In trod u ction
Th er e is oft en a la pse of a t lea st a week bet ween t h e t im e wa ges a r e ea r n ed a n d t h e t im e t h ey a r e a ct u a lly pa id. F or in st a n ce, a n em ployee wh o is pa id biweek ly wor k s du r in g week 1 a n d week 2 bu t is n ot pa id u n t il week 3.
U n der IRS r egu la t ion s, wa ges a r e t a xa ble wh en con stru ctively received by (a ct u a lly m a de a va ila ble t o) em ployees, r ega r dless of wh en ea r n ed. Th is is k n own a s t h e pr in ciple of “con st r u ct ive r eceipt .”
P R OB LE M 1: Accou n t Cor p pa ys em ployees week ly. E m ployees wh o wor k fr om F ebr u a r y 5 t h r ou gh F ebr u a r y 9 a r e pa id for t h is wor k on F ebr u a r y 13. Wh en a r e t h ese wa ges su bject t o feder a l in com e t a x wit h h oldin g (F ITW) a n d F ICA wit h h oldin g?
S OLU TION 1: On F ebr u a r y 13. Th ese wa ges a r e su bject t o F ITW a n d F ICA on t h e da y t h a t t h ey a r e pa id. Th u s, t a xes a r e wit h h eld on F ebr u a r y 13. Th e em ployer ’s F ICA t a x lia bilit y a lso is in cu r r ed on F ebr u a r y 13, t h e da y t h a t wa ges a r e a ct u a lly pa id t o em ployees.
U n claim ed Ch eck s
Sa y t h a t you pr epa r e pa ych eck s on Decem ber 22, 2001. H owever , som e em ployees a r e on va ca t ion a n d do n ot cla im t h eir ch eck s u n t il 2002. Ar e t h e wa ges t a xa ble in 2001 or 2002?
Th e a n swer is 2001. U n der t h e r u le of con st r u ct ive r eceipt , wa ges a r e con st r u ct ively (a ct u a lly) r eceived wh en fu n ds a r e a va ila ble t o em ployees wit h ou t su bst a n t ia l lim it a t ion . If pa ych eck s a r e a va ila ble t o em ployees, bu t t h ey do n ot pick t h em u p, wa ges a r e t a xa ble on t h e da y wh en t h ey cou ld h a ve cla im ed t h e ch eck s.
P R OB LE M 2: An t h on y is t er m in a t ed on pa yda y, Decem ber 31, 2001. Alt h ou gh h is ch eck is r ea dy for h im on t h a t da y, h e does n ot pick it u p u n t il J a n u a r y 14, 2002. Sh ou ld t h ese wa ges be r epor t ed on An t h on y’s W-2 for 2001 or 2002?
S OLU TION 2: Gen er a lly spea k in g, t h e wa ges sh ou ld be r epor t ed on An t h on y’s W-2 for 2001 beca u se t h e pa ych eck wa s a va ila ble t o h im in t h a t yea r . It wa s h is ch oice t o t a k e r eceipt on J a n u a r y 14, 2002.
P R OB LE M 3: ABC Cor p. fa iled t o pr epa r e a pa ych eck for n ew h ir e Ma r ga r et on Decem ber 31, 2001. Th e em ployer discover ed t h e er r or on Decem ber 31, bu t did n ot pr epa r e h er pa ych eck u n t il J a n u a r y 3, 2002. Sh ou ld t h e com pa n y in clu de t h ese wa ges in Ma r ga r et ’s t a xa ble
in com e for 2001 or 2002?
S OLU TION 3: Th ese wa ges sh ou ld be in clu ded in h er t a xa ble in com e for 2002—t h e yea r in wh ich t h ey wer e m a de a va ila ble t o h er .
S electin g th e Correct A n n u al
T ax R ate
Th e feder a l in com e t a x a n d/or F ICA t a x r a t es a n d lim it s gen er a lly ch a n ge ever y yea r . F or in st a n ce, in 2000, OASDI wa s 6.2% of t h e fir st $76,200 in wa ges. In 2001, t h e r a t e is 6.2% of t h e fir st $80,400.
Beca u se t h e feder a l in com e t a x a n d F ICA t a x r a t es a n d lim it s ca n a n d oft en do ch a n ge ever y yea r , t h e r u le of con st r u ct ive r eceipt is pa r t icu la r ly
im por t a n t a t t h e en d of t h e yea r .
