Gross Repayment - Worked Example
Author: Ryan F. Donovan
Updating Author: Alice Gilman
If an employee is paid wages that are not ultimately due, the employer can make corrections. However, the method of making the corrections is based on how and when the original payment actually occurred.
When Joan Smith began working for Acme Widget Corporation she received two months' worth of wages up front totaling $4,000. She left her job at Acme after working there for only one month. She must repay $2,000 - the second months' pay. Her net pay for the second month is $1,600. She began and ended employment at Acme within the same calendar year.
To remove the gross pay from Joan's wage data, Acme must do the following:
- Ask Joan to write a check back for the net pay. Joan writes a check back to Acme for $1,600, which is the full $2,000 minus any taxes withheld and not actually paid to her.
- Acme recovers all taxes paid to the federal government. Acme paid a total of $553 in taxes withheld from the $2,000 in overpaid wages. $400 of that amount was for the employee portion of Social Security tax - 6.2%; Medicare tax - 1.45%; and federal income tax. In addition, Acme paid $153 for the employer matching portion of Social Security tax ($2,000 × 0.062 = $124) and the employer Medicare tax ($2,000 × 0.0145 = $29).
This scenario assumes that Joan's pay did not exceed the Social Security withholding limit between the time the overpayment occurred and when the overage was corrected.
Scenario 2 - Subsequent Calendar Year With Gross-up
Alice Thomas starts working for Acme Widget Corporation on July 1, 2016. As part of her employment offer, Acme agrees to pay her a net bonus check of $5,000, which is grossed up for federal income, Social Security and Medicare taxes, for total gross pay of $7,423.90. Alice agrees to two bonus conditions. First, if Alice terminates employment within one year, she must pay back the bonus. Second, if repayment of the bonus is required as a result, Alice must pay Acme the gross amount of the bonus, not the net she received. Alice resigns effective March 1, 2017, less than one year after she started. Based on the agreed bonus conditions, Alice must pay back the gross amount of the bonus.
Acme must do the following:
- Retrieve the gross pay back from Alice. Alice writes a check back to Acme for $7,423.90. She then claims this repayment when she files her personal income tax return. Acme cuts a check back to Alice for $567.93.
- Acme retrieves the Social Security and Medicare tax from the federal government. Since Alice's gross pay and taxes were not posted and removed within the same year, Acme can recover the Social Security and Medicare tax but not the federal income tax. Unless Acme is able to recover the $500 in federal income tax from Alice, it will not be recoverable, which is why Alice was asked to agree to repay this amount herself should she leave Acme in less than a year. By Alice paying back the gross amount, Acme can recover the federal income tax that cannot be recovered when filing Form 941-X. However, Acme will be able to recover the employee Social Security tax ($7,423.90 × 0.062 = $460.28) and the Medicare tax ($7,423.90 × 0.0145 = $107.65), which, when added together, is $567.93, the amount of the check Acme wrote back to Alice ($460.28 + $107.65 = $567.93). In addition, Acme will have paid $567.93 in the employer share of Social Security tax ($7,423.90 × 0.062 = $460.28) and Medicare ($7,423.90 × 0.0145 = $107.65). This scenario assumes Alice's pay did not exceed the Social Security withholding limit in 2017 after she received the sign-on bonus.
Alice may claim a credit for the amount she repaid, but she will not be able to claim a credit for the Social Security and Medicare tax because the credit belongs to Acme, which already returned the amount to her.
Scenario 3 - Subsequent Calendar Year
Joe Smith starts working for Acme Widget Corporation on January 2, 2017 and resigns on February 2, 2017. Acme paid him two months' worth of wages - $4,000 - up front. Since Joe only worked for Acme for one month, he was obligated to repay the second month's wages of $2,000. Joe's net pay for the one month worked was $1,347. Acme remitted $653 in employee taxes for the overpayment, and $153 in employer Social Security and Medicare tax ($2,000 × 0.062 = $124) + ($2,000 × 0.0145 = $29). He did not repay Acme before the end of 2017. Joe was required to work through December 31, 2017 to earn all of the wages.
To correct this overpayment, Acme did the following:
- Retrieved the net pay and federal income tax from Joe. Joe wrote a check back to Acme for the $1,347 net pay. Additionally, Joe wrote back a check for $500 for the federal income tax. Acme corrected Joe's wages and removed all associated Social Security and Medicare tax, but not federal income tax. Acme received a refund of both the employee and employer portions of the Social Security and Medicare tax. Joe claimed a credit of $1,847 on his personal income tax return for 2017, to be filed in 2018. The federal income tax was recovered because the IRS does not refund federal tax paid for a prior year. If it were not recovered from Joe, it would not have been recovered at all.
- Acme will recover the Social Security and Medicare tax. Acme will recover the Social Security and Medicare tax in 2018, even though it was paid in 2017. Acme's total refund of employee taxes is $153 for the employee share of Social Security and Medicare tax. Acme also paid $153 in employer Social Security tax ($2,000 × 0.062 = $124) and Medicare tax ($2,000 × 0.0145 = $29). This scenario assumes that Joe's pay did not exceed the Social Security taxable wage limit between the time the overpayment occurred and when the overage was corrected.
Because the repayment of the overpaid wages did not occur in the same quarter in which originally paid, Acme filed Form 941-X for the quarter as soon as the repayment was made. For example, if the overpayment occurred in May 2017 and the net is repaid in February 2018, Form 941-X should be filed for the 2nd quarter of 2017.