Everyone enjoys a good storybook fable from time-to-time during childhood. These myths often have been based on some true situation or person, and as they have been handed down from generation to generation, each subsequent retelling has seen a slightly different twist added. That is how a fairy tale is born.
So go the myths of the relocation industry. To understand the myth-based assumptions that often crop up, we will explore a few of the more prevalent myths around today.
Relocation Myth 1. If the transferee’s temporary housing bill is paid directly to a corporate housing company, it is not taxable and does not have to be added to the transferee’s wages.
This myth started about the time a change in tax regulations was enacted regarding how “deductible” (excludable) moving expenses are reported on Internal Revenue Service (IRS) form W-2. Prior to 1994, these deductible expenses were reported in the income boxes of the W-2 form. Beginning in January 1994, these same expenses were to be reported in box 13 of the W-2 form under the Revenue Reconciliation Act of 1993. To make things more interesting, the law changed in 1998 to eliminate the reporting of these deductible expenses paid directly to a vendor on the W-2, the same year as the demise of IRS form 4782 (The W-2 reporting box for transferee-paid excludable expenses switched to Box 12 in 2001.). However, these changes apply only to household goods, 30 consecutive days of storage, the final move en route travel expenses (except meals and personal vehicle mileage in excess of $.15 per mile), and not to any other relocation expense types regardless of who receives payment.
Relocation Myth 2. Household goods and final move amounts that are included in a lump-sum payment, based on historical or market data, are deductible by the transferee and therefore do not have to be grossed-up.
While it may seem logical that historical or market data may provide a good indicator of the cost for household goods shipment and final move expenses, IRS specifically states that unless these expenses are adequately accounted for by the transferee to the employer, they do not meet the deductibility guidelines under Internal Revenue Code §217. The transferee may account for such expenses by providing receipts, cancelled checks, and bills to the employer as evidence of incurring those costs. Without such evidence, as is the case with a lump sum, these expenses would be fully taxable to the transferee at the time the payment is made.
Relocation Myth 3. Household goods and final move expenses should be added to earnings and reported in the W-2 wage boxes.
This was indeed a true statement, prior to 1994. However, more recent tax law changes have altered how deductible relocation expenses should be handled. In the past, these expenses were fully deductible by the transferee when filing the federal tax return. Current guidelines allow the transferee to deduct costs associated with moving household goods, 30 days of storage, and their final trip to the new location (except meals and personal vehicle mileage in excess of $.15 per mile) when paid by the transferee. As a rule, these expenses should be listed on the W-2 in box 12 coded with a “P” only if they are reimbursed directly to the transferee. They should not be listed on the W-2 at all when they are paid to a service provider. Applying incorrect tax codes for excludable expenses can result in an additional tax burden or windfall to the transferee or a W-2C issued by the employer.
Relocation Myth 4. Homesale programs are taxable if the move does not meet the 50-mile test or if the transferee does not meet the time test (IRS publication 521).
It surprises many relocation professionals to learn that homesale programs, when handled properly, fall under different sets of tax guidelines from the mileage and time tests. While the tax status of relocation payments is dictated by Internal Revenue Code §217, homesale programs look to Revenue Ruling 72-339 for tax protection. In other words, a corporation can take on the burdens and benefits of buying an employee’s home (for a business purpose) without jeopardizing the tax-protected status of the homesale program regardless of the distance or time tests we normally associate with relocation.
Relocation Myth 5. The buyer value option (BVO) program is an approved program by the U.S. federal government as a tax-protected homesale option.
This myth seems to stem from the IRS’s position that the assigned sale homesale program creates taxable income to the transferee. However, they have not formally announced a position on the amended value sale program and, as a result, its sibling—the BVO. While IRS has said it will not challenge a properly structured amended value sale, no such position was provided for the BVO, putting this program at a higher tax risk. It is essential, then, that BVO programs follow the Worldwide ERC® 11 Key Elements, because it is reasonable to expect that any stance IRS takes on this program—should they take one—will be dependent on these same factors.
Relocation Myth 6. All taxable relocation payments should be reported as income to the destination state.
