Background. It occasionally happens. A church treasurer pays an employee more than the salary authorized by the church board. In most cases, this is due to an innocent mistake. But what happens if the treasurer and employee later discover the mistake, and attempt to correct it? Can the employee “give back” the excess to the church? And what if the mistake is discovered in the following year? How does a return of the excess affect the employee’s taxable income, and the church’s payroll reporting obligations? The IRS addressed these questions in a recent publication.
What the IRS said. Here are the tax consequences for employees who return to their employer in “year 2” excess salary received in “year 1”:
* The employer does not reduce the employee’s wages for FICA and federal income tax withholding purposes for year 2.
* The employer does not reduce the employee’s taxable income for year 1, or reduce the amount of income taxes withheld in that year.
* The repayment in year 2 of excess salary received in year 1 has no effect on the Form W-2 for year 2. The employer should furnish the employee a separate receipt acknowledging the repayment for the employee’s records.
* To the extent additional FICA taxes were paid in year 1 because of the erroneous salary payment, the repayment of the excess salary in year 2 creates an overpayment of FICA taxes in year 1, and credit may be claimed by the employer with respect to its FICA tax liability for that prior year.
* The employee may claim in year 2 a miscellaneous itemized deduction on Schedule A in the amount of the excess salary that was repaid.
* To the extent repayments in year 2 of erroneous salary paid in year 1 result in a reduced amount of social security (and Medicare) wages for year 1 and reduced amounts of employee social security (and Medicare) taxes paid for that year, the employer is required to furnish corrected Forms W-2 for year 1 showing the employee’s corrected “social security wages,” corrected “social security tax withheld,” corrected “Medicare wages and tips,” and corrected “Medicare tax withheld.” No changes should be made in the entries for “Wages, tips, other compensation” (Box 1 of Form W-2) or for “Federal income tax withheld” (Box 2 of Form W-2). SCA 1998-026.
This article originally appeared in Church Treasurer Alert, March 1999.