Included in this year’s top 10 frequently asked questions (FAQs):
- FAQ 1: Gift cards
- FAQ 2: Moving expenses
- FAQ 3: Cell phones
- FAQ 4: Employee loans
- FAQ 5: Day care
- FAQ 6: Educational assistance
- FAQ 7: Nonqualified deferred compensation
- FAQ 8: Wellness benefits
- FAQ 9: Paid family and medical leave
- FAQ 10: Former employee group-term life
FAQ 1: Are gift cards considered wages subject to employment tax and withholding?
Facts: We distribute grocery store gift cards each December that are redeemable only for specific food items such as a holiday turkey, ham or fruit basket. Since these gift cards are redeemable for items that are otherwise considered de minimis and cannot be exchanged for cash, is their value subject to employment tax and withholding?
Answer: IRS regulations clearly state that fringe benefits provided to employees through a gift card represent “cash-in-kind” and must be included in wages subject to federal employment tax and withholding. It does not matter that the employee is not allowed to redeem the card for cash. Furthermore, the doctrine of constructive receipt applies, meaning the cash value of the gift cards is subject to federal income tax (FIT), federal income tax withholding (FITW), Social Security/Medicare (FICA) and federal unemployment insurance (FUTA) at the time they are made available to employees.
The same tax treatment applies to gift cards issued to employees throughout the year and when employees can visit a third-party website to select items of merchandise/store cards for redeeming company recognition awards.
FAQ 2: What is the tax treatment of moving expenses paid on behalf of employees assuming we are a civilian employer?
The requirement that gift cards be taxed and reported immediately when made available can be problematic for those employers that reimburse managers and supervisors for the purchase of gift cards through the expense reimbursement process (i.e., December expense reports are not submitted until January). For this reason, many companies require that gift cards be issued through Human Resources or another appropriate department so that payroll can be notified immediately of the wage transaction for timely tax and reporting. (IRS Reg. §1.132 6(c); TAM 200437030 IRC §451.)
Facts: We have a policy that when we ask employees to transfer to another of our store locations we reimburse them for the cost of moving their household goods and personal effects and lodging and meal expenses they incur in their final trip from the old work location to the new.
Answer: Whether moving expense reimbursements are subject to FITW, FITW, FICA and FUTA depends on when the expenses were incurred.
- Moving expenses incurred through December 31, 2017: For moving expenses incurred through December 31, 2017
IRC §132(g) allows an exclusion from wages for FIT, FITW, FICA and FUTA purposes for moving expenses reimbursed or paid directly by the employer to the extent those moving expenses were deductible under IRC §217. Through December 31, 2017, IRC §217 excludes from taxable income the cost of moving household goods and personal effects from the former residence to the new, the first 30 days of storage for a domestic move, and lodging and mileage expenses incurred during the period of travel from the former residence to the new place of residence. An exclusion was not allowed for meal expenses incurred during the period of travel from the old location to the new. Special rules applied to foreign moves.
- Moving expenses incurred January 1, 2018, to December 31, 2025: Under the Tax Cuts and Jobs Act (TCJA) and effective January 1, 2018, through December 31, 2025, all moving expense reimbursements paid to employees or directly to third parties on behalf of employees are included in wages subject to FIT, FITW, FICA and FUTA. An exception to this provision applies to members of the Armed Forces on active duty moving pursuant to a military order and incidental to a permanent change of station. (TCJA §11048.)
- Expenses incurred prior to January 1, 2018. In IR-2018-190 and IRS Notice 2018-75, 2018-41 IRB 556, the IRS announced that moving expenses incurred prior to 2018 but that are reimbursed or paid after December 31, 2017, are excluded from wages subject to FIT, FITW, FICA and FUTA if they were excluded from taxable wages prior to the changes made under TCJA. This rule also applies to payments made to a third party in 2018 for moving services provided prior to 2018. To qualify for this exclusion, the IRS explains that employees must not have claimed the expenses on their 2017 federal personal income tax returns.
- Form W-2, box 12, code P. In 2019, the IRS clarified in its frequently asked questions about moving expenses that non-taxable moving expenses incurred by civilians prior to January 1, 2018, should not be reported on the 2018 Form W-2 in box 12, code P. This IRS clarification came because of tax filing service providers rejecting 2018 Forms W-2 with information included on Form W-2, box 12, code P for non-military personnel.
