A last minute move by Congress to increase the 2014 transit benefit limit, several significant legal decisions and the midterm elections take top billing as important developments in tax year 2014 creating challenges for employers now and in the years ahead. Also noteworthy are numerous federal, state and local reporting and tax payment changes that will require immediate consideration this year-end.
On 13 November 2014, a six-member panel of Ernst & Young LLP’s experienced Employment Tax Services professionals shared their perspectives and insights concerning these developments for participants of its webcast, “2014 employment tax year in review.”
2014 employment tax highlights at a glance
- The parity in transit and parking benefits is retroactively reinstated for 2014, giving employers little time to avoid time-consuming Forms W-2c and Social Security/Medicare (FICA) tax refunds.
- From an employer’s perspective, the Additional Medicare Tax follows rules similar to federal income tax withholding.
- 2014 Form W-2 reporting changes include a greater risk that the SSA will reject Form W-2 files with certain errors and a new form for third-party payers of sick pay.
- Don’t forget to update your EIN responsible-party information.
- Employers are gearing up for new Affordable Care Act information reporting requirements.
- Congress could soon accelerate the Form W-2 filing due date.
- Dynamic state marriage equality laws continue to create payroll tax confusion and compliance challenges.
- Supreme Court rules that lump-sum severance is subject to FICA, but tax-saving Supplemental Unemployment Benefit (SUB) plans are still viable.
- 2014 sees tougher stance by courts and states on classifying workers as independent contractors.
- Ernst & Young LLP’s state roundup demonstrates the importance of having a local compliance focus.
- More localities mandate employer-provided transit benefits
Highlights of the webcast and a few of the key takeaways follow.
Law retroactively increases 2014 monthly transit benefit limit
On 19 December 2014, the President enacted Public Law No: 113-295 that retroactively reinstates through 31 December 2014 a number of the employer-related extenders that expired on 31 December 2013.
Under the Tax Increase Prevention Act, a one-year reinstatement applies to the parity in parking and transit benefits, the Work Opportunity Tax Credit and a few other employer-related business tax credits, such as the Indian tax credit and the wage tax credit for military reservist differential pay.
The 2014 monthly tax-free limit on transit (including van pool) benefits is increased from $130 to $250 to match the limit set for parking benefits in Rev. Proc. 2013-35. Accordingly, employers that have provided transit benefits in excess of $130 per month in 2014 may need to make adjustments to their employees’ 2014 taxable wages reflecting the increase in the monthly tax-free limit of up to $120 per month ($250 - $130).
A similar eleventh-hour move occurred for tax year 2012 when fiscal cliff legislation enacted on December 31, 2012, caused employers to scramble to make wage adjustments and issue tax refunds to avoid filing Forms W-2c.
It is likely the IRS may again issue special rules as it did in IRS Notice 2013-8 that would allow employers to show all transit benefit-related adjustments for 2014 on the 2014 fourth quarter Form 941-X.
Unlike the 2012 retroactive change in transit benefits, employers should have time before December 31, 2014, to issue refunds of Social Security/Medicare (FICA) and federal income tax withholding overpayments to employees, thereby avoiding time consuming gathering of employee FICA consent letters and issuance of Forms W-2c.
Following are considerations in handling 2014 retroactive transit benefits adjustments.
- Employer-provided transit benefits. If employers incurred the cost for 2014 transit benefits, and such cost exceeded $130 per month, an adjustment that reduces employees’ taxable wages of up to $120 per month of that excess cost can be made to the last wage payment in 2014. Accordingly, any refund of Social Security, Medicare or federal income tax withholding will be automatically reflected as an increase in the employees’ net pay.
If it was not possible to make the adjustment in tandem with a regular or bonus wage payment made to employees between now and December 31, 2014, employers will need to separately refund FICA and federal income tax withholding overpayments. Keep in mind that refunds of federal income tax withholding are normally prohibited after December 31, 2014.
