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One of the most overlooked opportunities for avoiding unnecessary relocation costs can be found in the payroll department. The penalty for out-of-compliance relocation payroll practices can exceed US$10,000 per move per year. If a company moves just 50 employees annually and is out of payroll compliance, penalties could range up to $500,000 for each year of non-compliance—a significant and avoidable expense.
Which relocation payments are subject to withholding under the current tax law? While Internal Revenue Service (IRS) does not specifically state the taxability of every expense type, unless an expense is expressly excluded from tax under the law, it will be subject to payroll tax withholding. Relocation costs that are subject to tax withholding include (but are not limited to):
- interview trip costs that were not specifically incurred by the prospective employee (e.g., costs attributed to a spouse, significant other, dependents, and the like);
- househunting expenses such as airfare, personal car mileage, lodging, meals, rental car, tolls, and other travel expenses incurred by the employee and/or others on the trip;
- temporary living expenses including corporate housing, meals, rental car, parking, and non-refundable fees;
- return visits home by the employee and/or family members or costs paid for non-company employees to visit the employee in the new location while in temporary quarters;
- meals during the final trip for each relocating family member (except for New Jersey and Pennsylvania state taxes);
- final trip mileage for personal vehicles in excess of the federal deductible rate of 27¢ per mile (2008 rate after June 30, 2008);
- excess storage of household goods beyond 30 consecutive days;
- costs to sell a home;
- homesale programs that do not comply with Revenue Ruling 2005-74 and the Worldwide ERC® 11 Key Elements;
- costs to purchase a home in the new location;
- mortgage points and interest;
- lease settlement costs;
- apartment search fees;
- loss-on-sale amounts;
- babysitting, pet sitting, and elder care costs while the employee is traveling or in temporary quarters;
- miscellaneous expense or other allowances;
- unsubstantiated lump sums;
- cash advances that do not conform to the 30/60/120 day accountable plan rules; and
- tax assistance.
These costs, in addition to others, are taxable as income to the employee in the pay period in which they are paid. During that pay period, all taxes should be withheld from the payment for federal, FICA (Social Security/Medicare), state, and local taxing authorities.
Principles of Compliance
A recent survey of payroll professionals revealed some of the reasons employers may not be in compliance, including:
Status quo. They are following the same process they always have followed, which, in this case, is to not be in compliance.
Too difficult. Complying with relocation payment withholding requirements is an administrative burden, so it is not being completed.
Lack of knowledge. They were unaware of current laws regarding relocation expense taxability and so were not withholding correctly.
To be in payroll compliance, it is important to remember these rules:
- Most relocation payments are considered income to the employee and must be reported in the wage boxes of the employee’s IRS form W-2.
- Payroll tax withholding is due for taxable relocation expenses in the pay period in which they are paid, according to Circular E/IRS Publication 15.
- Payments made to a service provider do not present the employer with an opportunity to avoid nor delay payroll tax withholding on those payments.
- Non-taxable (excludable) expenses reimbursed to the employee must be reported in Box 12 of the employee’s W-2 and coded with a “P.”
- Non-taxable (excludable) expenses paid directly to a service provider should not be reported on the employee’s W-2.
- IRS form 1040 Schedule A deductible (FICA only) expenses are fully taxable in the pay period in which they are paid for all taxing authorities.
- Employer-paid taxes (tax assistance) are income to the employee and must be reported in the wage boxes of the employee’s W-2.
- Taxable relocation expenses are not exempt from payroll tax withholding whether the employee incorrectly submits them as normal business expenses or the employer pays them as such, intentionally or not.
Employers cannot avoid paying taxes on these expenses by using a third-party or vendor. Any of these expense types paid to a vendor still is subject to payroll withholding in the pay period in which the expense was paid. The employer may not pass expenses through a qualified homesale program to avoid the tax liability of these expenses; doing so can jeopardize the employer’s entire homesale program and it can become subject to substantial penalties.
An employer may not intentionally delay withholding taxes on relocation payments to vendors. Waiting until year-end to add taxable vendor payments to employee income and withholding taxes at that time is not in compliance with current guidelines.
In some cases, an employee may submit a relocation expense statement to the local office in the new location, and that office reimburses the employee. This does not, however, relieve the employer of the duty to gather that data, add those costs to the employee’s income, and withhold appropriate payroll taxes.
Some employers own property in which employees visiting the local office will stay; however, when an employee is relocated and stays in this type of property, the use of this property becomes imputed income to the employee. The employer must have the property evaluated (with substantiation) to identify the current market rental price, then use that amount as the basis to calculate the imputed income amount.
For example, if the property evaluation determined the unit could rent for $3,000 a month in the current market and the relocated employee stays in the property for 45 days, the employer must add (impute) $4,500 to the employee’s income ($3,000/ 30 days x 45 days = $4,500) and withhold appropriate taxes.
Schedule A Deductible/FICA-only Expenses
Certain payments (with a few rare exceptions) are deductible by the employee on IRS form 1040—Schedule A. These payments include mortgage interest, real estate taxes, and new mortgage points. When an employer pays these expenses—either to the employee or on the employee’s behalf—and adds them to the employee’s W-2 as income, the employee can deduct these expenses from their federal tax return using Schedule A just as they normally would.