For more information. see the IRS’ frequently asked questions about moving expenses.
FAQ 3: What is the tax treatment of employer-provided cell phones and cell phone allowances?
Facts: We provide cell phones to our field engineers and sales staff for which we pay all monthly charges incurred and for our administrative staff we provide a monthly cell phone allowance. What is the federal tax treatment of both options?
Answer: In response to the law change in 2010 that removed cell phones from listed property, the IRS issued guidance explaining the revised rules governing the tax treatment of employer-provided cell phones and other similar telecommunication equipment fees. (IRS Notice 2011-72.)
Note that the guidance deals only with telecommunication fees. If the employer purchases a cell phone and transfers ownership of the device to the employee, the value of the cell phone itself is treated as taxable wages. (IRC §83, RS Reg. §1.482-3 and the IRS Fringe Benefits Audit Techniques Guide (02-2005).)
Under IRS guidance pertaining to monthly cell phone fees, the portion of qualified employer-provided cell phone usage that is not connected to business is treated as a de minimis fringe benefit exempt from FIT, FITW, FICA and FUTA. Additionally, the portion of qualified employer-provided cell phone usage having a business connection need not meet the substantiation requirements of IRC §162.
- What is “qualified” cell phone usage? Qualified cell phone usage is defined as cell phone services that are provided for “non-compensatory business reasons.” Cell phone services are considered provided for non-compensatory business reasons if there are substantial reasons relating to the employer’s business (other than providing compensation) for providing the employee with cell phone services. IRS guidance gives the following examples of non-compensatory business reasons for furnishing cell phone services to employees:
- The employer always needs to contact the employee for work-related emergencies.
- The employee is required to be available to speak with clients at times when the employee is away from the office.
- The employee needs to speak with clients in other time zones at times outside of the employee’s normal work day.
Examples of cell phone services not provided to employees primarily for non-compensatory business reasons include:
- To promote the morale and good will of an employee
- To attract a prospective employee
- As a means of furnishing additional compensation to an employee
Cell phone allowances. If employees are reimbursed for their cell phone expenses, IRS field guidance indicates that its examiners should be certain that such reimbursements are reasonably related to the employer’s business needs and that the reimbursement is reasonably calculated. Furthermore, the reimbursement cannot be a substitute for regular wages. In addition, the field guidance instructs examiners to look more closely at arrangements allowing for reimbursement of unusual or excessive expenses. (SBSE-04-09110083, 9-14-2011)
Examples of reimbursement arrangements that may be excessive and that IRS examiners are instructed to review closely include:
- Reimbursement for international or satellite cell phone coverage to a service technician whose business clients and other business contacts are all in the local geographic area where the technician works.
- A pattern of reimbursements that deviates significantly from a normal course of cell phone use in the employer’s business (e.g., an employee received reimbursements for cell phone use of $100 per quarter in quarters 1 through 3 but receives a reimbursement of $500 in quarter 4).
A policy of providing employees with cell phone allowances wherein employees are not required to periodically provide a monthly statement detailing the type and amount of expenses incurred presents the risk that the allowance could be considered excessive in relationship to employees’ job duties and the type of services purchased or the actual usage fees incurred.
For this reason, it is prudent to establish allowances and reimbursements for cell phone usage based on periodic substantiation from employees that includes a copy of their monthly cell phone statements and an explanation of how those expenses are connected to their current job duties.
FAQ 4: What is the federal tax treatment of the portion of an employee loan balance that is later forgiven?
Facts: Last year we entered into a loan agreement with one of our employees requiring that he repay, in 24 monthly instalments, the principal portion of a loan we provided to him of $5,000. He has been on disability leave since the time the loan was granted and was determined that the loan balance would be forgiven. What is the federal tax treatment of this $5,000 forgiven loan balance?
Answer: The outstanding loan balance is subject to FITW, FITW, FICA and FUTA on the day that it is forgiven. Any unpaid interest that may have applied is included in taxable wages subject to FIT, FICA and FUTA but it is not subject to FITW. (IRS §7872; IRS Publication 535.)
