EY - Employment tax year-end planning essentials

Employment tax year-end planning essentials

Year-in-review webcast at a glance

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Tax year 2013 will be remembered as one of the most challenging for employment tax professionals. Multiple events triggered the need to implement change in a variety of areas, from wage withholding to fringe-benefit plan design.

On 13 November 2013, a five-member panel of EY’s Employment Tax Advisory Services team shared their perspectives and insights about these developments in a webcast, Employment tax year in review.

2013 employment tax webcast at a glance

  • The Supreme Court’s ruling in Quality Stores could mean significant FICA refunds on severance pay.
  • Late changes in the 2012 fiscal cliff legislation continue to challenge employers and employees.
  • The additional Medicare tax will present new year-end challenges.
  • 2014 is the start of the new responsible-party reporting requirement.
  • 2014 is the last year to claim the payroll HIRE Act tax credit.
  • Same-sex partner benefits were significantly affected in the Windsor decision.
  • New state laws mean a new approach to unemployment insurance management.
  • The federal unemployment insurance (FUTA) credit reduction will continue in 2014 for many states.
  • State budget initiatives in 2013 meant numerous retroactive changes in state income tax withholding.
  • This year’s pay card controversy renews the importance of employers adopting leading practices.

Highlights of the webcast and a few of the key takeaways follow.

FICA on severance

For many years, and beginning with a case brought before the courts by CSX Corporation, it has been argued that severance pay provided to involuntarily terminated employees should not be subject to Social Security/Medicare (FICA) tax, whether paid periodically as a supplemental unemployment benefit or paid in a lump sum.

In 2008, the Federal Circuit ruled in favor of the IRS in CSX, concluding that similar severance-type payments were subject to FICA (CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008)). CSX did not request a rehearing, and on 11 August 2008, the opinion was considered final.

In 2012, the Sixth Circuit Court of Appeals affirmed the 2010 decision of the Michigan District Court that Quality Stores is entitled to a refund of FICA that it collected and paid on severance payments. Because the courts were divided on the matter, the Government requested that the Supreme Court agree to hear the case. The Court agreed to the request, and oral arguments are scheduled for 14 January 2014. (United States of America v. Quality Stores Inc., et al., No. 10-1563.)

For more information about the Quality Stores case and the value of filing protective FICA refund claims, click here

2013 federal withholding tax changes

Under the Affordable Care Act, and effective this year, employees are subject to an additional Medicare tax of 0.9%.

Also effective in 2013, and for the first time in history, investment income is subject to Medicare tax. The Net Investment Income Tax (NIIT), as it is called, is 3.8%.

Both the additional Medicare tax and NIIT apply to covered income in excess of $125,000 for taxpayers married filing separately ($200,000 for single filers and $250,000 for joint filers).

Although the 0.9% additional Medicare tax applies to wages in excess of $125,000, $200,000 or $250,000, depending on the employee’s tax filing status, employers withhold it only when wages exceed $200,000. It is the responsibility of employees to reconcile what their employers withhold against their actual liability as shown on new Form 8959, Additional Medicare Tax.

Employers also do not withhold the NIIT; therefore, employees with covered investment income are responsible for paying 100% of the liability as shown on new Form 8960, Net Investment Income Tax — Individuals, Estates, and Trusts.

In addition to the 2013 launch of these new Medicare taxes, an increase in the federal income tax rates applicable to high-income taxpayers was enacted as part of the fiscal cliff legislation Congress agreed to in the final hours of 2012 session. Effective 1 January 2013, the top federal income tax rate increased from 35% to 39.6% for adjusted gross income in excess of $400,000 (individual filers), $425,000 (heads of households) and $450,000 (married filing jointly).

Employers were not required to implement these federal income tax changes until 15 February 2013, a delay that could have resulted in under-withholding for some employees.

For more information about how 2013 payroll tax changes affect your employees, click here.

Same-sex partner benefits in the wake of Windsor

This year’s ruling in United States v. Windsor resulted in a change in the federal marriage definition that applies to income tax by expanding it to include lawfully married same-sex couples. In Revenue Ruling 2013-17, the IRS clarified that a “place of celebration” standard applies in determining whether a same-sex couple is lawfully married.

This standard means that couples who are married in a jurisdiction that recognizes same-sex marriages are treated as married even if they reside in a jurisdiction that does not. The federal marriage definition continues to exclude civil unions, domestic partnerships or similar arrangements.

The revenue ruling was effective 16 September 2013; however, taxpayers may request refunds of tax on same-sex spousal health benefits provided in previous open tax years (generally, 2010 through 2012).

