As we perhaps thankfully approach the end of 2020, it is time again to reflect on the past year and plan for the next. For US mobility and payroll departments, it is that magical season of year-end compensation reporting. Here, the hope may be that the usual payroll process will be enough to get the job done efficiently. However, in a year when the dictionary company, Merriam-Webster, has declared “pandemic” as its “Word of the Year” and where use of the word “remote” has increased by 300%, it is probably not surprising that the term “usual” will need further consideration.
To assist mobility and payroll teams as they finalize the US reporting and withholding requirements for their organization’s mobile and cross-border employees, this month’s newsletter provides a top 10 list of payroll matters to review at the end of this unprecedented year.
Working from home became the new norm during 2020. Unfortunately, many companies have found that the actual location of an employee’s “home” and the address on file for payroll reporting purposes were not always the same. In fact, in some cases, the employee may have been working in a different state or country, creating potentially new reporting and withholding requirements for the company.
As payroll requirements may differ based on where your employees are living and working, it is critical that you have a process in place to obtain and verify this data and to understand the payroll tax rules that apply. In addition, having remote workers may create additional complexities.
- If your company does not currently have payroll capabilities in all countries or states where you have employees (domestic or international), you may need to consider the administrative costs of setting up payroll capabilities in these locations.
- The payroll structure for remote workers can vary significantly based on many factors, including whether the change in work location for the employee is temporary in nature or permanent. Accordingly, it is important to understand the specific employee scenario.
- If the company will pay for the travel costs associated with the employee traveling to their physical office of employment, will such payments be taxable? If so, who will pay the tax costs on the taxable travel benefits—the company or the employee?
Given the complexity, it is important to leverage technology and your mobility tax provider to help identify the risks and requirements and to support compliance efforts.
Treatment of disaster relief payments
On March 13, 2020, President Trump declared the ongoing COVID-19 pandemic to warrant a national emergency as defined under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. Due to this determination and while the national emergency is in effect, Section 139 of the Internal Revenue Code allows private entities to provide qualified disaster relief payments to individuals on a tax-free basis.
A qualified disaster relief payment includes any amount paid by an employer to or for the benefit of an employee to reimburse or pay “reasonable and necessary” personal, family, living, or funeral expenses incurred as a result of a qualified disaster. The IRS, in Revenue Ruling 2003-12, provided an example of company paid disaster payments that would not be subject to US federal reporting or withholding requirements. In the example, receipts were specifically not required, but documentation (i.e., a written policy) was used to support the need of company payments for reasonable and necessary expenses that qualify for exclusion under Section 139. Although not required, employee sign-off on the documentation may be important in supporting the position that the payments were in compliance with the exclusion requirements.
The IRS has not provided a list of expenses that could qualify for relief. However, under the COVID-19 emergency, potential categories of reimbursable expenses that may qualify include costs for temporary housing, medical expenses not covered by insurance, and expenses incurred to allow for work from home arrangements. See our November 2020 newsletter for a more expansive list of potentially qualifying expenses.
Qualified disaster relief payments are exempt from federal and most states’ personal income tax for the recipient and are exempt from federal tax withholding, FICA, FUTA, Medicare, and self-employment taxes for all parties if structured properly. Further, qualifying payments are still deductible business expenses for the employer, even though they are not taxable to the recipients.
If you have employees living in one state and working in another, there will likely be payroll complexities that have to be addressed. Here, the general rule is that state withholding and reporting will generally be based on where the employee is physically working. However, there are exceptions to this rule:
- Reciprocity agreements: some states will agree with other states that the reporting and withholding will remain with the resident state. Note that proper payroll documentation is typically required to support this treatment.
- Convenience of the employer rule: a limited number of states (Arkansas, Connecticut, Delaware, Nebraska, New Jersey, New York, and Pennsylvania) will continue to require withholding and reporting for workdays spent in a taxpayer’s “home office” in another state if the individual is assigned to an office in their state.
- COVID-19 related legislation: a number of states have introduced legislation that is designed to ease compliance burdens relating to temporary work from home scenarios.
In the end, the company is responsible for appropriately tracking their employees, understanding these rules and appropriately reporting and withholding for their employees. Tax, penalties, and interest can be assessed to the company if this reporting and withholding is not done correctly.
Deferral of payroll tax obligations
In response to a Presidential directive, the IRS issued Notice 2020-65 on August 28, 2020. This notice allows employers the option to defer the employee portion of Social Security tax (i.e., for 2020, the 6.2% tax on wages up to a cap of $137,700) from September 1, 2020 through December 31, 2020, for eligible employees who earn less than $4,000 per bi-weekly pay period or a pay period by pay period basis.