Note that under IRC §3121(a)(15) if the wages are considered paid at the time the individual is entitled to disability insurance benefits under section 223(a) of the Social Security Act, the entitlement began prior to the calendar year in which such payment is made, and if the employee did not perform any services for the employer during the period for which such payment is made, the wages attributable to the forgiven loan balance may be excluded from FICA.
FAQ 5: Are employer-paid emergency day care expenses considered in the annual $5,000 tax-free limit?
Facts: Under our fringe benefits policy, we offer two types of dependent care assistance benefits: (1) all employees may elect to contribute to a dependent care flexible spending account on a pretax basis under our cafeteria plan but their pretax election cannot exceed $5,000 per year (or $2,500 if they are married, filing separately and their spouse also has the same benefit) and (2) we have contracts with two area day care facilities that employees may use in the event of an emergency or a work scheduling conflict (e.g., the regular day care provider is ill, or the employee is asked to work at a time when the regular day care provider is not expected to be available).
Answer: Qualified dependent care assistance benefits over $5,000 per employee per year ($2,500 in the case of a married taxpayer filing separately) are included in wages subject to FIT, FITW, FICA and FUTA. Qualified dependent care assistance benefits include pretax contributions made to a dependent care assistance flexible spending account and the fair market value of employer-provided day care facilities, whether those facilities are located at or away from the workplace.
Under your policy, you make direct payment to the child care facility on behalf of your employees. In this case, the fair market value of the benefit is the fee incurred by you for the child care facility on behalf of your employees. (Note that the fees incurred and not the amounts paid to the day care facility are used in determining the annual benefit provided to employees.)
When determining an employee’s total annual dependent care assistance benefit, all qualified benefits are considered. Hence, in determining an employee’s total annual dependent care assistance benefit, the company must take into account the amount the employee elected to contribute on a pretax basis to the dependent care assistance flexible spending account for the calendar year and any fees incurred by the employer in providing child care services under the emergency day care policy.
There is no exclusion from taxable wages for “emergency” day care services that are required because of a work emergency. (IRC §129(a)(2)(A); IRS Notice 89-111, 1989-2 CB 449, as supplemented by IRS Notice 90-66, 1990-2 CB 350, as corrected by IRS Announcement 90-136, 1990-50 IRB 19.)
FAQ 6: How do we determine the tax treatment of educational expense reimbursements?
Facts: We make various reimbursements to employees and direct payments to universities and other organizations for educational expenses. Some of this educational expense is covered under a policy that provides employees with financial assistance toward an undergraduate or graduate degree. Other educational expenses reimbursed or paid directly to educational organizations include continuing education and courses connected to licensing and technical skills training. What is the tax treatment of these educational expenses, and what kind of documentation should be maintained for tax and reporting purposes?
Answer: There are two exclusions available for the educational expenses of employees: qualified educational assistance (IRC §127) and working condition fringe benefits (IRC §162). The distinction between these two exclusions is significant because an annual limitation of $5,250 applies to qualified educational assistance, while education that meets the definition of a working condition fringe is excluded from federal taxable wages without limitation.
The challenge facing employers arises both in determining which of the exclusions apply and maintaining documentation consistent with the exclusion being claimed.
- Working condition fringe. In general, educational expenses fall within the category of a working condition fringe and are excluded from wages if the education assists employees in improving skills or in performing the duties they were assigned at the time of the educational event. (Treas. Reg. §§1.162 5(a)(1) and (2).) For instance, mandatory instruction in independence guidelines for financial statement auditors, attendance at an employment tax conference by members of the employment tax staff or required attendance by manufacturing plant workers in a safety program will most likely meet the definition of working condition fringe benefits.
- Educational assistance. In contrast, education expenses incurred on behalf of, or reimbursed to, employees do not meet the definition of a working condition fringe benefit if the education enables employees to (1) meet the minimum educational requirements for qualification in their current jobs, (2) qualify for a promotion or salary increase or (3) qualify for a different position (transfer) or for a new trade or business. I Education used to pursue a hobby does not qualify for the exclusion. (Treas. Reg. §1.162-5(b) (2) and (3).)
