Explore the essential steps for managing excess salary taxes, including repayments and payroll adjustments for churches and employees.
Key Takeaways:
- IRS guidelines govern the repayment of excess salary received in a prior year.
- Repayments affect FICA taxes, taxable income, and payroll reporting.
- Proper documentation is essential for compliance and record-keeping.
Excess salary payments can create complex tax and payroll scenarios. This article explains IRS guidance for addressing these situations, ensuring compliance for both employers and employees.
Background: What Are Excess Salary Taxes?
Occasionally, a church treasurer may overpay an employee due to an innocent mistake. If discovered, the employee may wish to return the excess to the church. Understanding the tax and payroll implications is critical for handling these scenarios appropriately.
IRS Guidance on Excess Salary Repayments
According to the IRS, here are the key tax consequences for employees who repay excess salary:
- No FICA or Federal Income Tax Adjustments in Year 2: The employer does not adjust FICA taxes or federal income tax withholding for year 2.
- No Year 1 Taxable Income Adjustments: The employee’s taxable income and income taxes withheld for year 1 remain unchanged.
- Receipts for Repayment: The employer should provide the employee with a receipt for the repayment, which the employee should keep for their records.
- FICA Tax Overpayments: Repayment of excess salary in year 2 creates an overpayment of FICA taxes for year 1. Employers may claim a credit for this overpayment.
- Itemized Deduction for Employees: Employees may claim a miscellaneous itemized deduction on Schedule A in year 2 for the amount repaid.
- Corrected Forms W-2: Employers must issue corrected Forms W-2 for year 1, reflecting adjusted social security and Medicare wages and taxes. However, no changes should be made to Box 1 (“Wages, tips, other compensation”) or Box 2 (“Federal income tax withheld”).
Source: IRS SCA 1998-026
Example:
Assume a church treasurer overpays an employee in year 1, and the error is discovered in year 2:
- The employee repays the excess salary to the church in year 2.
- The employer must provide a receipt for the repayment.
- Corrected Forms W-2 must be issued for year 1, adjusting social security and Medicare wages.
FAQs About Excess Salary Taxes
- Can employees adjust their taxable income for prior years?
No, taxable income for prior years remains unchanged when repaying excess salary. - What documentation is required for repayments?
Employers should issue a receipt for the repayment and provide corrected Forms W-2 for the affected year. - Can employers recover overpaid FICA taxes?
Yes, employers can claim a credit for FICA tax overpayments from the prior year. - How do repayments affect Schedule A deductions?
Employees may claim a miscellaneous itemized deduction for the repayment in the year it is made.
Conclusion
Managing excess salary taxes requires careful attention to IRS guidance. Churches and employees should document repayments accurately and ensure compliance with payroll reporting rules to avoid complications. Consulting a tax professional can help navigate complex scenarios effectively.
For further details, consult the IRS website or explore resources on Church Law & Tax.