Additionally, absent any special rules from the IRS to the contrary, FICA refunds made after the filing of 2014 Forms W-2 with the Social Security Administration will result in the added burden of filing 2014 Form W-2c and collecting FICA refund consent letters from employees.
- Employee pre-tax contributions. If employees paid for their transit benefits with pretax contributions, and absent any IRS special rule to the contrary, an adjustment reducing their 2014 taxable wages will not apply unless they can make a catch-up pretax contribution before 31 December 2014.
- Employee after-tax contributions. If employees made after-tax contributions in addition to pre-tax contributions under a qualified transportation fringe benefit plan, up to $120 per month of their after-tax contributions may be reclassified as pre-tax contributions thereby reducing their taxable wages for 2014.
If it was not possible to make the adjustment in tandem with a regular or bonus wage payment made to employees between now and 31 December 2014, employers will need to separately refund FICA and federal income tax withholding overpayments. Keep in mind that refunds of federal income tax withholding are normally prohibited after 31 December 2014.
Additionally, absent any special rules from the IRS to the contrary, FICA refunds made after the filing of 2014 Forms W-2 with the Social Security Administration will result in the added burden of filing Form W-2c and collecting FICA refund consent letters from employees.
Employers should keep in mind that states do not necessarily follow the federal rules for transit and van pool benefits, and these rules should be reviewed before making adjustments to 2014 state taxable wages.
- 2015 transit benefit considerations. Congress could reinstate the transit benefit parity for 2015; however, employees making pre-tax contributions for this benefit will not be eligible for any tax credit unless employers give them an option to make after-tax contributions in addition to their pretax contributions.
For this reason, employers should consider an after-tax contribution option up to the 2015 monthly limit of $250 per month. For example, employees are allowed to contribute up to $130 per month on a pre-tax basis, and up to $120 per month on an after-tax basis.
Why Additional Medicare Tax is similar to federal income tax withholding
Late last year, the IRS issued final regulations (TD 9645) explaining the requirements for employer withholding and reporting of the Additional Medicare Tax that was effective with wages paid on and after January 1, 2013.
The final regulations explain the important difference between Social Security/Medicare (FICA) and the Additional Medicare Tax of 0.9% applicable to wages in excess of $200,000 — namely, the prohibition on adjusting withholding amounts after the close the year. If an employer withholds too much or too little FICA tax from wages, a correction can be made to the withholding amount on Forms 941 and W-2 for the statute of limitations (generally, three years).
However, similar to federal income tax withholding, no adjustment is allowed to the amount of Additional Medicare Tax withheld if the error is discovered after the close of the tax year.
Consequently, if employers discover in 2015 that they withheld too much Additional Medicare Tax in 2014, they will need to instruct affected employees to claim a refund when they file their federal income tax returns. If a 2014 withholding shortage is discovered in 2015, employers are liable to pay the shortfall over to the IRS. All or a portion of the withholding liability can be abated to the extent employees provide a statement (Form 4669) showing they paid the tax to the IRS.
Note: The IRS has not yet updated Forms 4669/4670 to include the Additional Medicare Tax.
Recently, the IRS issued an announcement clarifying the instructions for reporting corrections to Additional Medicare Tax wages and contributions on Form 941-X, Adjusted Employer’s Quarterly Federal Tax or Claim for Refund. See page 17 for more information.
Read our special report for more tips and facts about the Additional Medicare Tax.
2014 Form W-2 reporting changes include greater risk of SSA rejecting your Form W-2 files and new third-party sick pay form
Form W-2 files the SSA will now reject
Beginning in tax year 2014, the SSA will reject Forms W-2 for correction where Medicare wages are less than the total reported Social Security wages and tips, where the Social Security wages and tips are zero but there is Social Security tax withheld, or where Medicare wages are zero but there is Medicare tax withheld. Household employers’ Forms W-2 will also be rejected if the Social Security and Medicare wages are equal to or less than the annual amount exempt from Social Security and Medicare tax (i.e., $1,900 for 2014).