Except for education used to pursue a hobby of the employee, the above-referenced educational expenses may qualify for exclusion from federal taxable wages of up to $5,250 per year if provided under a written plan of the employer that meets the requirements of IRC §127.
Degree programs. Difficulty generally arises in determining whether education pursuant to a degree program meets the definition of a working condition fringe. As previously explained, to meet the definition of a working condition fringe benefit, the education connected to the degree program must support the position that the employee was not eligible for a promotion, transfer or a new trade or business because of completing the course of study. Several courts have reviewed this issue and have favorably concluded that employees’ expenses incurred for higher education were job-related in nature and were deductible as a working condition fringe. (See Blair v. Commissioner, T.C. Memo., 1980-488 and Beatty v. Commissioner, T.C. Memo. 1980-196.)
In Allemeier, Jr. v. Commissioner the court explained that in determining if educational expenses are excluded under IRC §162 or subject to the annual $5,250 exclusion from wages under IRC §127, the facts and circumstances of each benefit recipient must be evaluated. The court further explained that in making this determination, a “common sense approach” should be applied. In other words, the employer needs to compare the job duties of employees before completion of the education program with the duties after completion of the educational program. If the job duties are substantially the same, the educational expenses are excluded from wages, without limitation, as a working condition fringe benefit. Conversely, if the job duties of employees after completion of the educational program are substantially different, the requirements of IRC §127 must be met, and if those expenses are paid from a qualified IRC§127 plan, amounts over $5,250 per year are included in wages subject to FIT, FITW, FICA and FUTA.
- Documenting education expenses. As a practical matter, employers should gather information at the time educational expenses are incurred or reimbursed that lays out the details needed to determine whether the education is a working condition fringe benefit or is subject to the employer’s written plan for educational assistance. As a leading practice, such documentation is maintained in the form of a transmittal document that assists accounts payable and payroll in determining the appropriate tax treatment of the benefit. This same transmittal document can also be referred to if the employer is asked to justify its tax treatment of the education benefit (e.g., a tax audit).
This document, which is approved by Human Resources and the Benefits and Tax departments, should answer the following questions:
- What are the employee’s current primary job duties?
- How does the education support the employee’s current primary job duties?
- Is this education necessary to the employee performing his/her current job duties?
- Is this education necessary to the employee qualifying for different primary job duties (e.g., a promotion or transfer?)
- What are the employee’s anticipated primary job duties at the conclusion of this educational program and for the foreseeable future?
FAQ 7: How is the distribution for FICA tax owed on nonqualified deferred compensation reported on Form W-2?
Facts: We have two nonqualified deferred compensation (NQDC) plans for our executives, both meeting the requirements under IRC §3121(v) and IRC §409A. Under one plan, we pay on behalf of employees any FICA taxes that are due at the time an amount vests in the plan. Under the other plan, we require that employees take a distribution at the time of vesting that is equal to the federal, state and local withholding taxes that are owed due to the vesting. What is the correct way of determining the total distribution that is required for FICA and other tax withholding purposes and how are these amounts on Form W-2?
Answer: Under the so-called “special timing rule” under IRC §3121(v)(2) and the IRS regulations, compensation deferred under an NQDC plan must be considered as “wages” for FICA purposes when earned or, if later, when no longer subject to a substantial risk of forfeiture (i.e., when “vested”). Thus, amounts deferred pursuant to an NQDC plan are required to be considered as wages for FICA tax purposes at the time they are no longer subject to a substantial risk of forfeiture.
Under the so-called “nonduplication rule,” once a deferred amount is considered under the special timing rule, neither that amount nor the income attributable to that amount will be subject to FICA taxes at the time of distribution. Thus, benefits under an NQDC plan generally will be subject to federal (and if applicable, state and local) income tax withholding at the time they are actually or constructively paid (typically upon distribution) but will be subject to FICA taxes only to the extent those amounts have not previously been taken into account as FICA wages under the special timing rule.
