To avoid tax reporting and withholding penalties as 2015 draws to a close, employers need to properly plan and check their reporting for employees under non-qualified deferred compensation, fringe benefits, health benefits or other remuneration. Year-end planning for employers is important, because employee information reporting, including both Form W-2 and the new Affordable Care Act (ACA) Forms, is now subject to significantly increased penalties.
Employers are obligated to withhold Federal Income and Federal Insurance Contributions Act (FICA) taxes on wages, and may satisfy this obligation by actually withholding from the wage payments, withholding from other wages paid to the employee, or accepting a check from the employee for the withholding obligation. Failure to withhold can result in the employer becoming liable for the non-withheld taxes. Beginning in 2015, the penalties for errors or omissions for information returns have dramatically increased and can be as high as $500 per copy of return.
FICA Tax Withholding on Non-Qualified Deferred Compensation
Prior to January 1, 2016, employers should withhold on any amounts earned by an employee under a non-qualified deferred compensation plan (NQDC), which becomes vested and ascertainable in 2015. In the case of a NQDC arrangements, the FICA tax, comprised of Social Security and Medicare taxes, can apply when NQDC plan amounts are no longer subject to a substantial risk of forfeiture and are ascertainable, meaning that the amount can be calculated accurately. This special FICA timing rule for NQDC results in imposing a FICA tax before plan benefits are paid.
Because FICA tax is generally withheld when wages are paid, employers must pay careful attention to the special timing rule that applies for FICA tax withholding on NQDC amounts. A painful reminder of the rule is this year’s decision in Davidson v. Henkel Corp. In Henkel, a class of retiree participants in a NQDC plan claimed that the payout of vested benefits were reduced because Henkel Corp. had not withheld NQDC amounts in accordance with the special timing rule which would have reduced the total amount of FICA tax liability. The court agreed, finding that the failure to withhold FICA taxes under the special timing rule was both a violation of the implied terms of an NQDC plan, as well as a violation of the Employee Retirement Income Security Act of 1974 (ERISA).
Henkel Corp. makes clear that failures related to the special FICA timing rule for NQDC amounts can result in serious consequences. Unless employers withhold prior to year-end for any NQDC amounts that became subject to FICA tax in 2015, they could be penalized in both the form of additional amounts of FICA tax, owed by both the employer and employee, as well as liability under ERISA.
Employers are advised to check accruals under their NQDC plans and withhold from any NQDC which has become vested and ascertainable at any time in 2015. Note that the employer would first look to withholding from either the deferred compensation balance or other wages paid this year. The employer may need to seek a check from the employee if the amount withheld is not sufficient to satisfy FICA tax liability.
Impute Income and Withholding from Taxable Fringe Benefits
December 31, 2015, marks the deadline for determining the proper value of any taxable fringe benefits enjoyed during 2015. The Internal Revenue Service (IRS) requires the value of fringe benefits to be imputed in income when not specifically excluded under a provision of the Internal Revenue Code (Code). Taxable fringe benefits include, but are not limited to, the fair market value of the personal use of a company-provided automobile; taxable meals; season tickets to sporting events; personal travel on company aircraft; taxable spousal travel; prizes; and awards.
The IRS allows an employer to impute income for taxable fringe benefits on a periodic basis, as infrequently as once per year, rather than when the taxable fringe benefit is actually provided. In addition, employers can adopt a cut-off date as early as November 1 for gathering information to report the value of imputed income for taxable fringe benefits in 2015 for benefits provided in the last 12 months. See Announcement 85-113.
Cafeteria Plan “Use It or Lose It” Deadline
Unless an employer adopts a grace period provision, the “use it or lose it” deadline for “Cafeteria Plans” is December 31. Section 125 of the Code “Cafeteria Plans” allow employees to direct wages on a tax-free basis for the payment of medical bills and other health benefits. These contributions save both income tax for the employee and FICA for the employee and employer. The catch is the notorious "use it or lose it" rule. Employees must decide at the beginning of the year how much to contribute to the plan. Generally if the amount contributed is not used by December 31, the excess is forfeited.
A popular exception to the December 31 deadline is the availability of a “grace period” provision. This provision extends the deadline until as late as March 15, 2016. This allows expenditures up through March 15, 2016, to be used against amounts contributed in 2015.
If employers do not adopt the grace period provision to accommodate employees, employees will need to do the traditional last-minute trip to the drug store, dentist or optometrist to use up the funds in their accounts for medical benefits. Employers may wish to remind their employees of this deadline so as to avoid the any unexpected forfeitures of employee contributions or alternatively may wish to adopt a grace period to accommodate delays.
New Form W-4 to Increase Withholding
Employers withhold federal income tax in accordance with the Form W-4 provided by each employee. Withholding from wages pursuant to the Form W-4 is considered to have been paid ratably throughout the year. In contrast, estimated tax payments made with respect to non-wage income is credited only when paid and may result in penalties for each quarter’s underpayment. Employees are permitted to file a new Form W-4 at any time during the year to increase or decrease the amounts withheld from periodic wages and bonuses. An employee, including a highly paid executive, may wish to increase withholdings on the last remuneration paid in 2015 in order to avoid interest and penalties related to underpayment penalties from income outside of employment or with respect to under-withheld additional Medicare tax.