The rejection of Form W-2 files puts employers at risk for late or non-filing penalties, making it important that electronic files are tested before filing them. AccuWage is a free service the SSA makes available to test Form W-2 files for identifiable reporting and record layout errors. Businesses that rely on a third party to file their Forms W-2 should consider asking their vendors to provide them with confirmation that their Form W-2 files were successfully cleared through AccuWage.
New IRS form applies to certain third-party payers of sick pay
Insurance providers and other third-party payers of sick pay are required to file a “third-party sick pay recap” to reconcile their Forms 941 to Forms W-2 in those instances where their client employers file the Forms W-2 to report third-party sick pay. Prior to 2014, the “third-party sick pay recap” was filed using a “dummy” Form W-2 and Form W-3.
Effective for tax year 2014, the Form 8922 is instead used for this purpose. The IRS will be updating Publication 15-A sometime in December to reflect this reporting change.
Don’t forget to update your Employer Identification Number responsible-party information
Beginning 1 January 2014, any person or entity with an Employer Identification Number (EIN) is required to report a change in the responsible party on IRS Form 8822-B, boxes 8a through 9b, within 60 days of such change. If the change in responsible party occurred before 2014, a Form 8822-B was required to be filed by 1 March 2014, reporting only the most recent change.
The instructions for Form 8822-B state that while reporting a change in the responsible party is mandatory, there are no penalties for failing to do so. However, it is important to keep in mind that neglecting to provide this information puts the responsible party at risk of not receiving IRS notices concerning his or her personal liability for tax deficiencies, and penalties and interest will accrue against the responsible party notwithstanding the failure to receive these IRS documents.
The responsible party named on the Form 8822-B is not determinative of the individual who will ultimately bear personal liability for trust fund tax. Rather, the IRS identifies responsible parties based on all of the facts and circumstances. For this reason, it is important to carefully consider who is named the responsible party on Form 8822-B as these are the persons who will need to be immediately aware of any IRS inquiries or collection efforts that personally affect them.
For more information concerning who is a responsible party, see the IRS website.
Businesses are gearing up for Affordable Care Act information reporting
Under the Affordable Care Act (ACA) and starting next year (for filing in 2016), large employers are required to provide information statements to employees and information returns to the IRS that contain details about employees’ health coverage benefits.
This new information reporting effort is substantial in scope and requires a coordinated effort between payroll departments and benefits enrollment and insurance plan administrators.
On the other hand, the reporting infrastructure necessary to produce employee statements and IRS returns is similar to the annual filing of federal Forms W-2. Consequently, while payroll departments will be dependent on data from other internal and external systems to meet the reporting requirements, they will likely be integral in the compliance effort.
On 24 July 2014, the Department of the Treasury and the IRS released long-awaited draft tax forms for the ACA’s information-reporting requirements for employers and health insurers under IRC §6055 (Forms 1094-B and 1095-B) and IRC §6056 (Forms 1094-C and 1095-C).
Under §6056, employers must provide information to the IRS and employees about coverage that employers offer to their employees. IRC §6055 requires insurers and employers with self-insured plans to report to the IRS information on individuals enrolled in health coverage plans. The information-reporting requirements generally apply to large employers as defined under the ACA (i.e., employers with at least 50 full-time equivalent employees).
Employers must begin collecting information required to be reported when the employer mandate takes effect on 1 January 2015, and information returns will be filed for the first time in 2016. The final regulations apply the same filing schedule used for Forms 1099 to the filings required under IRC §6055 and IRC §6056.
That is, annual returns for the calendar year must be filed with the IRS electronically by the following 31 March, or by 28 February if filed on paper. Statements to employees must be provided annually by 31 January.
For more information, read our special report.
Congress could accelerate Form W-2 filing deadlines to combat tax refund fraud
In August 2014, the US Government Accountability Office (GAO) issued a report to Congress examining steps that can be taken to curb the “large, evolving threat of (IRS tax) refund fraud.” The report focused on the type of tax refund fraud involving an individual’s theft of valid taxpayer identifying information (e.g., Social Security Number and Employer Identification Number) when submitting tax returns.
