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Editor: Mark
H. Ely, J.D., CPA
Employee Death and Taxes • IRS Audit Plans • Third-Party Authorizations • Electronic Filing Limited Waiver • Magnetic Media Reporting Editor's note: Mark Ely is former chair of the AICPA Relations with the IRS Committee. Deborah J. Pflieger is the current chair. Ms. Barnes, Ms. Hyde and Messrs. DeGeorgio, VanDeveer and Goldstein are members of that committee.
Reporting of Payments Following Employee's Death When an employee dies, the employer has to determine not only what the company owes to the deceased employee's estate or beneficiaries, but also the appropriate tax reporting of the payments. Because of the varying nature of amounts payable to an estate or a beneficiary, employers and practitioners might find the instructions confusing or inconsistent. When an employee dies, the employer will often owe the employee for accrued current wages, vacation accruals, bonuses earned, etc. Since these amounts are earned by the employee before death but paid to his estate or beneficiary, the payments are income in respect of a decedent under Sec. 691(a). The payments are taxable to the estate or beneficiary and not to the decedent. The amounts were earned, however, for services rendered by the decedent, who should, therefore, receive credit for those earnings for Social Security and Medicare purposes. Thus, if the payments of accrued compensation are made in the year the employee died, the employer must withhold Social Security and Medicare taxes and pay any applicable FUTA tax. Rev. Rul. 86-109 is the cited authority on reporting death benefits and compensation payments made after an employee's death, and the instructions for Forms W-2 and 1099 provide further detail on how to report such payments. If the accrued compensation payments are made in the year of death, the applicable amounts should be reported as Social Security wages (box 3) and Medicare wages (box 5) on the decedent's final W-2, so that proper credit for those earnings is received. The wages are not taxable to the deceased employee, however, and, thus, not subject to Federal income tax withholding and not included in total wages (box 1) on Form W-2. The gross compensation amount is reported to the estate or beneficiary on Form 1099-MISC in box 3 as "Other Income." If payments of a deceased employee's earned compensation are made after the year of death, the amounts are not subject to FICA (Social Security and Medicare) or Federal income tax withholding. Thus, the payments in years after death are reported to the estate or beneficiary on Form 1099-MISC, but not on Form W-2. The instructions for Forms W-2 and 1099-MISC provide both an explanation and an example of the appropriate reporting. Death benefits and distributions from both qualified and nonqualified plans, including gratuitous post-death salary continuation payments, are reported on Form 1099-R. Death benefits and other distributions from qualified plans are not subject to FICA and FUTA taxes (Sec. 3121(a)(13)). If the death benefits or distributions are paid out of a qualified plan, the payments are subject to Federal income tax withholding under Sec. 3405; see Rev. Proc. 86-109. Post-death distributions from nonqualified deferred compensation plans are generally treated as taxable wages but, like post-death payments of accrued current compensation, are not subject to income tax withholding. The timing of the distributions and whether the plan is a "nonqualified deferred compensation plan" under Secs. 3121(v)(2) and 3306(r)(2) determine whether FICA and FUTA taxes will apply to the distributions. Death benefits paid under a nonqualified plan, such as gratuitous post-death salary continuation payments, are exempt from FICA and FUTA taxes. In general, amounts deferred under certain nonqualified deferred compensation plans are subject to FICA and FUTA taxes at the later of when the services are performed or when there is no substantial risk of forfeiture (Secs. 3121(v)(2) and 3306(r)(2)). Thus, in many cases, Social Security and other payroll taxes will have been paid long before distributions are made from the plan. Like payments for accrued current compensation, distributions made in the year of the employee's death will be subject to FICA and FUTA taxes if the distributions are either from a plan or arrangement that is not a "nonqualified deferred compensation plan" under Secs. 3121(v)(2) and 3306(r)(2) or from a nonqualified deferred compensation plan under which the amounts were not properly subjected to FICA and FUTA taxes in earlier years. Nonqualified plan distributions in years after the employee's death are not subject to Social Security, Medicare and Federal unemployment taxes. Distributions from both qualified and nonqualified plans are reported on Form 1099-R, with distribution code "4" (indicating that the amount is paid to a decedent's beneficiary). If any of the distribution amounts are subject to Social Security and Medicare taxes, the Social Security and Medicare wages will be included on the decedent's final W-2, like post-death current compensation payments. Income from stock options exercised after death and from the vesting of restricted stock at the time of death are generally taxed and reported in the same manner as compensation payments after death. The taxable amounts are not subject to Federal income tax withholding and are reported on Form 1099-MISC in box 3. Income from the vesting of restricted stock at death, and income from the exercise of stock options in the year of death, will generally be subject to FICA and FUTA taxation, and reported as Social Security wages and Medicare wages on the employee's final W-2. There is an exception from FICA and FUTA taxation, however, if the employer for pre-1998 years had treated vested options as nonqualified deferred compensation and subject to payroll taxes at that time. Income from the exercise of stock options in years following death is not subject to Social Security or Medicare taxes. In summary, taxable compensation and plan distributions will be reported as taxable income to the payee beneficiary on either Form 1099-MISC or Form 1099-R. Payments of compensation earned by the decedent and paid in the year of death (except for most plan distributions) are subject to Social Security and Medicare withholding and will be reported as Social Security and Medicare wages on the employee's final W-2, but will not be included in taxable wages on the W-2 (as those amounts are reported to the payee beneficiary on Form 1099). From Carol T. Barnes, CPA, Cole, Evans & Peterson, CPAs, Shreveport, LA, and Deborah J. Pflieger, PricewaterhouseCoopers LLP, Washington, DC