Relocation payments are taxable at the time payment is made. If the transferee has not begun working in the new position, relocation expenses paid prior to the new job start date should have taxes withheld for the state/locale in which they were earned—in this case the old job location. Relocation policies often dictate that gross-up will be calculated for the destination state. While the employer’s relocation policy may dictate how state gross-up is calculated, payroll withholding rules are much more regimented by federal and state taxing authorities. As a result, states most likely will require withholding on relocation expenses paid while the transferee is earning income or working in that state.
Relocation Myth 7. The transferee’s current payroll state is the most accurate state to calculate tax gross-up and withholding.
Referring back to the previous myth, this would seem to be a correct statement, assuming the transferee has filed the appropriate paperwork so that the state in which the transferee was documented in payroll as having been taxed is consistent with the transferee’s current job location. Often, a transferee moving from a lower tax state to a higher one will not file the payroll state change form until after he or she has moved his or her residence. Conversely, a transferee moving from a higher tax state to a lower one often will file the payroll state change form as soon as possible. Regardless of where the transferee owns a residence (resident home), taxes should be withheld in the locale in which the income is earned (tax home). As a rule of thumb, the date in which the transferee is effective in, or spends the majority of time at, the new work location is the date taxes should be withheld on the transferee’s wages for that work state. It is the transferee’s responsibility to ensure the correct tax state is on file in the payroll system.
Relocation Myth 8. It is perfectly tax compliant to wait until year-end to calculate tax gross-up on taxable relocation expenses.
Yes and no. Tax gross-up and payroll withholding are often thought to be one and the same; however, for all intents and purposes, they are quite different. Gross-up is a benefit to the transferee and can be calculated in whatever fashion the relocation policy dictates. Payroll withholding, on the other hand, has a fairly strict set of standards for calculating the amount of withholding necessary to comply with tax law and when tax deposits are to be made. When a taxable relocation payment is made, it becomes income to the transferee and taxes must be withheld in that same pay period, and those taxes must be rapidly deposited with the government. Waiting to do so leaves one subject to fairly stiff penalties. On the other hand, the decision as to whether the employer chooses to assist the transferee with the tax burden via a tax gross-up is a matter of policy. In other words, tax gross-up (tax assistance payment made by the employer) can be paid at any time during the year, whereas payroll taxes must be withheld and paid over to IRS in the pay period in which the payment was made for all taxable relocation payments.
Relocation Myth 9. Employer-paid gross-up must equal the required minimum (supplemental) payroll tax withholding set by federal and state taxing authorities.
As noted earlier, it is important to understand the difference between tax withholding and gross-up. Tax withholding is the requirement that, by law, tax deposits must be made on a regular basis for employee income, whereas tax gross-up is a benefit to the transferee and may be calculated on any formula the employer chooses. Many employers will gross-up taxable relocation expenses to meet minimum withholding requirements. However, it is important to note that if the employer decides to gross-up at a lower tax rate, for example, the transferee is required to pay the remaining tax liability requirement, which should be deducted from the transferee’s reimbursement or period paycheck. In any circumstance in which a transferee pays part of the taxes due on relocation expenses, close communication is necessary with the transferee and/or the transferee’s tax professional to ensure they understand the ramifications of the program and can plan finances accordingly.
Relocation Myth 10. Mortgage points and interest paid by an employer, either to the transferee or on the transferee’s behalf to a third-party, are deductible by the transferee and, therefore, do not need payroll taxes withheld.
Because mortgage points are deductible on the transferee’s federal and state tax returns (31 states and Washington, DC, allow the deduction), an employer’s policy may be to withhold taxes for Social Security and Medicare only, coining the term “FICA-only expenses.” The thought process behind this decision was that the employer would have made an adjustment to recoup the federal and state taxes paid on Schedule A deductible expenses at the end of the tax year, so they have instead accelerated the recapture of the gross-up overpayment into the pay period tax withholding. This logic is not in compliance with IRS regulations and could expose the employer to penalties for under-withholding. The fact that an employee will be able to take a deduction and eventually will owe no tax on a net basis does not excuse failing to withhold and make required tax deposits.
Relocation Myth 11. Mortgage points, interest, and state taxes paid by an employer are not deductible by the transferee on Schedule A of IRS form 1040.