The deferred compensation rules under IRC §409A generally prohibit the acceleration of the time or schedule of any payment from an NQDC plan, without regard to if it is allowed under the terms of the NQDC plan. (Treas. Reg. §1.409A-3(j) (1)), Prohibition on Acceleration of Payments, In general.) The Treasury Regulations under IRC §409A provide several exceptions to this general rule. (Treas. Reg. §1.409A-3(j)(4).) The implication of making a prohibited acceleration of payments is that the employee would be subject to the constructive receipt of income measured as the net present value of their remaining vested NQDC benefit. This amount would not only be subject to federal, state and local (if applicable) income taxation, but would additionally be subject to further “pyramiding” (or gross-up) of federal and state income taxes on the additional distribution of amounts to cover these income tax liabilities.
There is a specific exception under the regulations that permits an accelerated distribution from an NQDC plan to pay the FICA tax imposed under the “special timing rule” of IRC §3121(v)(2). This exception also permits an NQDC plan to provide for an additional accelerated distribution “to pay the income tax at source on wages imposed under IRC §3401 or the corresponding withholding provisions of applicable state, local, or foreign laws as a result of the payment of the FICA or RRTA amount, and to pay the additional income tax at source on wages attributable to the pyramiding IRC §3401 wages and taxes.” [emphasis added.] (Treas. Reg. §1.409A-3(j)(4)(vi).)
Calculation of federal, state and local wages subject to withholding when a distribution is made from NQDC plan for FICA tax obligation:
As explained previously, IRS regulations allow a plan to make a distribution to cover the FICA tax obligation that occurs at the time of vesting. However, because federal income tax withholding (and state/local income tax withholding, if applicable) is also required at the time of distribution, it is necessary that a gross-up calculation be performed to arrive at the amount that is subject to withholding and reported in Form W-2, boxes 1, 3 and 5 (and the applicable state and local boxes). This gross-up calculation does not take into account any additional FICA taxes because of the nonduplication rule previously explained.
Example: Assume that Jane participates in an NQDC plan under which $75,445, representing contributions from 2017 to 2018, vests in 2019. The plan document provides that any withholding taxes owed will be distributed from the plan. Assume also that Jane’s year-to-date wages at the time of vesting are $300,000 and she is subject to state income tax at the rate of 6.25%. Jane’s year-to-date wages at the time of vesting exceeded the 2019 social security wage limit; therefore, Jane has a FICA tax obligation at the time of vesting of $1,772.96 ($75,445 x Medicare tax of 1.45% and Additional Medicare Tax of 0.9%, or 2.35%).
To arrive at the federal and state wages subject to income tax withholding:
- 100% - federal income tax rate of 22% - state income tax rate of 6.25% = 71.75%
- $1,772.96/71.75% = $2,471.02
A tax obligation at time of vesting:
A plan may also provide that the employer will pay any withholding tax obligations that are incurred by its employees at the time of vesting. In this case, the payment of the employees’ FICA tax obligation by the employer represents wages subject to federal income tax (and state/ local income tax as applicable), Social Security (up to the wage limit) and Medicare tax withholding. As in our previous example, a gross-up calculation is needed to arrive at the amount that is subject to withholding and reported in Form W-2, boxes 1, 3 and 5 (and the applicable state and local boxes). This gross-up calculation must take into account any additional FICA taxes that are owed as a result of the employer’s payment of the employee’s FICA, federal and state income tax obligations.
Example: Assume that Randy participates in an NQDC plan under which $36,938, representing contributions from 2018, vests in 2019. The plan document provides that any withholding taxes owed will be paid by his employer. Assume further that Randy’s year-to-date wages at the time of vesting are $250,000 and he is subject to state income tax at the rate of 7.35%. Randy’s year-to-date Social Security wages at the time of vesting exceeded the 2008 wage limit; therefore, the FICA tax obligation is $868.04 ($36,938 x Medicare tax of 1.45% x Additional Medicare Tax of 0.9%, or 2.35%).
To arrive at the federal and state wages subject to income tax withholding:
- 100% - federal income tax rate of 22% - Medicare tax of 1.45% -Additional Medicare Tax of 0.9% - state income tax rate of 7.35% = 68.3%
- $868.04/68.3% = $1,270.92
FAQ 8: What is the federal tax treatment of wellness benefits and can they be part of our cafeteria plan?
Facts: We offer employees various incentives under our health plan, including free annual health screenings, cash incentives for weight loss and smoking cessation, and free gym membership subsidies. Are these benefits excluded from federal taxable wages?
