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TAX CLINIC

and the company is responsible for any is required to repay that amount to an “administrative error,” as the IRS
additional tax incurred on this income the employer. details, this term is defined for employ-
because of the assignment. ment tax purposes as an error that re-
Hypothetical tax: Tax equalization Overpayment of tax is not an sults in the inaccurate reporting of the
is accomplished by collecting “hypo- administrative error amount withheld. While an employer
thetical taxes” from an assignee. At the When an employee repays an employer may have overpaid tax based on the
start of an assignment or tax year, the for wages received in error in the current hypothetical tax estimate, the company
company estimates the amount of taxes year, the employer may offset the repay- accurately reported that overpayment
the assignee would incur in the United ment against current-year wages and in the year paid. As the overpayment
States had the assignee not been on as- may be able to report the repayment as does not result in a difference between
signment. The assignee’s salary is then an adjustment on Form 941-X, Adjusted the amount the employer reported as
reduced by this “estimated hypothetical Employer’s Quarterly Federal Tax Return withheld and the amount actually with-
tax” amount, which the company uses or Claim for Refund, to recover any em- held from the assignee’s wages, there is
to fund the assignee’s actual tax liability ployment taxes withheld on those repaid no administrative error to be corrected
on equalized income. This estimated wages. However, when an assignee is in a subsequent year. Therefore, the
hypothetical tax amount is not consid- required to repay an amount to the em- employer may not seek a refund of
ered “wages” or income for federal tax ployer under a tax equalization program, this overpayment.
purposes, and, accordingly, it reduces the the repayment represents a return of
amount of wages reported to the IRS wages received in a prior year. The em- Recovery of the employer
and the employee on Form W-2, Wage ployer may wish to report the repayment portion of FICA tax
and Tax Statement. as an adjustment on Form 941-X to While the company cannot recover
The company meets the assignee’s recover any employment taxes withheld overwithheld federal income tax that
actual U.S. and host country tax liabili- on those repaid wages and issue a Form was paid on behalf of an employee
ties by paying the taxes directly to the W-2c, Corrected Wage and Tax Statement, through Form 941-X, the same is not
relevant tax authority and including the to remove the overpaid tax from the true of Federal Insurance Contributions
tax payment in the assignee’s report- assignee’s wages and withholdings, but, Act (FICA) tax, for which a refund or
able compensation (a tax gross-up). For as the IRS memorandum details, this credit can be claimed by the employer
federal tax purposes, all wages (including approach is not consistent with federal in a subsequent calendar year. Prior to
assignment allowances and tax pay- income tax wage withholding rules. claiming a refund or credit for FICA
ments) reduced by any hypothetical tax When a company funds an assignee’s tax, the company must make reasonable
amounts are reported by the employer tax obligations through direct payments efforts to first repay or reimburse the
on Form 941, Employer’s Quarterly Fed- to the IRS, the tax payments made on employee for the employee’s portion
eral Tax Return. the assignee’s behalf represent income of FICA tax and secure the employee’s
After the calendar year ends, a hypo- and reportable wages to the assignee. For consent for the employer to pursue the
thetical tax return is prepared to deter- employment tax purposes, these pay- refund claim.
mine the amount of taxes the assignee ments are deemed to have been withheld Additionally, the company must file a
would have incurred had the assignee by the company from the employee’s Form W-2c and Form W-3c, Transmit-
not been on assignment, and a reconcili- wages and are therefore reportable on tal of Corrected Wage and Tax Statements,
ation is performed between this “actual the assignee’s Form W-2 as both wages with the Social Security Administration
hypothetical tax” amount and “estimated and tax withholding on those wages in to correct the reported FICA wages.
hypothetical tax” that had reduced the the tax year paid. Because these tax pay- While filing a Form 941-X and issuing
employee’s wages over the course of ments are properly considered wages in a Form W-2c may be administratively
the year. If the actual hypothetical tax the year paid, a company may not correct burdensome, especially considering that
amount is lower than the estimated an overpayment based on a hypothetical an assignee’s remuneration is likely to
hypothetical tax amount, the company tax estimate in a subsequent year. remain above the Old-Age, Survivors,
pays the assignee the difference, and An exception to this general rule and Disability Insurance threshold even
the amount is included in the assignee’s applies when the overpayment is due after the wage repayment, there is still
taxable compensation in the year paid. to an “administrative error.” Although an opportunity for companies to recover
However, if the actual hypothetical tax from the employer’s perspective, an significant tax costs with respect to
amount is greater than the estimated overpayment of tax based on a hypo- the Medicare portion of the FICA tax,
hypothetical tax amount, the assignee thetical tax estimate may seem like which is not subject to a cap.

10 June 2022 The Tax Adviser