While the full extent of the issue is unknown, the IRS estimates it paid $5.2 billion in fraudulent identity theft (IDT) refunds in filing season 2013, while preventing $24.2 billion (based on what it could detect).
On 31 July 2014, Senator Orrin Hatch (R-UT) introduced the Tax Refund Theft Prevention Act of 2014 (S.2736) that would support IRS tax fraud prevention efforts by making a number of changes in the procedures governing the filing of Form W-2 and 1099-MISC.
The bill, containing many of the fraud prevention measures included in the Administration’s budget for fiscal year 2015, proposes to make a number changes affecting businesses, including a change in due date for filing Forms W-2 with the SSA and Form 1099-MISC with the IRS to February 15, whether the forms are filed on paper or electronically. Further, by 1 January 2017, the Department of Treasury would be required to submit a report to Congress with recommendations pertaining to whether the Forms W-2, 1099-MISC or other return filing due dates should be further accelerated to January 31.
Some businesses are already meeting challenging deadlines for filing their Forms W-2 as the number of states (and localities) imposing a 31 January due date continues to grow.
Dynamic state marriage equality laws continue to present challenges in fringe benefit taxation
Last year’s ruling in United States v. Windsor resulted in changing the definition of marriage to include a same-gender couple.
In Revenue Ruling 2013-17, the IRS clarified that a “place of celebration” standard applies in determining whether a same-gender couple is lawfully married.
Under this standard, couples who are married in a state that recognizes same-gender marriages are treated as married for federal purposes even if they reside in a state that does not. The federal marriage definition continues to exclude from the marriage definition domestic partners and those with civil union and registered domestic partner licenses that may be lawful under state law.
For federal purposes (e.g., Social Security, Medicare, unemployment insurance and income tax), the revenue ruling was effective 16 September 2013.
The decision in Windsor deals only with the federal marriage definition, leaving the matter of marriage rights under the control of the states. The decision triggered a legal challenge of state laws preventing same-gender marriage across the US. On 6 October 2014, the US Supreme Court declined to weigh in on a number of these cases and by 20 November 2014, the number of states allowing same-gender couples to marry rose to 35.
Confusion and complexities arise in determining whether same-gender partner benefits are subject to state income tax withholding and employment tax (e.g., unemployment and disability insurance). For instance, a state’s marriage laws are not necessarily determinative of the withholding and employment tax rules governing a same-gender partner’s benefits.
For example, some states that don’t issue civil union licenses to same-gender couples will exclude from wages health benefits provided to couples who obtained a civil union license in another state.
Additionally, the date that a state begins issuing marriage licenses to same-gender couples is not necessarily determinative of the date on which same-gender spousal benefits are excluded from state taxable wages. Rather, the tax effective date is based on the totality of the facts and the circumstances and any specific tax guidance issued by the state.
If businesses have not carefully evaluated their benefit enrollment process, studied the adequacy of their pay and deduction codes, and consulted with their employment tax advisors about state taxability configurations, chances are high that compliance gaps exist requiring immediate attention.
Supreme Court rules lump-sum severance is FICA taxable, but a SUB plan is still a viable tax-savings option
For many years, beginning with a case brought before the courts by CSX Corporation, it was 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 (SUB) 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. (United States of America v. Quality Stores Inc., et al., No. 10-1563.)
On 25 March 2014, the US Supreme Court decided the Quality Stores case, ruling that severance payments that fail to satisfy the IRS criteria for SUBs are subject to Social Security and Medicare (FICA). The 8 to 0 ruling by the justices was a decisive victory for the government, ending more than a decade of legal challenges triggered by CSX.
In its closing remarks, the Court noted that severance payments tied to the receipt of state unemployment benefits (SUBs) continue to be exempt from FICA tax under current IRS guidance (Rev. Rul. 90-72, 1990–2).
