Failing to Issue Form W-2 to Corporate Officers

20 May Failing to Issue Form W-2 to Corporate Officers

A corporate officer who performs substantial services for the corporation and receives compensation is considered to be an employee. The corporation should issue a Form W-2 reporting the compensation as wages and withhold proper amounts for federal income tax, FICA, and FUTA purposes. Recently, the IRS Small Business/Self-Employed Division issued a memorandum providing guidance to IRS agents when a corporation fails to treat an officer as an employee. If the corporation fails to issue a W-2, it may be eligible for relief under one of several avenues.

First, the corporation may be allowed to classify the officer as a non-employee under §530 of the Revenue Act of 1978 if all of the following conditions are met:

1. The corporation didn’t treat the individual as an employee.

2. Federal employment tax returns were filed on a basis consistent with the employer’s treatment of the worker as a non-employee.

3. The corporation had a reasonable basis for not treating the individual as an employee. This condition is difficult to overcome because §§3401(c), 3121(d)(1), and 3306(i) for purposes of income tax, FICA, and FUTA withholding, respectively, define an officer of a corporation as an employee for employment tax purposes.

4. The corporation didn’t treat any individual in a substantially similar position as an employee.

Secondly, §3509 reduces an employer’s liability for income tax withholding and the employee portion of the FICA taxes where the employer unintentionally failed to deduct and withhold those taxes because it treated the employee as a non-employee. That liability is reduced to 1.5 percent of the employee’s wages for income tax withholding and 20 percent of the employee’s portion of the FICA tax.

However, if the employer failed, without reasonable cause, to comply with applicable information reporting requirements consistent with the treatment of the employee as a non-employee, those percentages are doubled. If the employer intentionally disregarded the deduction and withholding requirements, it is liable for the full tax and the lower §3509 rates do not apply.

Example: Axel is an officer of Flying High Co., an S corporation, for which he performed substantial services and received compensation in 2008. Flying High Corp treated Abe as an independent contractor, but did not issue him either a Form W-2 or Form 1099-MISC. Instead, Flying High Corp treated Axel’s payments as a distribution and issued him a Schedule K-1. The lower rates of §3509(a) will be used as long as Flying High did not intentionally disregard the reporting requirements. If no K-1 or other appropriate information return was issued to Axel, still assuming no intentional disregard on the part of Flying High, the higher §3509(b) rates will be used to compute the tax.

Example: Fastrack Corp. knows that officers who perform services for a corporation are employees by statute. Bernie, an officer of the corporation, performs substantial services, but the corporation deliberately structures his pay as distributions or loan repayment in lieu of a salary or wages. Fastrack Corp. has intentionally disregarded the rules and regulations and does not qualify for the lower §3509 rates.

The IRS memorandum notes that reliance on the preparer is not always reasonable cause. The taxpayer must show he received advice from his counsel, that he relied on it in good faith, and that any such reliance was reasonable.

The §3509 rates do not reduce the employer’s liability for the employee’s portion of the FICA taxes for statutory employees described in §3121(d)(3) (i.e., certain agent- or commission-drivers, those who sell life insurance full time, home workers, and traveling or city salespersons).

If an individual could be classified as either a corporate officer under §3121(d)(1) or a statutory employee under §3121(d)(3), then the §3509 reductions of the employer’s liability for the employee’s portion of the FICA taxes do not apply.

Similarly, if the individual could be classified as either a common law employee under §3121(d)(2) or a statutory employee under §3121(d)(3), then §3509 reductions of the employer’s liability for the employee’s portion of the FICA taxes would be inapplicable.

To sum up the rule for corporate officers, §3509 reductions apply unless the officer could also be classified as an agent- or commission-driver, a full-time life insurance salesperson, a home worker, or a traveling or city salesperson.

If a corporate officer could also be classified as an employee under §3121(d)(3), then the §3509 rates apply only to the employer’s liability for income tax withholding and not to the employer’s liability for the employee’s portion of the FICA taxes.

IRS agents who do not allow the reduced tax rates must develop facts to support their position, and address those facts in their examination report. The IRS cannot issue an assessment for any unpaid employment taxes until after:

1. It has issued a Notice of Determination of Worker Classification

   (NDWC); and

2. The taxpayer has either exhausted its Tax Court remedies/failed to pursue them, or signed an appropriate waiver of restrictions on assessment.