In December 2014, Congress finally got around to fixing an inequity in the tax treatment of commuting expenses. The change is retroactive to January 1, 2014 and only applies for 2014.
(The Washington budget game keeps this from being a permanent fix.)Employees retroactively qualify for a monthly exclusion from taxable income up to $250, rather than $130, for mass transit assistance. 1 This puts mass transit users on par with the $250 monthly parking exclusion offered to auto commuters.
It’s a good deal for employees, but the retroactive application will drive payroll managers crazy. An alleged “easier way” just announced in IRS Notice 2015-2 is not that easy, and it only applies to companies that act fast prior to filing the last quarter’s Form 941 that is due on February 2, 2015. This alert describes the Notice 2015-2 procedures for those who can meet the tough deadline, and the traditional correction method that otherwise applies. It also points out that this rejuggling of taxable compensation may affect the administration of other payrelated benefits, such as 401(k) plans.
Note: This Advisory is required reading for payroll managers and HR directors of companies which sponsored a mass transit assistance plan in 2014. Of special interest will be the new law’s retroactive reduction of taxable compensation, and the unplanned effect of that on other benefits, like 401(k). Others may want to skip this one.
No retroactive increase on what was spent for mass transit.
The Notice makes clear that there is no retroactive way to increase the amounts that were spent for 2014 mass transit benefits. If the amounts spent for mass transit were kept to $130 per month, the new law doesn’t help employees or require any adjustments to the W-2 / Form 941 process.
The new law only applies to employees who spent more than $130 per month under the employer plan. They get a tax benefit and their employers are required to adjust W-2 and 941 reporting accordingly.
Example: Jill’s mass transit pass costs $250/month. She elected to buy a pass under an employer plan through monthly salary withholding of $250, and she was expecting to be taxed on the amounts over $130/month, i.e. $120 / month. The new law says that she will not be taxed because her expenses did not go over $250/month. Jill’s employer must file returns reflecting the correct tax treatment and excess withholding.
The normal way of correction
Notice 2015-2 procedures are described in the next section of this Advisory. Because many employers will not meet its tight deadline – full correction before filing the 4th quarter Form 941 (due on February 2) – let’s first review the “normal way” of correction when taxable income has been over-reported in a prior calendar year. Most employers will be stuck with this.
1. Pay or reimburse the employee for her share of excess social security & Medicare taxes. Payment is with a check. Reimbursement is application of the excess amount to the employee’s obligations in 2015. (An alternate procedure to file for refund on the employee’s behalf is usually too cumbersome.)
2. Do not pay or reimburse excess income tax withholding or the additional Medicare tax (the .9% extra withheld on wages over $200,000). Employees will have these amounts credited or refunded by filing individual tax returns.
3. Obtain and keep in your records (but do not file) an affidavit from each employee you reimburse stating:
I give my consent to have my employer (named above) file a claim on my behalf with the IRS requesting $____________ in overcollected social security and Medicare taxes for 2014. I have not claimed a refund of or credit for the overcollected taxes from the IRS, or if I did, that claim has been rejected; and I will not claim a refund or a credit of the amount.
4. File Form 941-X for each quarter of 2014 (4 filings) in which any employee was overtaxed because of the $130/month limit in effect at the time.
The Notice 2015-2 “easy way.”
Notice 2015-2 makes it a bit easier for employers who act fast. All corrections required by the Notice must be completed before filing the 941 for the last quarter of 2014. (The due date is February 2, but correction must be made before the actual filing.)
1. Pay or reimburse the employee her share of the excess social security and Medicare tax. This can be done with check or application of the excess amount to the employee’s obligations in January, 2015. Unlike the normal way, the option to pay or reimburse later than January will not be available, because this must all be done before the filing of the last quarter 2014 Form 941.
2. Unlike the normal way, refund any excess .9% additional Medicare tax that was withheld on wages over $200,000.
3. Unlike the normal way, no employee affidavits are required.
4. Like the normal way, do not refund excess income tax withholdings.
5. File Form 941 (4th quarter) by reducing the reportable wages (lines 2, 5a, 5c, and 5d (if applicable) by the mass transit benefits that will be untaxed because of the new law. Use this single form for all 4 quarters.
Note: unlike the normal way, the easy way does not require a 941-X filing for all 4 quarters. Instead, just catch the full year’s corrections in the last quarter’s 941.
6. In order that the taxes paid after reduction reconcile with the employer’s withholding liabilities, be sure to reduce the liability in line 14 (or schedule B if applicable) with the full amount of reduction, reducing the liability for what is owed for the latest month first. In the unlikely event the change exceeds the liability for that month, apply the excess to the next earliest month.
1. If possible, file a timely and correct W-2 by subtracting the additional mass transit benefit (all 4 quarters) from taxable wages and making adjustments to taxes paid as if you had known about this new rule on January 1, 2014.
2. If you have paid or reimbursed the refunds, and an incorrect W-2 has been distributed but not filed yet with SSA, mark the VOID box on each copy A. Then, prepare correct W-2s, send them to SSA, and mark employee copies B, C and 2 as CORRECTED. Give those to the employees.
3. If you have paid or reimbursed the refunds and already filed incorrect W-2s with SSA, distribute Forms W-2c with correct information and file them with SSA under normal correction procedures.
Does this affect pay-related benefits?
It might. All of this affects the definition of taxable compensation. Most qualified retirement plans and other benefit plans add back voluntary salary reductions when defining “compensation.” If the commuter assistance plan was limited to voluntary salary reductions, “compensation” definitions stay the same and there is no problem.
However, many employers also contribute to their commuter assistance plans. This generosity creates a problem. The “tax break” granted by Congress will reduce taxable income by up to $120 per month. Most qualified retirement plans, like 401(k)s, do not consider tax-free employer contributions to commuter assistance plans as “compensation.”
Example: Joe’s employer pays for mass transit passes up to $250 per month, treating amounts over $130 per month as taxable compensation. His employer has been contributing 6% of Joe’s taxable compensation to his 401(k) account. The change in law reduces Joe’s taxable compensation by $120 per month. Joe’s employer has now over-contributed $86.40 to Joe’s 401(k) account (6% of $120 x 12) and may have to adjust it under IRS correction procedures to keep the 401(k) plan in compliance.
In typical fashion, Congress didn’t think about employer inconvenience and the unnecessary bureaucratic tangle which is caused by last minute legislation, even when a change seems simple. As we know, there is nothing simple about benefits these days. A copy of Notice 2015-2 is at this link.
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