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How Can You Untangle Special Wage Payments?

 

The Internal Revenue Service defines special wage payment as "an amount paid by an employer to an employee (or former employee) for services performed in a prior year."

SWPs include:

  • Back pay.
  • Severance pay.
  • Accumulated vacation or sick pay.
  • Bonuses.
  • Sales commissions.
  • Deferred compensation.
  • Payments resulting from retirement.
  • Stock options.

These payments must be reported to the IRS for federal income tax, Medicare tax and Social Security tax purposes, and to the Social Security Administration because of the impact they could have on the employee's Social Security benefits.

Effect of SWPs on Social Security

Social Security benefits are based on the recipient's lifetime earnings. For beneficiaries who are still working, the SSA obtains their current earnings from boxes 1, 3 and 5 of their Form W-2. Those boxes reflect their federal, Social Security and Medicare wages, respectively.

Per IRS rules, employers must report SWPs and associated taxes withheld in the year the payment is made — not the year in which the payment was earned — thereby inflating the beneficiary's current W-2 earnings.

If the beneficiary is retired and receives accumulated wages or payment for work done prior to getting Social Security benefits, the SWP will likely not affect their benefits.

However, if the beneficiary is working and receiving Social Security benefits, the SWP may cause a reduction in their benefits, since there is a limit on how much they can earn for the year. This can be corrected by reporting the SWP to the SSA. Upon receiving the appropriate documentation about the SWP, the SSA will restore the deducted benefit amount.

SWP reporting

All wages earned in a previous year and paid in a subsequent year must be reported to the SSA. This includes SWPs made to retired employees and employees who are working while receiving Social Security benefits.

Employers must report SWPs to the SSA on Form SSA-131. In Part 1 of the form, include the tax year being reported, the employee's Social Security number, and your business name and address.

In Part 2, state your Employer Identification Number, whether or not the employee is retired and the last date they did any work for you. In addition, state the total wages paid in the tax year being reported but that were for services done in a previous year. If any of those wages will be paid after the tax year being reported, list the individual amounts and the year in which they will be paid.

You can report SWPs electronically via the SSA's Business Services Online system. There's also a paper option, but this method has limitations.

Note that we've only scratched the surface of SWPs. You can get more detailed information by consulting IRS Publication 957. If you need to report a SWP, contact your payroll service provider for further guidance.

 

 
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Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
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