Answer: In a 2016 Technical Advice Memoranda (TAM), the IRS clarified the extent that employer-provided wellness benefits are included in wages subject FIT, FITW, FICA and FUTA. The TAM gave focus to wellness benefits provided under an IRC §125 cafeteria plan, but it is also instructive about wellness benefits generally. (TAM No. 201622031, 4-14-2016.)
While a TAM, or information letter, may not be cited as precedent it does provide insight into how the IRS may rule under similar facts and circumstances.
- Free health screenings. Under the facts in the ruling, an employer’s wellness program provided employees with free health screenings as well as other accident and health plan benefits that are excluded from taxable wages under IRC §106. These wellness benefits are available to employees even if they are not enrolled in the employer’s health insurance coverage plan. The IRS held that the value of employer-provided health screenings is excluded from wages subject to FIT, FITW, FICA and FUTA.
Under IRC §105(b), an employee may exclude from taxable wages amounts received through employer-provided accident or health insurance if those amounts reimburse expenses incurred by the employee (including the employee’s spouse, dependents and children under age 27) for personal injuries and sickness.
- Wellness benefits under a cafeteria plan and gym memberships. Under the facts in the ruling, all employees, including those who are not covered under the employer’s health insurance plan, may elect to buy into the wellness program by making a pretax contribution through the employer’s IRC §125 plan. In addition, employees who participate in the wellness program may receive benefits that do not qualify as medical expenses under IRC §213(d), such as gym memberships.
The IRS held that benefits offered under an employer’s wellness program that provide medical care as defined under IRC §213(d) are generally excluded from wages subject to FIT, FITW, FICA and FUTA under IRC §105(b) and IRC §106(a). Under IRC §125, an employee’s pretax contributions for coverage under the plan are also excluded from wages subject to FIT, FITW, FICA and FUTA.
- Taxable wellness benefits. Any other benefit provided by the wellness program that is not medical care as defined under IRC §213(d) is included in taxable wages subject to FIT, FITW, FICA and FUTA unless it qualifies as an exempt fringe benefit under IRC §132.
For example, the value of an athletic facility operated by or on behalf of the employer and available on the employer’s premises is excluded from wages subject to FIT, FITW, FICA and FUTA. However, reimbursement of an employee’s cost for athletic facilities not operated by the employer is included in wages subject to FIT, FITW, FICA and FUTA. (IRS Reg. §1.132-1(e).)
- Reimbursement of pretax contributions for the wellness program. Under the facts in the ruling, employees may be reimbursed for all or a portion of their cafeteria plan pretax contribution toward the cost of the wellness program.
The IRS held that any employer reimbursement of employee pretax contributions toward the cost of the wellness program is included in wages subject to FIT, FITW, FICA and FUTA.
The scheme whereby employers reimburse employees for a portion of their pretax contributions, also referred to as “double dipping,” was addressed in Rev. Rul. 2002-3 (2002-3 I.R.B. 316). In that ruling, the IRS states that if an employer makes payments to employees that reimburse a portion of the health insurance premiums paid by an IRC §125 pretax deduction, such payments fail to meet the exclusions under IRC §106(a) and IRC §105(b) and are therefore included in taxable wages subject to FIT, FITW, FICA and FUTA.
- Cash incentives under a wellness plan. The IRS held that cash incentives are included in wages subject to FIT, FITW, FICA and FUTA because under IRS Reg. § 1.132-6(c), a cash award (other than overtime meal money and local transportation fare) never qualifies as an exempt de minimis fringe benefit.
FAQ 9: Is leave taxable when received under a public or private paid family and medical leave insurance plan?
Facts: Our employees currently receive paid family and medical leave (PFML) either through a state plan (e.g., New Jersey), or, where there is no state plan, under a private third-party insurance policy. Are these leave benefits included in federal taxable wages and reported on Form W-2?
Answer: The tax and reporting of PFML under an insurance plan differs depending on if the benefits are paid by a state fund or by a private plan (i.e., employer’s self-insured plan or a plan carried with a third-party insurance provider.)