To pay the deferred amount of the employee portion of Social Security tax, the employer will ratably withhold the amount of Social Security tax deferred from the employee’s paychecks from January 1, 2021 through April 30, 2021. Interest, penalties, and additions to tax will begin to accrue on May 1, 2021, with respect to any unpaid tax.
If your company participated in this program, you will have items to consider in both 2020 and 2021:
- For 2020, you should include any wages for which you are deferring Social Security tax on the employee’s 2020 Form W-2 (in box 3, Social security wages or box 7, Social security tips). However, any deferred tax would not be reflected in the 2020 W-2 in box 4 (Social security tax withheld).
- In 2021, you will need to file a 2020 Form W-2c (Corrected Wage and Tax Statement) to report the tax that was deferred in 2020 but withheld in 2021.
New Form W-4
Proper documentation is the cornerstone of an appropriate payroll process, with Form W-4 being a critical form in supporting the payroll withholding process for employees. The IRS introduced a redesigned version of this form for 2020 to allow for a more accurate withholding calculation and to address changes in the tax law. Because the IRS did not require everyone to complete a new Form W-4, many companies will need to use different withholding tables, based on the forms that are on file. For this reason, it is important to understand the requirements regarding use of the form. The IRS, in Circular E, provided a good summary of the requirements:
- Employees who have submitted Form W-4 in any year before 2020 aren't required to submit a new form merely because of the redesign. Employers will continue to figure withholding based on the information from the employee's most recently submitted Form W-4. The withholding tables in Publication 15-T allow employers to figure withholding based on a Form W-4 for an earlier year as well as the redesigned 2020 Form W-4.
- While you may ask your employees to submit new Forms W-4 using the redesigned version of the form, you should explain to them that they’re not required to do this and if they don't submit a new Form W-4, withholding will continue based on a valid Form W-4 previously submitted.
- All newly hired employees after 2019 must use the redesigned form. Similarly, any other employees who wish to adjust their withholding must use the redesigned form.
In addition to US federal documentation, states may also have documentation requirements to support appropriate withholding. Your mobility tax provider can assist in outlining the specific documentation required and in helping your mobile employees properly complete the forms to support their tax position.
Taxation of moving expenses
The Tax Cuts and Jobs Act suspended the ability for companies to exclude certain qualified moving expenses (e.g., shipment of goods, day-of-move travel, lodging) from an employee’s taxable income and for the employee to deduct these amounts on their tax return. This suspension is currently set to remain in effect through 2025 (there is an exception to this change for certain active-duty members of the armed forces).
To make matters more complicated, not all states have conformed to the federal tax law changes and payroll systems may not be equipped to handle the differences. As such, it is critical to understand both the technical US federal and state laws along with the practical considerations relating to payroll administration.
Income inclusion for employer-provided tax preparation services
The IRS issued guidance in 2018 to advise that the full amount of employer paid Home and Host country tax return preparation fees should be considered compensation and must be included in Form W-2. Although the IRS guidance is not considered “law,” it is a clear indication of the IRS position. For tax equalized assignees, the fees for company-related services, such as hypothetical tax withholding calculations, global coordination of tax services, and preparation of tax equalization calculations remain non-taxable for US tax purposes and do not need to be included in Form W-2.
Many companies have historically included a smaller imputed benefit in their employees W-2s, based on the personal “value” of the tax services that were provided. However, as this is likely contrary to the IRS position, it would be recommended to review the position with your mobility tax provider. It is also important to note that there are withholding exceptions that may apply to help reduce the company's gross-up cost.
Use of fiscal year cut-off for compensation reporting purposes
The compensation accumulation process for cross-border payroll purposes can be time consuming and complex. To provide enough time to meet payroll reporting deadlines, many companies have used fiscal-year reporting for employee benefits (e.g., reporting on a November 1 – October 31 basis on the Form W-2, rather than on a calendar year payment basis). Although IRS rules allow for fiscal-year reporting, this rule is often misapplied in the context of compensation reporting for mobile employees.
The IRS allows fiscal year reporting for certain non-cash benefits (e.g., employer supplied automobile) provided during the last two months of the calendar year, or any shorter period within the last two months. This rule provides companies with the time necessary to compute the income inclusion for these non-cash benefits. For example, assuming an October 31, 2020 cut-off, a company would report the imputed income relating to the twelve-month period ending October 31, 2020 in the employee’s 2020 Form W-2. The company reports the imputed amount relating to November and December 2020 in the 2021 Form W-2.
