Awarded Back Pay

[peggysioux5]

Taxpayer (local city employee) was awarded a large back pay in 2016 that was for 2014, 2015 and 2016. He was advised by the city that he would be receiving amended W-2's for 2014 and 2015 for portions of the back pay. I was surprised at the handling of the back pay.

Pub 957 states:

Reporting Back Pay

The Internal Revenue Service (IRS) and the SSA consider back pay awards to be wages. However, for income tax purposes, the IRS treats all back pay as wages in the year paid.


Are there certain circumstances where the wages would be correctly reported in the previous years?

Peggy Sioux

[FDNY]

I agree, my experience in NYC is the retro check is reported and taxed in year received, that happened every few years, never had a contract on time.  Unless  there is some requirement to do this  your CA locality needs someone to talk to them. 

[michaelmars]

What if the back pay was for a year out of the statute and the withholding created a refund.  He wouldn't get it by amending.  I think it should go all in the year received.

 

[Max W]

The W-2 mistake could be a blessing in disguise.

If all the back pay is reported in the year paid, it could push the client into a higher tax bracket(s) and either reduce any refund , or increase tax due.

It could be that the corrected W-2's and subsequent amended returns might be beneficial. It could be an interesting problem.

[peggysioux5]

It definitely would be more beneficial to the taxpayer to be able to amend prior year tax years rather than claim the lump sum in the current tax year.  But.....what is my requirement as a tax preparer.  The taxpayer has now received copies of the W-2c's and the city (large city in CA) that employees him adjusted his income box 1 of the W-2c's. Taxpayer does not pay into Social Security or Medicare so no adjustment in box 3 or 5. The taxpayer is a police officer who had a case brought against him and the outcome was in his favor so he received his back pay. Is there certain circumstances where there are exceptions?? I would think a large city would know how to properly handle. Taxpayer said that other officers who were in similar circumstances filed amended tax returns after receiving the W-2c's.   Being he has W-2c's, should I amend previous years' tax returns even though the W-2c's are not in line with IRS regulations?

Peggy Sioux
 

[BHoffman]

Pubs are not regulations and have no authority at all.  Pub 957 is just guidance for employers reporting back pay and other special compensation payments to the SSA.  There is an exceptions paragraph.

I would prepare the amended returns with no worries.

 

[Abby Normal]

I would explain it to the IRS and do it right. You don't want to incur substantial understatement penalties for prior years.

[peggysioux5]

2 hours ago, Abby Normal said:

I would explain it to the IRS and do it right. You don't want to incur substantial understatement penalties for prior years.

Being taxpayer received W-2c's in 2016 for prior years, would those understatement penalties still apply?

[jklcpa]

6 minutes ago, peggysioux5 said:

Being taxpayer received W-2c's in 2016 for prior years, would those understatement penalties still apply?

No. I think this is covered in sec 6662 and 6662A under the sections "Special Rule for Amended Returns".

[jklcpa]

I'm just now catching up on this topic, but I'm a little confused about why the city issued corrected W-2s for those earlier years since the LEO doesn't pay FICA or Medicare and why you are considering filing amended returns. This should be taxable on the individual's return in 2016 since that is when it was received.

It seems that maybe (just guessing) that the city handled it this way because maybe other city employees that do pay into FICA and Medicare would need those corrected W-2s so that their earnings record properly reflects wages in the years they should have been reported, but the LEO shouldn't be reported that way and the city is in error with its reporting here.

[peggysioux5]

4 minutes ago, jklcpa said:

I'm just now catching up on this topic, but I'm a little confused about why the city issued corrected W-2s for those earlier years since the LEO doesn't pay FICA or Medicare and why you are considering filing amended returns. This should be taxable on the individual's return in 2016 since that is when it was received.

It seems that maybe (just guessing) that the city handled it this way because maybe other city employees that do pay into FICA and Medicare would need those corrected W-2s so that their earnings record properly reflects wages in the years they should have been reported, but the LEO shouldn't be reported that way and the city is in error with its reporting here.

So what would be the correct procedures being I have corrected W-2c's for previous years?  Should I include the income in 2016 even those the 2016 W-2 is not going to reflect the award pay and attach an explanation of the situation with copies of the W-2c's?  I would think the IRS would send audit letters for the previous years once they receive the W-2c's and no amended returns will have been filed; so I would handle that issue once audit letters arrive?  Appreciate everyone's input. 

Peggy Sioux

[jklcpa]

2 hours ago, peggysioux5 said:

So what would be the correct procedures being I have corrected W-2c's for previous years?  Should I include the income in 2016 even those the 2016 W-2 is not going to reflect the award pay and attach an explanation of the situation with copies of the W-2c's?  I would think the IRS would send audit letters for the previous years once they receive the W-2c's and no amended returns will have been filed; so I would handle that issue once audit letters arrive?  Appreciate everyone's input. 