For more information about SUB plans and other ways to manage tax expenses associated with severance pay, read our special report.
Courts and states take tougher stance on classifying workers as independent contractors
Worker misclassification occurs when a business treats a worker meeting a law’s employment test as an independent contractor. As compared to independent contractors, employees are generally protected by various labor laws, and payments made to them are covered wages for income tax, unemployment insurance and other payroll taxes.
Worker misclassification occurs not only when an employer erroneously classifies an employee as an independent contractor, but also when the worker is not classified at all and becomes part of the underground economy.
Misclassified and “underground” workers reduce revenues necessary for paying unemployment benefits while adversely affecting an employee’s ability to receive UI benefits, workers’ compensation coverage, Social Security benefits, health insurance coverage, retirement benefits, and protection under the federal, state and local wage-hour laws. Additionally, businesses that don’t properly treat workers as employees unfairly compete against those businesses that do.
Two trends have converged in 2014 to heighten employer awareness of the standards they use in treating workers as independent contractors rather than employees: a tougher stance by some of the courts and an increased audit focus stimulated in large part by federal funding to the states.
2014 state roundup
Numerous ballot initiatives were passed in the 2014 midterm elections that will require a greater employer focus on local compliance issues in the months and years ahead. Of significant note is the addition of two cities (District of Columbia and New York City) that will join San Francisco in requiring employers with 20 or more employees to provide transit benefits to their employees.
Mobile workforce tax compliance is a continued concern as several states maintain their aggressive nonresident income tax withholding audits. State rules vary considerably in terms of the amount of time or wages, if any, that can be overlooked in determining if a nonresident income tax obligation applies. It appears that Congress will not enact federal legislation (HR 1129) this year that would prohibit states from imposing an income tax on wages earned by employees who have spent 30 or fewer days in the calendar year working in a state.
State tax filing and tax payment requirements were also revised in a number of states. Maine, for instance, will end combined reporting effective 1 January 2015, and a number of states are imposing electronic filing and tax payment requirements on all employers.
2014 unemployment insurance roundup
The markets’ collapse of 2007 and 2008 placed an unusual strain on state unemployment insurance (SUI) trust funds, so much so that, at the peak of the recession in 2009, 21 states had taken loans from the federal government. In addition to higher federal unemployment insurance taxes (FUTA) that apply to employers in states with an outstanding federal unemployment insurance (UI) loan balance, higher SUI taxes can also apply.
SUI taxes have declined somewhat in response to the improved economy. For tax year 2014, for instance, 24 states lowered their base SUI tax rates and two states lowered their SUI wage base.
Recovery, however, has been much slower for many of those states with sizeable federal UI loans. Employers in states with an outstanding federal UI loan balance as of November 10 of the calendar year are subject to a FUTA credit reduction that increases the FUTA tax rate that applies to them. In 2013, employers in 13 states were subject to a higher FUTA tax due to the FUTA credit reduction, compared to eight in 2014. Several states will continue to have federal loan balances on 10 November 2015, and employers in those states face FUTA tax rates of 2.6% or more (as compared to the normal net FUTA tax rate of 0.6%).
For several years, the Administration has proposed raising the federal wage base from $7,000 to $15,000, a move that would automatically increase the state SUI wage base in more than 30 states with a wage base below $15,000. It is speculated that forcing these states to maintain a higher wage base will pave the way for future solvency and reduce the higher costs employers incur when SUI benefit payouts are financed.
For more information on the state electronic filing requirements for unemployment insurance and Forms W-2, see our 2014 payroll year-end checklist.
More localities mandate employer-provided transit benefits
This year, a number of municipalities joined San Francisco in requiring that employers make qualified transit benefits available to their employees. Under a qualified transit benefit plan, employers either provide transit benefits directly to their employees or allow employees to purchase their transit passes with pre-tax contributions. Employers will need to consider if their transit benefit plans meet the latest IRS qualified plan requirements.
See our special report for more details on the local transit benefit requirements.