Employee Overpaid by $19,000 in 2016

[marlenew]

Client was overpaid by $19,000 in 2016 and not discovered until 2017 and told she has to pay back the full amount in 2017. I was reading the 525 pub and it's not quite clear. Can anyone recommend where I can get more info on how to handle this. I'm thinking this won't affect her 2016 return but next year I would recalculate her 2016 return and either take a credit or deduction on the 2017 return. The company said she would get a 2016 W2-C for the fica taxes which would be taxable when repaid???

[kathyc2]

You don't indicate if the overpayment was the fault of the employer or the employee. If it was the fault of the employer, I wouldn't have a lot of faith that they would get any W2c's correctly prepared.

If this was my client and it was the fault of the employer, I would advise that the 19K be paid back as a pre-tax deduction of 2017 pay rather than a cash payback. I would also have client request employer make up to them any additional tax paid if there is a higher 2 year tax paid from income in the incorrect years than what it would have been if handled correctly.

[kathyc2]

I was thinking that being a cash basis taxpayer, the 2016 would have to report pay received during the year. On second thought, I don't see why the 19K could not be treated as a non-taxable loan. In that case, the W2C would reduce boxes 1, 3 and 5 by 19K, and boxes 4 and 5 calculated on the lower amounts. The company will receive the refund of lower employee FICA tax of 1,454 so the amount employee needs to pay back would be lowered by that amount.

Then, if for some reason the employee doesn't pay back the 17,546 in 2017 employer would report the defaulted amount on 2017 W2.

[Roland Slugg]

What a mess. Does your client still work for that company? If so, I like kathyc2's idea of trying to get the employer to treat the excess $19k as a loan. This would require the issuance of an amended W-2 to the employee, as well as several corrected reports by the employer ... W-2c, W-3c, 941c, maybe others plus state forms as well. That's a lot of paperwork, and the company might not want to do it.

The second best option is probably the take-back-this-year approach, perhaps a little at a time over several months. It should be done by reducing the gross salary, not by treating the repayment as a deduction.

If the $19k o/p was due to the employEE's actions, then I would not propose that he/she seek to recover from the employer an additional amount for overall higher taxes paid over the two year period. However, if the o/p was due to an employER error, I believe that would be appropriate, if applicable.

If all else fails, the "claim of right" doctrine may be of use to your client. See Code §1341 and related Regs.

[marlenew]

Claim-of-Right for repayment in following year per Pub 525 Page 34 and IRC 1341

Hopefully this helps someone else...Overpayments and repayments in the current year
Overpayments are considered paid when received and must be included in the employee’s income when received. If the employee repays the advance or overpayment during the same year they received it, the employer should exclude the amount from the employee’s income when filing the W-2.
If the employee doesn’t repay the advance or overpayment until a subsequent year, they’ll need to repay the gross amount – the net amount they received plus any federal or state income tax. The employer can’t collect federal or state income tax withheld in a prior year, so no correction can be made for income taxes withheld. The employee can, however, claim a deduction on their personal income tax return for the tax they repaid.
Current Calendar Year
If repayment is made in the same calendar year as the overpayment, the employee will repay the net pay amount of the overpayment. The Payroll Department will reduce the employee’s taxable wages and associated taxes for that calendar year to ensure the year-end W-2 Form is correct.
Prior Calendar Year(s)
If repayment is not made in the same calendar year that the overpayment occurred, the employee must repay the net pay amount of the overpayment plus the associated federal and state taxes.
The Company can only recover the overpaid Social Security and Medicare taxes. Since the company can recover the Social Security and Medicare taxes, Company will reduce the repayment amount by those associated taxes, if applicable.
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 is not entitled to file an amended tax return for that year. Instead, the employee is entitled to a deduction (or credit, depending upon the amount repaid) for the wages repaid on their personal income tax return in the year of repayment.
Once repaid, the Payroll Department will issue a corrected W-2 Form, reducing only applicable Social Security and Medicare wages and taxes and issuing the employee a W-2c. The Payroll Department, if requested by the employee, can also issue a Statement of Corrected Income which details the amount repaid by the employee and the year repaid. The employee can use this Statement for their current tax return for a credit or a deduction.

[taxea]

The income has to be reported in the year received. Has the employer requested reimbursement or how will it be paid back? Whatever happens be sure to calculate and deduct SS and Medicare taxes on Sch A that relate to this.