Unsettled Advances

[Golden Rocket]

This is a classic "What Would You Do" question.

You do not perform weekly payroll services for your client, except you do file quarterly payroll taxes for him, so you do have access to his payroll records and tax deposits. Additionally, at the end of the year, you issue W-2s, W-3s, 1099s, 1096s, etc.

During the course of the year, one of his employees was advanced $2000 for an upcoming travel advance. Before the trip the employee quit and never came back. The employer had the opportunity to withhold the advance from his final check but failed to do so. The employee never paid back the $2000, although contacted repeatedly by the employer.

The IRS has a blurb about having to force compensation upon the employee (instead of the employer taking a bad debt deduction).

Which of the following MOST NEARLY describes the action you would take?

a) Write off the advance and take a $2000 deduction for bad debts.
b) Add $2000 to this employees' W-2 and deduct the associated expense as salaries and wages. This will cause the employer to have to cough up payroll taxes, also deductible.
c) Send the employee a 1099-MISC and avoid paying payroll taxes on this guy.
d) Send the employee a 1099-C indicative of the employer's intent to cease collection activity.

You can also select "None of the above" if you submit an alternate course of action...

[Gary2]

Before I give a direct answer to your question, options a and d are not mutually exclusive. However, the 1099-C doesn't indicate "intent to cease." It indicates that collection has ceased, either because it's legally unenforceable, because of sound business reasons and policy, or other events enumerated in the instructions.

Do you have a link to the IRS blurb about forcing compensation? Assuming the employer has an accountable plan in place, my direct answer is that the rules for an accountable plan should apply. In this case, my memory is that when an employee fails to provide the proper substantiation, then the advance is treated as if they were paid under a non-accountable plan, i.e., as ordinary W-2 wages, options (b). See Pub. 15, under accountable and non-accountable plans. I'm not sure how to handle the employee's share of the FICA; possibly, the employer could just pay them as well, and gross up the amount added to the W-2 to include that amount.

[Golden Rocket]

The Blurb is a Blob

No Blurb Gary. Came up years ago as a result of some comptroller's threat to add to W-2s if certain people didn't turn in their expense reports to absolve their advances. (Kinda stupid really. Withholding the advance from the paycheck would have produced instant reporting if he had the kahunas to do it)

I would say the inaction of a single employee to follow company procedure does not invalidate a company's accountable plan. Guy just didn't do what he was supposed to do. I think somewhere in the mix compensation will end up being part of the answer, just don't know how to get the employer off the hook for payroll taxes.

I think the OP would have been very similar if the employer had just loaned the money (instead of a travel advance) and the employee just quit without repaying the loan...

[erchess]

I vote B

The money was advanced under an accountable plan and not properly accounted for. I don't see any other options. In my old age I have learned not to fight with the government over trifling sums.

[MichaelG]

None of the Above

Here is what I would suggest to the client:

Don't throw good money (payroll taxes) after bad.

This is employee theft, file a police report. Wait a reasonable length of time - maybe 12 months. The employer may not get all or any of the money back. If not, write it off as a bad debt. The police report should be enough documentation that collection attempts were made.

[Burke]

I agree. As a former manager in a large corporation, we had the same plan in effect when I worked there. To get the advance our employees had to sign a document indicating the requirement to repay, and if they terminated employment, the amount was due in full as of the last paycheck. It's a bad debt. They could also turn it over to a collection agency or go to small claims court. The failure to withhold out of the last check does not obviate the debt.

[Gary2]

Here is what I would suggest to the client:

Don't throw good money (payroll taxes) after bad.

This is employee theft, file a police report. Wait a reasonable length of time - maybe 12 months. The employer may not get all or any of the money back. If not, write it off as a bad debt. The police report should be enough documentation that collection attempts were made.

Which is it, theft (reported on 4864) or a bad debt (reported as an expense directly on the business return)?

To be theft, it needs to be illegal. It's not necessary to have a conviction, or even an arrest. But depending on local processes, merely filing a police report may not be enough proof that a criminal act took place. I suppose it's possible that this could be considered larceny, fraud, or embezzlement, but it's not clear that there's any criminal intent. I'd want a legal opinion.

To be a bad debt, it has to be totally or partially worthless. Similar to theft, it's not necessary to get a judgment, or even file suit. But it is necessary to take reasonable steps. I don't see a police report as being a reasonable attempt at collection, unless perhaps it serves the need of locating the person, because just getting a person arrested won't recover the debt. On the other hand, repeated attempts to contact the person, including certified mail, might be enough - I don't know. But the collection efforts should be sound from a business perspective.

Or to put it another way, getting paid back is a much better result than taking the deduction. So if you're going to take it as a bad debt, you should at least be prepared to answer why small claims court wasn't pursued, or a lawyer wasn't asked to write a letter.

[KathMorgan]

Accountable Plan?

Assuming the employer uses an accountable plan or a non-accountable plan then I don't see where he has a choice but to use choice B. Unless he is willing to follow the route of going to collections or court to prove a bad debt. In the long run if he uses choice B it "costs" him the additional FICA taxes (which he gets to deduct) over what he has already paid but the ex-employee ends up having to claim the income. The additional taxes are going to be a lot cheaper then persuing the bad debt route. Pay the taxes, include it on the W2, take the deductions and press on. Now, if it was $100,000 or so, that may be different. But for $2000, not cost effective.