u a lly pa id t o em ployees. U n claim ed Ch eck s Sa y t h a t you pr epa r e pa ych ecks on Decem ber 22, 2001. H owever , som e em ployees a r e on va ca t ion a n d do n ot cla im t h eir ch ecks u n t il 2002. Ar e t h e wa ges t a xa ble in 2001 or 2002? Th e a n swer is 2001. Un der t h e r u le of con st r u ct ive r eceipt , wa ges a r e con st r u ct ively (a ct u a lly) r eceived wh en fu n ds a r e a va ila ble t o em ployees wit h ou t su bst a n t ia l lim it a t ion.

3 If pa ych ecks a r e a va ila ble t o em ployees, bu t t h ey do n ot pick t h em u p, wa ges a r e t a xa ble on t h e da y wh en t h ey cou ld h a ve cla im ed t h e ch ecks. P ROB LEM 2: An t h on y is t er m in a t ed on pa yda y, Decem ber 31, 2001. Alt h ou gh h is ch eck is r ea dy for h im on t h a t da y, h e does n ot pick it u p u n t il J a n u a r y 14, 2002. Sh ou ld t h ese wa ges be r epor t ed on An t h on y's W-2 for 2001 or 2002? 141. Mastering Payroll S OLU TION 2: Gen er a lly spea kin g, t h e wa ges sh ou ld be r epor t ed on An t h on y's W-2 for 2001 beca u se t h e pa ych eck wa s a va ila ble t o h im in t h a t yea r . It wa s h is ch oice t o t a ke r eceipt on J a n u a r y 14, 2002. P ROB LEM 3: ABC Cor p.

4 Fa iled t o pr epa r e a pa ych eck for n ew h ir e Margaret on December 31, 2001. The employer discovered the error on Decem ber 31, bu t did n ot pr epa r e h er pa ych eck u n t il J a n u a r y 3, 2002. Sh ou ld t h e com pa n y in clu de t h ese wa ges in Ma r ga r et 's t a xa ble in com e for 2001 or 2002? S OLU TION 3: Th ese wa ges sh ou ld be in clu ded in h er t a xa ble in com e for 2002 t h e yea r in wh ich t h ey wer e m a de a va ila ble t o h er . S electin g th e Correct A n n u al T ax R ate Th e feder a l in com e t a x a n d/or F ICA t a x r a t es a n d lim it s gen er a lly ch a n ge ever y yea r . F or in st a n ce, in 2000, OASDI wa s of t h e fir st $76,200 in wa ges. In 2001, t h e r a t e is of t h e fir st $80,400.

5 Beca u se t h e feder a l in com e t a x a n d F ICA t a x r a t es a n d lim it s ca n a n d oft en do ch a n ge ever y yea r , t h e r u le of con st r u ct ive r eceipt is pa r t icu la r ly im por t a n t a t t h e en d of t h e yea r . EXAMP LE: Con n ie is pa id $80,400 fr om J a n u a r y 1, 2001, t h r ou gh Decem ber 25, 2001. F r om Decem ber 26, 2001, t o Decem ber 31, 2001, sh e ea r n s $1,000 bu t is n ot pa id u n t il J a n u a r y 3, 2002. Th e $1,000. pa id in 2002 is su bject t o t h e fu ll F ICA t a x, even t h ou gh h er la st $1,000 in wa ges ea r n ed du r in g 2001 exceeded t h e 2001 m a xim u m OASDI wa ge lim it of $80,400. Th e r u le of con st r u ct ive r eceipt is im por t a n t for a n ot h er r ea son.

6 E a ch em ployee's feder a l a n d st a t e in com e t a x lia bilit y is ba sed on wa ges pa id for t h e yea r . Th e h igh er t h e wa ge a m ou n t r epor t ed on a n em ployee's W-2, t h e m or e feder a l a n d st a t e in com e t a x t h e em ployee owes. P ROB LEM 4: E dwa r d's yea r -t o-da t e F ICA t a xa ble wa ges on Decem ber 15, 2001, wer e $80,400. H e ea r n ed a n a ddit ion a l $500 fr om Decem ber 15 t h r ou gh Decem ber 31, bu t wa s n ot pa id t h is $500 u n t il J a n u a r y 3, 2002. H ow m u ch of t h e $500 pa ym en t is su bject t o F ICA. (OASDI a n d H I)? 142. when WAGES BECOME TAXABLE SOLUTION 4: Th e fu ll $500 is su bject t o t h e F ICA t a x r a t e of (com bin ed OASDI a n d H I t a xes) beca u se t h e wa ges wer e n ot r eceived u n t il 2002.