- PFML paid by a private plan. Unlike disability pay, which is exempt from federal taxable wages to the extent the employee pays the insurance premium, PFML benefits paid under an employer’s self-insured plan or under a third-party insurance plan are wages subject to FIT, FITW, FICA and FUTA and are reported on Form W-2. This is true even if the employee pays 100% of the cost the PFML insurance premium. The difference in the tax treatment of disability and PFML insurance benefits is that disability insurance provides wage replacement in the event of the employee’s own illness while PFML insurance provides the employee with wage replacement to care for family members. (IRC §105(a); IRS Reg. §1.104-1(d); IRC §3401; IRC §3121a) (4); IRC 3306(b)(4).)
- PFML paid by a state fund. When PFML is paid by a state fund, the state fund is required to report the payments on Form 1099-G and not Form W-2. This differs from disability benefits paid by a state fund, which are reported on Form W-2 if the employer pays all or a portion of the state disability insurance contribution.
It is important to note that federal law has not kept up with state trends in PFML and there is no direct statutory authority concerning the federal tax treatment of PFML benefits. Instead, we turn to IRC § 61, which states that gross income includes income from whatever source derived unless specifically excluded and IRS guidance instructing state agencies to use Form 1099-G to report payments in the nature of unemployment compensation.
In response to questions raised by California’s PFML program that took effect in 2004, the IRS Chief Counsel issued a technical memo in 2005 to address if amounts paid to an individual under the California PFML program are included in gross income under IRC §85 under two scenarios (the employee itemizes or does not itemize deductions on Form 1040). The IRS held in both cases that California’s PFML benefits are included in gross income according to the statutory authority of IRC §85; however, the fact pattern addressed in the IRS technical memo was specific — the PFML payments will be paid from the state disability fund, will be funded entirely by employee contributions and the payroll deductions are mandatory. (CCA 200630017.)
IRC §85 states that unemployment compensation is included in gross income and defines unemployment compensation as any amount received under a law of the United States or of a state which is in the nature of unemployment.
IRS Reg. §1.85 further explains that amounts in the nature of unemployment compensation also include cash disability payments made pursuant to a governmental program as a substitute for case unemployment payments to an unemployed taxpayer who is ineligible for such payments solely because of the disability.
The IRS explains on its website that recipients of unemployment compensation can voluntarily request federal income tax withholding by completing Form W-4V and that such payments are reported by the recipient as “other income” on (line 19) of the Form 1040). The instructions for 2018 Form 1040 (pg. 87), line 19 state:
“You should receive a Form 1099-G showing in box 1 the total unemployment compensation paid to you in 2018. Report this amount on line 19. However, if you made contributions to a governmental unemployment compensation program or to a governmental paid family leave program and you aren’t itemizing deductions, reduce the amount you report on line 19 by those contributions. If you are itemizing deductions, see the instructions on Form 1099-G.”
FAQ 10: How is former employees’ group-term life insurance reported on the Form W-2?
Facts: We provide group-term life insurance to our retirees, but because they are former employees, we are unable to withhold FICA taxes. How is this reported on Form W-2?
Answer: The employer is relieved of collecting or paying a former employee’s share of FICA on group-term life insurance over $50,000, but only to the extent it was provided to employees during periods in which there was no longer an employment relationship. If the employer failed to collect FICA for taxable group-term life insurance while the employee was still actively employed, it remains the employer’s obligation to withhold or pay the employee’s share of FICA.
Example. Employee John receives taxable group-term life insurance valued at $10 per month. He worked for the employer through September 30, 2019, when he was laid off. His employer agreed to provide his life insurance benefits through December 31, 2019. The employer must collect or pay John’s share of FICA for taxable group-term life insurance provided through September 30. John may be responsible for paying his share of FICA for taxable group-term life provided in October through December. The employer will match the FICA that John pays.
- Form W-2 reporting is required. The employer is required to report FICA taxes it fails to withhold from a former employee’s taxable group-term life insurance on the Form W-2 in the year in which the obligation was incurred. For 2019, the value of the group-term life over $50,000 is reported in Form W-2, box 12, code c. In Form W-2, box 12, code M the employer reports the Social Security tax not withheld and in Form W-2, box 12, code N the employer reports the Medicare tax not withheld. Note that the IRS may assess penalties for Forms W-2 on which amounts are reported in box 12, codes M and N but no amount is reported in box 12, code C.