The IRS issued Notice 2013-61 to provide guidance for employers and employees making claims for refunds or adjustments of FICA taxes and income tax withholding resulting from Windsor and the holdings of the revenue ruling.

Special administrative procedures are provided for employers using the optional retroactive application of the revenue ruling.

The process of determining whether same-sex spousal health benefits are subject to federal income tax withholding and employment tax hinges on state civil marriage laws. For example, if an employee is married in Minnesota (allows same-sex marriage) but lives and works in Louisiana (prohibits same-sex marriage), same-sex spousal health benefits are excluded from federal taxable wages.

Confusion and complexities arise in determining whether same-sex spousal benefits are subject to state income tax withholding. State income tax determinations hinge on the state income tax laws and regulations that apply in the employee’s resident and work state. In Missouri, for instance, same-sex marriage is prohibited; however, married couples that file their federal income tax return as married (or married filing separately) must file their Missouri state income tax return the same way. (See Missouri Executive Order 13-14.)

To learn more about the broad implications of the Windsor decision, click here.

New laws mean a new approach to unemployment insurance claims management

When employers don’t respond fully and timely to unemployment insurance (UI) claim notices, costly overpayments are made. To address the growing problem, federal law requires all of the states to adopt legislation holding employers and their agents more accountable in the claims notification process.

As part of “UI integrity,” states are required — by no later than 21 October 2013 — to prohibit the non-charging of UI benefit overpayments to an employer’s account that are the result of failure by any employer, both experienced-rated and reimbursing, or by the employer’s agent, to respond timely or adequately to the state’s request for information relating to a UI claim if a pattern of failing to respond to such requests has been established.

Federal law doesn’t define “pattern of failure” but gives the states the freedom not only to define the term but to impose other sanctions as well. For instance, in addition to charging employer accounts for benefit overpayments, Virginia also imposes a $75 penalty beginning with the third offense.

All employers incur a direct or indirect cost when UI benefits are charged to their accounts. For experience-rated employers, benefits charged to their accounts are used in determining their future state UI tax rates. Reimbursing employers (limited to electing nonprofit and governmental entities) are required to pay directly for benefits charged to their accounts.

Absent the provision contained in the UI integrity law, an employer’s account could be credited for erroneously collected UI benefits, regardless of whether the employer responded in a timely fashion to the original claim notice. Under the UI integrity law, once the deadlines are reached for responding to claim notices and other state information requests, employers give up their right to have their accounts credited for the overpaid UI benefits.

Likewise, if an employer does not provide complete details regarding the separation from employment (for instance, it simply states that the individual should not be eligible), the employer’s account cannot be relieved of those UI benefit charges. For employers (or their third-party providers) accustomed to perfecting their responses to UI claim notices after the initial determination period, the implications of the UI integrity law could have a significant monetary impact.

For more information concerning state UI integrity laws and how to respond, click here.

Retroactive state laws challenged employers throughout 2013

This year, seven states enacted retroactive changes in their income tax laws that involved individual tax rates and/or the fringe benefits included or excluded from gross income. Retroactivity in state income tax laws is unusual, but when it occurs it challenges employers and the software vendors that support them.
Employers bear the responsibility of monitoring developments and watching for corresponding updates from payroll software providers. This process is customary just prior to the start of a calendar year, when substantial tax changes are generally in effect. Random and unexpected changes throughout the year aren’t likely to get the same level of attention and may even be overlooked.
Retroactive income tax laws can also challenge employees since they generally rely on their employers to withhold enough throughout the year to satisfy their income tax liability. Employees may not take into account that employers don’t usually make retroactive changes to employees’ income tax withholding.

For more information about 2013 retroactive income tax withholding changes, click here.

This year, seven states enacted retroactive changes in their income tax laws that involved individual tax rates and/or the fringe benefits included or excluded from gross income. Retroactivity in state income tax laws is unusual, but when it occurs it challenges employers and the software vendors that support them.

Employers bear the responsibility of monitoring developments and watching for corresponding updates from payroll software providers. This process is customary just prior to the start of a calendar year, when substantial tax changes are generally in effect. Random and unexpected changes throughout the year aren’t likely to get the same level of attention and may even be overlooked.

Retroactive income tax laws can also challenge employees since they generally rely on their employers to withhold enough throughout the year to satisfy their income tax liability. Employees may not take into account that employers don’t usually make retroactive changes to employees’ income tax withholding.

 

For more information about 2013 retroactive income tax withholding changes, click here.

For more information

EY - Employment tax year in review Download "Employment tax year in review" as a printable document.