Peggy Sioux

Since the LEOs isn't paying in to FICA and Medicare and there was no adjustment to boxes 3 and 5, there appears to have been no logical reason why the city issued corrected W-2s. I think that was an error on the city's part and suggest that you have your client contact the city to request that those be re-corrected to reflect their original amounts. I think it is all taxable in 2016 and should be included in this year's W-2. 

[Pacun]

Maybe I am wrong but I deal with the documents at hand. If I get a W-2C, I amend. If I audit every document that comes to my desk, I would ask each client to bring a copy of all paychecks, copies of the timecards and then make sure that the W-2 is correct. I trust the W-2 to be correct and I prepare taxes based on that. In this case, what's wrong with charging the client for amending the returns? If they own penalty for underpayment, then I have a good excuse to convince the IRS to have the penalty abated.

Sometimes we have to limit our scope and deal with the documents at hand. If we don't limit our scope, we might be jumping to other disciplines such as law.

 

 

 

[jklcpa]

1 hour ago, Pacun said:

In this case, what's wrong with charging the client for amending the returns?

What's wrong is that reporting the income in those prior years is the incorrect treatment, and the OP knows that.

I agree with your general sentiment that we shouldn't audit or have to tie in every statement or tax form that a client receives, but in this case she and the client know that those W-2c are not proper, and I think that when we know that without a lot of extensive investigation but that it comes up in a discussion or that it's blatantly incorrect with a cursory look at those documents, then I think that not only do we have the professional obligation to prepare returns properly, we also have a responsibility to inform the client that those W-2c forms were issued in error. If we prepare returns with forms that we know are incorrect and we do not at least inform the client of that fact or suggest that they try to have them revised/corrected, then I think that might leave us open to penalty assessments and malpractice claims.  These days, most accountant's malpractice insurance claims aren't from financial reporting, they are from tax-related suits.

1 hour ago, Pacun said:

Sometimes we have to limit our scope and deal with the documents at hand. If we don't limit our scope, we might be jumping to other disciplines such as law.

Right, we aren't attorneys, but in the OP's client's case, the law that we are interpreting and discussing is tax law that dictates proper reporting on the W-2s of back pay to the SSA by the employer and to the IRS by the individual.

[Pacun]

This is just from the top of my head.

Are we sure that it must be reported in the year received? Or the IRS says, it is OK to reported it in the year received if your employer doesn't allocate it in the years earned?

OK. You send back the client to the government... good luck with that. Or you "correctly" report the money in the year received then the client receives two letters for the two years that the client received a W2-C and didn't report it. Good luck with that too.

Let me ask another stupid question... how much money are we talking about? Are we talking about 3K which means 1K per year or what amount? I love when accountants consider materiality as important.

 

[DANRVAN]

22 hours ago, BHoffman said:

Pubs are not regulations and have no authority at all.  Pub 957 is just guidance for employers reporting back pay and other special compensation payments to the

 

The Pubs are usually based on authority.  In this case the authority is section 451(a) which very clearly says income is recognized in year received unless one of the special rules from 451(b) through 451(I) applies.

In regards to Pacun's comments; in this case the W-2c is clearly wrong.  The instructions for W-2 says report wages in year paid.

In Messina vs Commissioner, tax court ruled back pay was reported in year paid, not in years attributed.

An incorrect W-2c is not a free pass to incorrectly file false amended tax returns.

[DANRVAN]

1 hour ago, Pacun said:

 

OK. You send back the client to the government... good luck with that. Or you "correctly" report the money in the year received then the client receives two letters for the two years that the client received a W2-C and didn't report it. Good luck with that too.

If the employer will not correct the mistake, then I believe the remedy is to file form 4852 for each incorrect year. If the IRS letters still come, you have the tax code to back you up.

I don't believe the basic accounting principle of materiality usually applies with the same meaning to tax law.  The choice is to charge the client to file two incorrect amended returns or charge him to correct the problem if the employer will not do it.

[Pacun]

Well... the IRS really cares about materiality if we are talking about $100 each year, the IRS will not care what year you include it in. So, let me ask a stupid question again:

How much money are we talking about?

[jklcpa]

3 minutes ago, Pacun said:

Well... the IRS really cares about materiality if we are talking about $100 each year, the IRS will not care what year you include it in. So, let me ask a stupid question again:

How much money are we talking about?

If you reread the OP's posts, you'll see that OP stated in first post that this was a large amount, later stated that it would be better if amendeds could be filed rather than one lump added into 2016, clearly because the lump would be in a higher bracket, and finally that this is a police officer that had a case brought against him with this back pay that now spans multiple years coming from a large city in CA, I'd say it's pretty safe to assume that we aren't talking about peanuts here.

 

[peggysioux5]

Approximately $40,000.

Peggy Sioux