As a complication for some executives who wish to avoid understatement penalties by increasing withholding on wages, there are special rules regarding supplemental payments (e.g. bonuses) of more than $1 million, which require withholding at exactly 39.6 percent. This means that any shortfalls in withholding cannot be “made up” by withholding from such supplemental payments so that the withholding is more than 39.6 percent. In such cases, any increased withholding may only be made from regular wages and can be made generally up to 100 percent of the regular wages.
Additional Medicare Tax
All wages that are subject to the regular Medicare tax rate of 1.45 percent are also subject to additional Medicare tax withholding if paid on wages in excess of $200,000. Under the Affordable Care Act (ACA), effective January 1, 2013, employers must withhold 0.9 percent as additional Medicare tax for every employee whose earnings reach $200,000 in the calendar year. Employers are required to begin withholding additional Medicare tax in the pay period in which employee wages reach $200,000 and continue to withhold it each pay period until the end of the calendar year. Additional Medicare tax is only imposed on the employee; there is no employer share of additional Medicare tax. The requirement to withhold on amounts above $200,000 may not be altered due to the marital status of the individual, which may result in more or less ultimate liability for the tax by the employee when the individual’s tax return is filed. Employees who anticipate having too little additional Medicare tax withheld may wish to complete a new Form W-4 and submit it to their employers before the company’s final pay period to have additional regular wages withheld. For more information about the additional Medicare tax withholding obligations by employers, see the IRS’ website.
Same-Sex Marriage Equality
In the second of two landmark decisions on same-sex marriage, the Supreme Court of the United States ruled on June 26, 2015, that the Fourteenth Amendment requires all states to license marriage between two people of the same sex, and recognize same-sex marriages lawfully licensed and performed in another state. (Obergefell v. US, No. 14–556, June 26, 2015.)
Employers, especially those in states where same-sex marriage was not previously legal, should review their payroll procedures with respect to taxation of same-sex partner benefits to ensure the proper federal and state tax treatment of benefits extended to same-sex spouses and consider how to communicate these changes to employees.
One significant change affecting many employees, and that may be retroactive, is the state and local taxability of same-sex spousal benefits. Employers will no longer need to apply special taxation rules to same-sex spouses based on the myriad of state tax laws, for example, those employers who were previously offering tax gross-ups in the form of increased compensation to provide equal treatment to employees who were taxed under state or federal law on the value of employer-provided coverage for a same-sex spouse or partner.
Now, all same-sex spouses will receive favorable state tax treatment. This only applies to married same-sex couples. Therefore, it should be noted that federal law, even post-Obergefell, will not apply the same favorable tax treatment to coverage provided for a non-dependent partner in a same sex domestic partnership or civil union.
Read more about same-sex and partner benefits here and here.
In Rev. Proc. 2014-61, the IRS provides that employers’ transit benefit programs may allow employees to receive a maximum allowed pre-tax parking benefit for 2015 of $250 per month and a maximum allowed pre-tax mass transit benefit for 2015 of $130 per month.
Employers should be mindful of the potential for a year-end retroactive increase in the amount of allowable monthly limits for mass transit benefits. Congress has done this before. In 2013, the American Taxpayer Relief Act retroactively increased the 2012 monthly transit benefit exclusion from $125 per month to $240 per month. This gave transit benefit parity with the parking benefit for 2012, which was $240. For many employers, this retroactive increase resulted in both decreased FICA and federal income tax liability.
If U.S. Congress passes retroactive parity measures, employers should be poised to react and amend Form W-2 accordingly. For more information about pre-tax transportation benefits as well as the 2013 retroactive increase in transit benefits, view our previous On the Subject.
Affordable Care Act Reporting
Employers of all sizes will be subject to the imposition of annual reporting requirements under the ACA. The IRS will use the information reported by employers and insurers under the reporting requirements of the ACA to both determine individual eligibility for premium tax credits as well as to determine individual compliance with the individual shared responsibility requirements. The first report is due in 2016 for 2015 coverage.
There are two types of reporting requirements: (1) reporting of minimum essential coverage and (2) applicable large employer (ALE) reporting on health insurance coverage offered under employer sponsored plans.
Annual reports of minimum essential coverage must be filed on IRS Form 1095-B and transmitted on Form 1094-B. Insurers; employers that sponsor self-insured group health plans; and those who provide minimum essential health insurance coverage are all required to file these reports. Employers that sponsor self-insured group health plans must report information about employees (and their spouses and dependents) if the employees enroll in the coverage. This is the case even if the employer is not an ALE subject to the employer shared responsibility provisions of the ACA. The 1095-B solicits information about the entity as well as specific information for each individual for whom minimum essential coverage is required.
ALE reporting must be filed on IRS Form 1095-C and transmitted on Form 1094-C. An ALE, generally defined as an employer with 50 (100 for 2015) or more full-time employees, is subject to the employer-shared responsibility provisions of the ACA. An ALE must describe the kind of health care coverage—whether health insurance or self-insured health care coverage—that it provides to its employees; provide a list of full-time employees; and detail both the coverage offered to each employee and the months to which the coverage applied. An ALE is also required to give each full-time employee a copy of the Form 1095-C that is filed with the IRS. By February 1, 2015, statements must be furnished to employees on paper by mail or hand-delivery, unless the recipient affirmatively consents to receive the statement in an electronic format.
An ALE with 250 or more information returns during the calendar year, must file the Form 1095-C and 1094-C electronically. Electronic returns must be filed through the ACA Information Returns Program: AIR. For more information about the filing of ACA returns, see our previous On the Subject. Employers should be aware that these returns are included in the category of information returns for which the new higher rate of penalties for incorrect or missing information returns apply.