E XAMP LE : Con n ie is pa id $80,400 fr om J a n u a r y 1, 2001, t h r ou gh Decem ber 25, 2001. F r om Decem ber 26, 2001, t o Decem ber 31, 2001, sh e ea r n s $1,000 bu t is n ot pa id u n t il J a n u a r y 3, 2002. Th e $1,000 pa id in 2002 is su bject t o t h e fu ll 7.65% F ICA t a x, even t h ou gh h er la st $1,000 in wa ges ea r n ed du r in g 2001 exceeded t h e 2001 m a xim u m OASDI wa ge lim it of $80,400.
Th e r u le of con st r u ct ive r eceipt is im por t a n t for a n ot h er r ea son . E a ch em ployee’s feder a l a n d st a t e in com e t a x lia bilit y is ba sed on wa ges pa id for t h e yea r . Th e h igh er t h e wa ge a m ou n t r epor t ed on a n em ployee’s W-2, t h e m or e feder a l a n d st a t e in com e t a x t h e em ployee owes.
P R OB LE M 4: E dwa r d’s yea r -t o-da t e F ICA t a xa ble wa ges on
Decem ber 15, 2001, wer e $80,400. H e ea r n ed a n a ddit ion a l $500 fr om Decem ber 15 t h r ou gh Decem ber 31, bu t wa s n ot pa id t h is $500 u n t il J a n u a r y 3, 2002. H ow m u ch of t h e $500 pa ym en t is su bject t o F ICA (OASDI a n d H I)?
S OLU TION 4: Th e fu ll $500 is su bject t o t h e F ICA t a x r a t e of 7.65% (com bin ed OASDI a n d H I t a xes) beca u se t h e wa ges wer e n ot r eceived u n t il 2002.
P R OB LE M 5: Rica r do’s yea r -t o-da t e F ICA t a xa ble wa ges a s of Decem ber 26, 2001, wer e $51,000. H e ea r n ed a n a ddit ion a l $500 fr om Decem ber 26 t h r ou gh Decem ber 31 bu t wa s n ot pa id t h e $500 u n t il J a n u a r y 3, 2002. Wh a t a m ou n t does t h e em ployer r epor t on Rica r do’s 2001 F or m W-2: $51,000 or $51,500?
S OLU TION 5: Th e em ployer r epor t s $51,000 beca u se t h e a ddit ion a l $500, t h ou gh ea r n ed in 2001, wa s n ot pa id u n t il 2002.
Postd atin g an d B ack d atin g
Paych eck s
Beca u se of t h e fa vor a ble or u n fa vor a ble effect t h a t t h e r u le of con st r u ct ive r eceipt h a s on t a x lia bilit y, em ployees a n d em ployer s som et im es r equ est t h a t ch eck s be post da t ed or ba ck da t ed.
E XAMP LE : U n der com pa n y policy, em ployee bon u ses a r e pa ya ble on Decem ber 31, 2001. To h elp h igh ly pa id em ployees defer feder a l in com e t a x, t h e em ployer post da t es t h ese ch eck s t o J a n u a r y 3, 2002, bu t dist r ibu t es t h em t o em ployees on Decem ber 30, 2001. U n der t h e r u le of con st r u ct ive r eceipt , t h ese wa ges a r e t a xa ble wh en m a de a va ila ble t o em ployees (2001), r ega r dless of t h e da t e of t h e pa ych eck . Alt h ou gh a ch eck da t e m a y seem t o be pr oof of wh en wa ges wer e r eceived, t h e IRS ca n ea sily det ect post da t in g by r eviewin g t h e em ployer ’s ca n celed pa ych eck s.
P R OB LE M 6: E a ch J a n u a r y 15, H essCo pa ys bon u ses for t h e pr eviou s yea r . All em ployees r eceivin g a bon u s r ea ch ed t h eir OASDI lim it in 2001. To a void wit h h oldin g F ICA on 2002 bon u ses, H essCo ba ck da t es bon u s ch eck s t o Decem ber 31, 2001, bu t dist r ibu t es t h em t o em ployees on J a n u a r y 14, 2002. Ar e t h ese ch eck s con sider ed wa ges for 2001 or 2002?
