Employment Tax Impact

A key principle in wage and tax reporting is the requirement that compensation is subject to employment tax and withholding in the year received. As a consequence, and with limited exceptions, wages are subject to federal income tax (FIT), federal income tax withholding (FITW), Social Security/Medicare (FICA) and federal unemployment insurance (FUTA) at the time wages are made available to employees without substantial limitation. (IRS Reg. §1.451-2(a).)

This doctrine of constructive receipt applies without regard to whether the wages were earned at the time of payment. For instance, a wage advance or wage overpayment continues to be subject to employment tax and withholding in the year received despite any future obligation of repayment.

Repayment of Current Calendar Year Claims 

When an overpayment is paid back in the same year, the employee’s repayment will be reflected in his or her IRS Form W-2 Wage and Tax Statement.   The Payroll and Tax Compliance office will reduce the employee’s taxable wages and associated taxes for that calendar year to ensure the year-end W-2 Form is correct.

Repayment of Prior Calendar Year(s) Claims 

Because of the strict rules provided by the Internal Revenue Service regarding how to handle the repayment of wages, individuals may not necessarily recover the additional tax liability from the previous year related to the overpayment. Therefore, it is imperative that employees ensure that their payments received are correct and any overpayments are paid back in the same year.

If an overpayment is paid back in a subsequent year, the employee’s W-2 for the year of overpayment will not reflect their repayment. The wages paid in error in the prior year remain taxable to the employee for that year because the employee received and had use of those funds during that calendar year.  The employee should consult the IRS Publication 525 (Repayments) with respect to reporting the repayment of wages for a prior year.

IRS rules for repayment of prior year wages allow for adjustments to Social Security and Medicare wages and taxes only. Once repaid, the Payroll and Tax Compliance office will issue a corrected W-2 Form (W-2c), reducing only applicable Social Security and Medicare wages.   Keep copy of your payments as receipt, as you may take a credit on your following year’s personal income tax return.