7 P ROB LEM 5: Rica r do's yea r -t o-da t e F ICA t a xa ble wa ges a s of Decem ber 26, 2001, wer e $51,000. H e ea r n ed a n a ddit ion a l $500 fr om Decem ber 26 t h r ou gh Decem ber 31 bu t wa s n ot pa id t h e $500 u n t il J a n u a r y 3, 2002. Wh a t a m ou n t does t h e em ployer r epor t on Rica r do's 2001 F or m W-2: $51,000 or $51,500? S OLU TION 5: Th e em ployer r epor t s $51,000 beca u se t h e a ddit ion a l $500, t h ou gh ea r n ed in 2001, wa s n ot pa id u n t il 2002. Postd atin g an d B ack d atin g Paych eck s Beca u se of t h e fa vor a ble or u n fa vor a ble effect t h a t t h e r u le of con st r u ct ive r eceipt h a s on t a x lia bilit y, em ployees a n d em ployer s som et im es r equ est t h a t ch ecks be post da t ed or ba ckda t ed.

8 EXAMP LE: Un der com pa n y policy, em ployee bon u ses a r e pa ya ble on Decem ber 31, 2001. To h elp h igh ly pa id em ployees defer feder a l in com e t a x, t h e em ployer post da t es t h ese ch ecks t o J a n u a r y 3, 2002, bu t dist r ibu t es t h em t o em ployees on Decem ber 30, 2001. Un der t h e r u le of con st r u ct ive r eceipt , t h ese wa ges a r e t a xa ble wh en m a de a va ila ble t o em ployees (2001), r ega r dless of t h e da t e of t h e pa ych eck. Alt h ou gh a ch eck da t e m a y seem t o be pr oof of wh en wa ges wer e r eceived, t h e IRS ca n ea sily det ect post da t in g by r eviewin g t h e em ployer 's ca n celed pa ych ecks. P ROB LEM 6: E a ch J a n u a r y 15, H essCo pa ys bon u ses for t h e pr eviou s yea r.

9 All em ployees r eceivin g a bon u s r ea ch ed t h eir OASDI. lim it in 2001. To a void wit h h oldin g F ICA on 2002 bon u ses, H essCo ba ckda t es bon u s ch ecks t o Decem ber 31, 2001, bu t dist r ibu t es t h em t o em ployees on J a n u a r y 14, 2002. Ar e t h ese ch ecks con sider ed wa ges for 2001 or 2002? S OLU TION 6: Th e da t e of t h e ch eck does n ot a lt er t h e fa ct s. Beca u se bon u s ch ecks wer e n ot m a de a va ila ble t o em ployees u n t il 2002, t h ey m u st be t r ea t ed a s 2002 wa ges (su bject t o 2002 F ICA a n d F ITW r a t es). 143. Mastering Payroll Postpon in g Paym en t of W ages Ma u r een is in a h igh in com e t a x br a cket in 2001 a n d expect s t o be in a lower in com e t a x br a cket in 2002.

10 Sh e a sks h er em ployer t o pa y h er Decem ber 2001 wa ges in J a n u a r y 2002. Wh a t sh ou ld t h e em ployer do? Un less t h e com pa n y h a s a for m a l defer r ed com pen sa t ion pla n , t a xes sh ou ld n ot a r bit r a r ily be defer r ed by post pon in g wa ge pa ym en t s. EXAMP LE: Wesley a sks h is em ployer t o dela y h is Novem ber a n d Decem ber pa ych ecks u n t il J a n u a r y 2002. H is em ployer a gr ees t o dela y pa ym en t of t h e $2,000, a n d h e is pa id in 2002 in st ea d of 2001. Wit h ou t a for m a l defer r ed com pen sa t ion pla n cover in g Wesley, h is em ployer m a y be r equ ir ed t o r epor t a n d t a x t h is $2,000 a s t h ou gh it wer e pa id in 2001. S alary A d van ces an d Overpaym en ts Beca u se wa ges a r e t a xa ble wh en con st r u ct ively r eceived, r ega r dless of wh en ea r n ed, a sa la r y a dva n ce or over pa ym en t of wa ges is t a xa ble wh en pa id t o t h e em ployee, even t h ou gh wa ges a r e n ot yet ea r n ed.