S OLU TION 6: Th e da t e of t h e ch eck does n ot a lt er t h e fa ct s. Beca u se bon u s ch eck s wer e n ot m a de a va ila ble t o em ployees u n t il 2002, t h ey m u st be t r ea t ed a s 2002 wa ges (su bject t o 2002 F ICA a n d F ITW r a t es).
Postpon in g Paym en t of W ages
Ma u r een is in a h igh in com e t a x br a ck et in 2001 a n d expect s t o be in a lower in com e t a x br a ck et in 2002. Sh e a sk s h er em ployer t o pa y h er Decem ber 2001 wa ges in J a n u a r y 2002. Wh a t sh ou ld t h e em ployer do?
U n less t h e com pa n y h a s a “for m a l defer r ed com pen sa t ion pla n ,” t a xes sh ou ld n ot a r bit r a r ily be defer r ed by post pon in g wa ge pa ym en t s.
E XAMP LE : Wesley a sk s h is em ployer t o dela y h is N ovem ber a n d Decem ber pa ych eck s u n t il J a n u a r y 2002. H is em ployer a gr ees t o dela y pa ym en t of t h e $2,000, a n d h e is pa id in 2002 in st ea d of 2001. Wit h ou t a for m a l defer r ed com pen sa t ion pla n cover in g Wesley, h is em ployer m a y be r equ ir ed t o r epor t a n d t a x t h is $2,000 a s t h ou gh it wer e pa id in 2001.
S alary A d van ces an d Overpaym en ts
Beca u se wa ges a r e t a xa ble wh en con st r u ct ively r eceived, r ega r dless of wh en ea r n ed, a sa la r y a dva n ce or over pa ym en t of wa ges is t a xa ble wh en pa id t o t h e em ployee, even t h ou gh wa ges a r e n ot yet ea r n ed.
Wh en a n em ployee r epa ys a n over pa ym en t or a dva n ce, h is or h er gr oss t a xa ble wa ges will be r edu ced by t h e a m ou n t of t h e r epa ym en t provid ed th e
repaym en t occu rs in th e sam e tax year as th e ad van ce. If a sa la r y a dva n ce is
r epa id in a yea r a ft er t h e yea r in wh ich t h e a dva n ce is pa id, t h e r epa ym en t ca n n ot be dedu ct ed fr om gr oss wa ges. In st ea d, t h e “cla im -of-r igh t r u le” a pplies. U n der t h e cla im -of-r igh t r u le, com plex r epor t in g r u les a pply for bot h t h e em ployee a n d t h e em ployer . Spea k t o a n a ccou n t a n t or lega l a dvisor for m or e in for m a t ion .
E XAMP LE : In J u ly, Ra n dy r eceives a sa la r y a dva n ce of $500 less wit h h eld t a xes. Ra n dy a gr ees t o r epa y t h e a dva n ce by h a vin g it dedu ct ed fr om h is Au gu st pa ych eck , wh ich wou ld n or m a lly be $1,500. H is em ployer will wit h h old t a xes on $1,000 ($1,500 less t h e r epa id a dva n ce of $500).
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WH EN WAGES B ECOME TAXAB LE
Problem I.
H ow m u ch F ICA wou ld you wit h h old fr om t h e followin g wa ge pa ym en t s?