As noted, this rule can only apply to specified non-cash benefits. Common benefits for mobile employees, including housing and cost-of-living allowances, and reimbursement for home leave expenses are cash benefits and are not eligible for this type of fiscal-year reporting, even if the benefit is not reimbursed or paid directly to the employee.
One possible solution is to implement a fiscal year cut-off for reimbursement of cash and non-cash benefits. For example, a company could use a December 1 – November 30 reporting period for benefits, if the company had a policy for suspending expense reimbursements in December. If implemented, this method should continue in future years.
Tax and payroll treatment for employee repayments
In the mobility tax space, employee repayments are not uncommon. For example, employees may need to return refunds from foreign tax returns to their employer or balances due to the company from tax equalization calculations.
In the past, many companies would treat these types of employee payments as “negative compensation” and would net the payment against other current-year taxable income (e.g., salary, bonus, cash allowances). For example, if an employee paid a 2019 tax equalization settlement to the company in 2020, the company would report it in payroll as a reduction to US federal taxable income on the employee’s 2020 Form W-2.
However, this practical approach is not correct, and the IRS has very specific procedures to handle such payments from an employee, referred to as the “claim of right” doctrine. This doctrine would apply if the repayment meets the following criteria:
- The payment must have been included in the taxpayer’s gross income in a prior tax year (or multiple tax years).
- The payment must qualify as a deduction because it is determined that the taxpayer did not have an “unrestricted right” to the item that had been included in compensation.
- The repayment/deduction must be in excess of $3,000.
To illustrate with an example, a company makes foreign tax payments for an employee in 2019 of $25,000 to cover the employee’s projected personal tax liability in their Host country. The $25,000 would be included as income on the employee’s 2019 Form W-2. However, when the 2019 Host country income tax return was prepared in 2020, it was determined that too much tax had been paid, resulting in a $5,000 refund to the employee. Under the tax equalization policy, this refund is required to be returned to the company, as they had made the original tax payments (hence, the individual should not have received a $25,000 benefit in the prior year and does not have a right to the refund). In this case, all three of the above criteria are met and the “claim of right” procedures would apply as follows:
- The employer would file a corrected Form W-2 for the year that the wages had originally been included in taxable income (the 2019 W-2 in our above example). This corrected W-2 would adjust for social security and Medicare wages and tax amounts only. The employer would refund the employee’s portion of social security and Medicare to the employee.
- Because the repayment is greater than $3,000, the employee can consider an itemized deduction or a credit to recover the overpaid income tax. In our example, the credit or deduction would occur in the 2020 US tax filing.
- If the payment had been subject to the Additional Medicare Tax, then the employee would need to file an Amended US federal tax return (Form 1040-X) for the prior year in which the wages or compensation was originally received to recover this overpayment (a 1040-X for 2019 in our example).
It is important to note that the “negative compensation” treatment referred to above can apply in limited circumstances. In revisiting our example, consider the following changes to the fact pattern:
- Instead of making the foreign tax payments for the employee’s 2019 tax liability in 2019, the company made the payments in early 2020.
- As before, the 2019 tax return is completed in 2020, with the $5,000 refund being returned to the company in 2020.
Here, the company could net the $25,000 payment and the $5,000 refund, reporting $20,000 of taxable benefit on the employee’s 2020 Form W-2.
Tax gross-ups through Form W-2c
Employers can have a difficult time accumulating worldwide income and properly applying tax gross-ups by the end of the calendar year. Thus, employers would often provide a tax gross-up after year-end as an “administrative error” and issue a corrected Form W-2 (Form W-2c) to include both the taxable wage and withholding increases for the gross-up. IRS regulations and guidance seemed to support this position.
However, the IRS clarified their position in 2017 on the definition of an “administrative error” and indicated that the definition does not include prior-year adjustments to federal income tax withholding paid by the employer (a gross-up). The IRS guidance also eliminated the possibility of correcting prior-year federal tax overpayments (gross-downs) through use of Form 941-X. Employers must now seek repayment from employees using the “claim of right” procedures as previously noted.
As can be seen from the above year-end payroll considerations, it is critical to stay up-to-date on current tax developments, especially given the additional complexities resulting from COVID-19. We’re here to help. If you would like assistance in anything covered in this article, schedule your free, 30-minute consultation with an expert from our team.
Author: Eric Loff
With more than 20 years of global tax experience, Eric serves as the Managing Director for GTN's West Central region. He is known for leading by example and finding the strengths in others; improving communication so all participants are engaged in a project; and serving as a bridge between a company and its expat employees. As a specialist on managing international assignment programs and the related tax, human resource, and payroll matters, he serves as a frequent speaker on global mobility topics.
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