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 Post subject: severance lump sum
PostPosted: Mon Jul 16, 2012 3:32 pm 
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Joined: Thu Jul 08, 2004 4:12 am
Posts: 50
Location: New York, NY
I am being asked to calculate withholding for lump sum severance payment over time, in this case over 18 semi-mo pay periods. We have new management here and this is the method used where he worked before coming here.

I could use one of the supplemental tax methods on each pay period amount, summarize the data and make one paycheck. It's a complicated calculation, with some pre-tax amounts included. Although, I think management probably wants to use reg wage schedules?

Before I get into trying to figure this out, is this an acceptable method to calculate withholding on lump sum supplemental wages?
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 Post subject: Re: severance lump sum
PostPosted: Mon Jul 16, 2012 6:13 pm 
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Joined: Mon Aug 04, 2003 7:13 am
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Location: Oakland, CA
IRS has specific rules for supplemental wage withholding which can be found in their publications 15 and !5A. I cannot tell based on what you have said whether or not your proposal follows one of the legal methods or not. I can say that the two most common legal methods are 25%-Flat Tax and Aggregate, and that 25%-Flat Tax can only be used if there are other non-supplemental wages in the pay period. Which does NOT sound like what you are talking about. If you have a fixed amount being paid over the each of the next 18 SM pay periods and you do not have annual aggregate supplemental wagss in excess of one million dollars, then you are going to end up using Aggregate. Lets say that we are making $2K payments per pay period, with a S-01 W-4. Treat it just like normal wages. That is Aggregate.

Now your new boss has some strange method IRS never heard of that his former employer. No kidding. All new bosses have some strange method that IRS never heard of used at their former employer. Aggregate is what IRS will hold your current employer responsbile for. If new boss's method underwithholds compared to that, then your new company (and possibly your new boss) will be held responsible for any underwithholdng.

Print out the rules from the IRS pubs. Show your boss the rules once. Then do whatever your boss says. Issue a very polite CYA memo ("as per your instructions, ..."). At that point you are not a legally responsible person as far as IRS concerned. But your boss might be.

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 Post subject: Re: severance lump sum
PostPosted: Tue Jul 17, 2012 3:21 am 
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Joined: Thu Jul 08, 2004 4:12 am
Posts: 50
Location: New York, NY
This is final check to departing employee - no regular wages in this payment. I checked off the "supplemental" box in taxes window (Paychex Preview). The result seemed to be very close to 25% flat rate, when I ran the same amount through an off-system paycheck calculator.

Both recipient and boss were surprised to hear about special tax treatment for supplemental wages. I didn't think to say anything about it when the term agreement came to me, although I did send a schedule, ahead of issuing the check, showing gross to estimated net to HR, in case the recipient wanted to know what net pay to expect. I guess they never connected.

They are now asking that I reverse the original payment and redo for better net pay result. Boss has been involved in many of these situations before and has never encountered supplemental wage issues.

Retirement is starting to look pretty good - a year ago at this time I really had no plans to retire. Now I actually look at the blizzard of material arriving daily from AARP!

Thank you, David, as always, for your help with this.
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 Post subject: Re: severance lump sum
PostPosted: Wed Aug 08, 2012 3:05 pm 
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Joined: Thu Jun 12, 2003 3:14 pm
Posts: 2602
Location: Carrboro, NC
Under the "new" rules (related to the inception of mandatory flat rate withholding) the optional flat rate method (25% of gross) may be used if tax was withheld from the employee's regular pay anytime during the current or immediately preceding calendar year. If the optional flat rate method is used, the payroll period does not matter - the result will be the same. If the aggregate method is used, the payroll period must be the regular payroll period previously used for the employee. That is, it cannot be spread out over future pay periods for purposes of calculating the income tax withholding (that method is only allowed for vacation pay paid in advance).

Then there are the alternative methods under section 3402(h) given the circumstances, the only one that makes any real sense might be the cumulative wage method. This would spread the payment retrospectively over the payroll periods for the year up to this point (but the severance would be "on top" of any pay already received by the employee.

From a technical standpoint, this would get the year to date withholding exactly to the "correct" withholding on the year to date compensation actually paid to the employee.

In order to use the cumulative wage method, the employer must have received an request, in writing, from the employee to use that method. In addition, the employee's last valid W-4 must be used for computing the withholding.

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Pat, EA in NC
Circular 230 Disclosure: This advice is not intended or written to be used, and it cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.


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 Post subject: Re: severance lump sum
PostPosted: Wed Aug 08, 2012 9:48 pm 
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Joined: Thu Jun 12, 2003 3:14 pm
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Location: Carrboro, NC
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18 semi-monthly periods is 9 months - which means, under the method requested, you will be withholding on four to five months worth of pay paid in this calendar year as if it were paid in 2013. Add on unemployment compensation (no withholding), premature withdrawals from the 401(k) plan, and/or (possibly) another job and this employee will have a huge tax liability due April 15, 2013 with no money to pay it. I see this in my practice when a person in that position gets notices of intent to levy from both the IRS and the state - and it is not pretty. The idea is to withhold the correct amount - not "get a better net pay".

If you check the supplemental pay box for Paychex, my guess is you are getting the optional flat rate. do one semi-monthly using 1/18th of the gross (with appropriate non-tax deductions) and the regular W-4 computations then multiply the resulting tax by 18. If that comes close to the 25% of the gross, the employee's marginal tax rate is greater than 25% and the employee will be underwithheld. Then try the cumulative wage method. That is an allowable method and should give you a better net pay than the flat rate unless this is a highly compensated employee and 25% is not enough.

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Pat, EA in NC
Circular 230 Disclosure: This advice is not intended or written to be used, and it cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.


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 Post subject: Re: severance lump sum
PostPosted: Thu Aug 09, 2012 3:35 am 
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Joined: Thu Jul 08, 2004 4:12 am
Posts: 50
Location: New York, NY
Patrick,
I tried the cumulative wage method - results in additional $1,800 net pay. I'll propose this today and let everyone know about getting a letter from recipient. Hope it suits all concerned.

Thanks for the very excellent guidance with this problem.
Allene


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