! J oh n is pa id biweek ly. On J a n u a r y 4, 2001, h e is pa id $800 for t h e bi-week ly per iod Decem ber 20, 2000, t o J a n u a r y 1, 2001. As of Decem ber 19, h e h a s h a d yea r -t o-da t e F ICA t a x wit h h eld on wa ges of $87,200. H ow m u ch F ICA sh ou ld be wit h h eld fr om h is $800 pa ych eck , a n d in wh ich ca len da r yea r wou ld it be wit h h eld? $ yea r
" Wh en pa ych eck s a r e dist r ibu t ed on Decem ber 31, 2000, Ma r ga r et is ill. Sh e picks u p h er pa ych eck for $425 on J a n u a r y 4, 2001. As of Decem ber 31, sh e h a s h a d yea r -t o-da t e F ICA t a x wit h h eld on $136,000. H ow m u ch F ICA sh ou ld be wit h h eld fr om h er $425 pa ych eck , a n d in wh ich ca len da r yea r wou ld it be wit h h eld? $ yea r
# L ou ise wor k s ou t of st a t e. H er p a ych eck for $375, d a t ed Decem ber 28, 2 0 0 0 , is d e la ye d in t h e m a il s o t h a t s h e r e ce ive s it on J a n u a r y 4 , 2 0 0 1 . As of D e ce m b e r 2 7 , 2 0 0 0 , s h e h a s h a d ye a r -t o-d a t e F I C A t a x w it h h e ld on $ 8 6 ,0 0 0 . H ow m u ch F I C A s h ou ld b e w it h h e ld fr om h e r $ 3 7 5 p a ych e ck , a n d in w h ich ca le n d a r ye a r w ou ld it b e w it h h e ld ? $ yea r
$ On Decem ber 15, 2001, J ose r eceives a pa r t ia l sa la r y a dva n ce of $50 fr om wh ich F ITW a n d F ICA a r e wit h h eld. H e r epa ys it in fu ll by h a vin g it dedu ct ed fr om h is Decem ber 31, 2001, pa ych eck of $900. H ow m u ch F ICA sh ou ld be wit h h eld fr om t h e Decem ber 31 pa ym en t , a ssu m in g t h a t J ose did n ot r ea ch t h e OASDI lim it in 2001? $
% On Decem ber 31, 2000, Tom r eceives a $500 pa ych eck post da t ed t o J a n u a r y 4, 2001. H ow m u ch F ICA sh ou ld be wit h h eld a ssu m in g t h a t h e did n ot r ea ch h is F ICA lim it in 2000 or 2001, a n d in wh ich ca len da r yea r wou ld it be wit h h eld? $ yea r
Problem II.
F ill in t h e bla n k s.
! U n der IRS r egu la t ion s, wa ges a r e su bject t o t a x wh en r eceived.
" U n der t h e r u le of con st r u ct ive r eceipt , wa ges a r e t a xa ble wh en fu n ds a r e t o em ployees.
# U n der t h e r u le of con st r u ct ive r eceipt , wa ges a r e t a xa ble wh en , r ega r dless of wh en .
$ A wa ge or sa la r y a dva n ce r epa ym en t fr om wh ich F ITW a n d F ICA wa s wit h h eld is fr om gr oss wa ges befor e com pu t in g t h e a m ou n t of wit h h oldin g.
Problem III.
Mu lt iple ch oice. Cir cle t h e cor r ect a n swer .
! Th e pr in ciple t h a t gover n s wh en wa ges becom e t a xa ble is: a . Gen er a lly Accept ed Accou n t in g P r in cipa l (GAAP ) b. ca sh a ccou n t in g
c. a ccr u a l a ccou n t in g d. con st r u ct ive r eceipt
" On Decem ber 31, 2000, E lm er r eceives a pa ych eck da t ed J a n u a r y 4, 2001. Th e Socia l Secu r it y wa ge lim it t h a t a pplies t o t h is pa ym en t is:
a . $0 b. $80,400 c. $72,600 d. $76,200
# Wa ges ea r n ed in 2000, bu t pa id in 2001 a r e t a xa ble a t t h e Socia l Secu r it y r a t e of:
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Problem I.
! $61.20 fr om 2001 wa ges
Wa ges a r e t a xa ble in t h e yea r pa id—n ot t h e yea r ea r n ed. To ca lcu la t e: OA S DI: $800 x 6.2% = $49.60 H I: $800 x 1.45% = $11.60 $49.60 (OASDI) + $11.60 (H I) = $61.20 " $6.16 fr om 2000 wa ges To ca lcu la t e:
$136,000 exceeds t h e 2000 OASDI wa ge lim it of $80,400. Th er e is n o H I wa ge lim it , t h er efor e $425 x 1.45% = $6.16 # $28.69 fr om 2001 wa ges To ca lcu la t e: OA S DI: $375 x 6.2% = $23.25 H I: $375 x 1.45% = $5.44 $23.25 (OASDI) + $5.44 (H I) = $28.69 $ $65.03 To ca lcu la t e:
$900 – $50 (a dva n ce) = $850 (F ICA t a xa ble)
OA S DI: $850 x 6.2% = $52.70 H I: $850 x 1.45% = $12.33 $52.70 (OASDI) + $12.33 (H I) = $65.03 % $38.25 fr om 2000 wa ges To ca lcu la t e: $500 x 7.65% = $38.25