For payroll purposes, these expenses are taxable for all taxing authorities at the time they are paid. Because the employee is able to deduct these expenses on their federal and a majority of state tax returns, employers often will recoup the excess federal and state taxes paid on these expenses through tax assistance at the end of the year.
Non-taxable Relocation Expenses
While most relocation expenses are considered taxable, certain expenses qualify as non-taxable. Non-taxable relocation expenses normally reside in one of three categories: excludable, business excludable, and homesale expenses.
Excludable expenses are those that are paid directly to the relocated employee but are not added to the employee’s income. Instead, they are shown on the employee’s W-2 form in box 12 preceded by a “P” code. This means it is not income to the employee unless the employee cannot substantiate these amounts when filing his or her federal tax return.
Business excludable expenses are the same expenses as excludable except that they are paid directly to a vendor or third-party instead of the employee. The other difference is that they do not show anywhere on the employee’s W-2 form; however, they still need to be reported on the employer’s IRS form 940 along with excludable expenses.
The relocated employee uses the information provided by the employer to complete IRS form 3903 to file along with their annual tax return.
Non-taxable (excludable/ business excludable) expenses include shipment of household goods; 30 consecutive storage days; final trip airfare and other en route public transportation; final trip lodging, phone, tolls, and parking; and final trip personal car mileage of 27¢ per mile (effective July 1, 2008).
Homesale expenses incurred using a qualified homesale program fall under separate tax rules from all other relocation expenses. IRC §217, the tax law that dictates the taxation of moving expenses, includes homesale costs as a taxable expense. However, when a qualified homesale program is in place, these expenses are tax-protected and would not be added to the employee’s income, nor are they reported on the employer’s IRS form 940.
IRS Revenue Rulings 2005-74 and 72-339 describe programs the IRS will accept as resulting in no tax to the employee on the home purchase and sale expenses incurred by the employer. These rulings allow an employer (or a representative third-party) to purchase an employee’s home for a business purpose (such as relocating the employee to a new work location) for the benefit of the employer provided that the purchase of the home by the employer (or relocation management company) from the employee and the sale of the home to an independent buyer are two separate and distinct transactions.
As such, expenses incurred as a result of a qualified homesale program are not taxable and include broker’s commission; normal and customary closing costs; carrying costs while the home is in inventory; repairs and improvements for an inventoried home; and homesale service fees.
Worldwide ERC® has developed a list of 11 Key Elements to assist employers and relocation management companies to stay within the bounds of homesale legislation. As such, there are several programs that qualify as tax-protected under Revenue Ruling 2005-74; appraised value offer (guaranteed buy out or full buy out) and amended value sale. IRS has been silent on a third program, the buyer value option.
Compliance Is Key
Penalties can be extensive to an employer that is intentionally or unintentionally out of payroll compliance for relocation payments. By following a few simple rules and using the right tools, staying in compliance does not have to be a burden. Technology is available that will assist companies in managing relocation expenses, capturing the taxability of an expense correctly, and calculating withholding taxes according to IRS payroll tax withholding guidelines.
Payroll Reporting
Taxable relocation payments should be reported in the pay period in which they were paid. This means that whether or not the employer provides tax assistance, taxes must be withheld for all taxing authorities on the gross payment amount.
Employers must withhold a minimum amount of tax, typically the supplemental tax rate/schedule for the taxing authority. Examples of current 2008 supplemental tax rates are:
Federal income: 25.0 percent
State income (California): 6.0 percent
In addition to federal and state income taxes, Social Security and Medicare taxes must be withheld. These 2008 rates are:
Social security: 6.2 percent on employee income up to $102,000.
Medicare: 1.45 percent on all income.
For a $1,000 payment where an employer is not providing tax assistance and the employee has not exceeded the Social Security income limit, the withholding would look like:
| Gross payment |
$1,000 |
|
| Less: |
|
|
| Federal withholding |
$250 |
($1,000 x 25 percent = $250) |
| State withholding (California) |
$60 |
($1,000 x 6 percent = $60) |
| Social Security withholding |
$62 |
($1,000 x 6.2 percent = $62) |
| Medicare withholding |
$15 |
($1,000 x 1.45 percent = $15 rounded) |
| Net payment |
$ 613 |
|
Additional taxes or special rules such as local taxes or state unemployment/disability taxes may need to be applied.
Examples of special taxes are:
California SDI: 0.8 percent on income up to $86,698
California mental health services: 1.0 percent on income exceeding $1,000,000
When an employer provides a tax assistance amount (gross-up), this, too, becomes taxable and payroll taxes must be withheld on the gross-up amount in addition to the taxable expense amount (together as the gross amount). Because tax assistance is a benefit, there is no right or wrong way to calculate it. However, regardless of the amount of tax assistance an employer provides to an employee for relocation expenses, the payroll withholding requirements still must be met in their entirety whether or not the tax assistance covers the full liability.
Rob Giese, GMS, CRP, CCHP, is the client account executive and marketing director for Equus Software, Denver, CO. He can be reached at +1 303 292 4200 or e-mail rgiese@equusoft.com.