On the opposite side of the spectrum from myth 10, this particular myth is a mistake often made by inexperienced tax return preparers. It might sound reasonable that, because the employer paid the Schedule A deductible expenses, the deduction is allowable by the employer and not the transferee. However, regardless of whether the employer paid one or more of these expenses, the transferee is allowed to take the deduction as long as the points meet the requirements of deductibility in IRS Revenue Procedure 92-12 and are reported properly on the settlement statement.
Relocation Myth 12. Taxable payments that are not grossed-up by the employer and are paid directly to a vendor do not need payroll taxes withheld until year-end.
When an employer does not fully gross-up taxable relocation payments to meet the minimum legal withholding requirements, it may seem easier to wait until year-end to report the taxable vendor payments and withhold at that time. However, taxes on all taxable relocation benefits must be withheld in that pay period in which the expenses are paid, whether the payment is to the transferee or a third-party, and the required tax deposits must be made at that time. Failure to do so may make one subject to penalties under Internal Revenue Code §6656.
Relocation Myth 13. Summer intern travel expenses to and from the job location are not taxable.
It would seem reasonable that, because the intern is traveling to the new location on a temporary assignment for the summer, the expenses associated with the travel would be considered business expenses. However, there are a number of regulations that point to summer intern travel expenses as being taxable. The intern could not qualify for moving expense deductions under Internal Revenue Code §217, because it is unlikely the move will meet the 39-week test. In addition, the intern’s “home” for purposes of business travel (away from home) most likely would be deemed that of the new location, invalidating the opportunity to claim these expenses as normal business expenses. Travel expenses for summer interns should be included in the intern’s taxable wages and are subject to withholding.
Relocation Myth 14. Spouse travel expenses are not taxable when accompanying the employee during a business trip.
Spouse travel expenses are, indeed, taxable during a business trip. If the spouse is also an employee of the corporation, his or her expenses may be considered business expenses if the spouse is accompanying the employee for a business purpose.
Relocation Myth 15. Short-term assignments (365 days or less) that are later identified to exceed 365 days in length do not need to tax benefits until day 366.
Short-term assignments that eventually convert to long-term or permanent assignments must begin taxing benefits on the date in which it is determined that the assignment will exceed 365 days. For example, if an employee is assigned to a nine-month assignment on January 1, and on July 1 the employer decides to make the assignment permanent, the employer cannot wait until January 1 of the following year (day 366) to begin taxing the employee’s benefits. Instead, the employer must begin taxing the benefits incurred as of the date it was determined to make the assignment permanent, in this case, July 1.
Relocation Myth 16. An assignment that extends to 500 days is considered a “business trip” if the employee returns home for at least 1 day before day 365.
This sure seems logical but there are a number of legal implications with this myth. An IRS memorandum has determined that a break in an assignment for less than three weeks does not constitute a reasonable time period to justify a break in the assignment under normal business expense rules. On the other hand, if there is a break in the assignment of at least seven months, that would be considered enough time away from the assignment to validate both assignments as business expenses. For a break in time between three weeks and seven months, the circumstances surrounding the break will be important to determine if the time of the break is reasonable enough. The location of the return assignment and whether the employee continued employment between assignments are two such indicators. Although IRS has not taken an official stance on this subject, the memoranda issued in 2000 most likely would be used to examine circumstances in reviewing these matters.
In establishing the basis for these myths and the real, underlying implications, we can steer clear of the legal issues that would stem from abiding these falsehoods...and all live happily ever after.
Robert L. Giese, CRP, is vice president, client relations and government services, for Orion Mobility, Littleton, CO, and a member of the MOBILITY Editorial Advisory Committee. He can be reached at +1 720 981 3343 or e-mail firstname.lastname@example.org.
David S. Oltman, CRP, is CEO/co-founder and director of taxation for Orion Mobility, Wilton, CT. He can be reached at +1 203 563 2102 or e-mail email@example.com.
Quentin Hormel, CRP, is tax manager for Orion Mobility, Wilton, CT. He can be reached at +1 203 563 2119 or e-mail firstname.lastname@example.org.