This article originally appeared in the November 2018 edition of Mobility Magazine.
Relocation is expensive. Companies want to make sure they receive some benefit in the form of future services for the costs incurred to move an employee. Therefore, relocation programs generally incorporate provisions requiring employees to repay all or a part of the expenses incurred to relocate them unless they continue to work for the company for a specified period.
Such provisions, usually called “payback agreements” or “repayment agreements,” take many forms. The enforceability of payback agreements (which is beyond the scope of this article) depends on local law, but the agreements can also have significant federal tax consequences that are, in general, poorly understood.
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A typical payback agreement might be structured as follows: When an employee is relocated, a written agreement is entered into in which the employee, in consideration of the employer’s payment of relocation expenses, agrees to repay all such expenses to the employer unless the employee continues to work for the employer for two years following the move. The agreement also provides that for every six months of continued employment, one-fourth of the potential obligation is forgiven. No promissory note is executed, nor is any interest due from the employee.
Although a number of other issues can arise, when the employee does in fact leave early, the tax treatment of the employee’s repayment of costs becomes an issue. Repayments in the same year as the move are not at issue, because such repayments are accounted for by simply adjusting withholding and payroll taxes. No deduction by the employee is necessary. However, if the repayment is in a year subsequent to the move, the employee has historically been allowed to claim a deduction for the repayment.
In Rev. Rul. 79-311, 1979-2 C.B. 25, the IRS holds that an employee who erroneously receives wages and repays them in a subsequent year is entitled to an itemized deduction as an employee business expense. However, wages repaid in the same year as receipt are not deductible. Rather, they are simply not includible as income in the first place. The ruling goes on to hold that in neither case is the erroneous payment treated as “wages” for FICA and FUTA purposes, and both employer and employee are entitled to adjust employment taxes accordingly.
In the case of repayment in the year of receipt, the company simply credits the employee with the excess withholding and FICA, and adjusts wages on its Form 941 for that year. In the case of repayment in a subsequent year, the company should provide the employee a Form W-2c for the FICA and Medicare collected (but not the withheld income tax), refund the employee share of FICA and Medicare to the employee, obtain a written statement from the employee that the employee will not independently seek a refund, and then claim credit (without interest) for the repayments of FICA and Medicare, as well as its own share of FICA and Medicare, on a subsequent Form 941. (See Treas. Reg. §31. 6413(a)-1 (b) (1); 31.6413(a)-2(a).)
Rev. Rul. 79-311 has been applied to repayment of moving expenses in PLRs 9050053 and 9313015 (IRS private letter rulings).
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In a case when the repayment occurs in a year subsequent to receipt of the benefits, the deduction allowed to the employee would be a “miscellaneous itemized deduction.” Such deductions include employee business expenses, and the deduction is allowable only to the extent that it exceeds 2 percent of adjusted gross income. Nevertheless, given the size of a typical relocation repayment—particularly when homesale expenses are included—the deduction saves the employee very significant amounts in taxes.
Read the rest of this article in the November 2018 edition of Mobility Magazine.