No matter how large or small, every company subject to a field audit should devote time to working with the IRS Compliance Team in developing a joint audit plan. The key to every successful audit is effective management of the audit process. A successful audit means no surprises. An effective audit plan reduces this and improves the efficiency of the audit and cycle time. By recognizing that every eventuality cannot be anticipated, the audit plan should be flexible enough to accommodate alterations as the audit proceeds. Sec. 7602 provides that the IRS may examine all records, including those not directly used to prepare the return, that may be "relevant or material" to the investigation into the correctness of the tax return. The basic data retention requirements can be found in Sec. 6001. Regs. Sec. 1.6001-1 requires that taxpayers retain sufficient records to establish the correctness of any income tax liability. Rev. Rul. 71-20 and Rev. Proc. 98-25 further define what records taxpayers must keep when they maintain the records on machine-sensitive data media or on an automatic data processing system. Failure to clearly identify and retain records that support items on the tax return could lead to the imposition of various penalties. Moreover, if the taxpayer fails to comply with the minimum recordkeeping requirements, the IRS could issue a Notice of Inadequate Records pursuant to Regs. Sec. 1.6001-1(d). In addition, penalties can also include, among other things, Sec. 6662 accuracy-related penalties and Sec. 7203 willful-failure criminal penalties. The only way for a taxpayer to fully understand and circumscribe the scope of an audit is through an audit plan. The concept of an audit plan can be traced to the Service's Examination Technique Guideline Handbook, which is included in the Internal Revenue Manual. The Manual, in chapter(s) 4200, et al., discusses various planning and examination techniques for IRS agents' use during an audit examination. The taxpayer's understanding of these and other of the Service's audit procedures, together with an audit plan, can simplify the audit process. An audit plan begins with the taxpayer's designation of an individual as the focal point for contact with the IRS examination team. The individual (or individuals) could be a company employee or a third-party representative. Third-party representative(s) are required to obtain a power of attorney prior to discussions with the Service by filing Form 2848, Power of Attorney and Declaration of Representative. The taxpayer needs to reach agreement on the physical location of the IRS audit team. Proximity to the company's books and records should be considered. The taxpayer's goal should be to place the audit team close to the company's records. If records are stored off-site, the examination team should also be off-site. Other important factors to consider include the number of offices, telephones, copy machines and personal computers at the company location. How the audit team will access the company's financial records and the confidentiality of the data must also be resolved. Questions such as what steps will be taken to protect the security of a company's proprietary information and whether the Service's examination team will be provided access to the taxpayer's computer system must be addressed beforehand. Specific audit techniques, such as statistical sampling and de minimis rules, should be discussed. A successful audit plan should also clarify, among other key roles, who will be receiving Information Document Requests (IDRs) and who will discuss potential issues with the IRS team. Thereafter, the taxpayer should establish who is going to be working on the examination. In addition, the taxpayer should obtain a complete list of the agents, specialists and managers who will comprise the audit team, and determine whether they will work on a full or part-time basis. The role of the IRS District Counsel should be clarified if the District Counsel will be assigned to the examination. It is also important to establish the official start date of the examination, as the official start date begins the 15-day period (see Rev. Proc. 94-69) under which to file a qualified amended return and potentially avoid substantial underpayment penalties under Sec. 6662. Once the basic logistical items are established, the key operational items relevant to how the audit will proceed are issue priority, overall scope, IDR process and audit timeline. Issue priority is often based on the taxpayer's prior audit experience and the Service's risk analysis. This part of the audit plan should detail the IRS's Examination program, including its scope. The plan should list the companies being audited, the potential areas to be examined, and which agents are assigned to each area. The plan should also indicate the time allotted to the examining agent for each area to be examined. The audit timeline is the linchpin of the audit plan. A reasonable timeline provides a measure for both the IRS and the taxpayer to determine whether problems arise, and to determine whether scheduled completion of the audit is likely. The initial timeline will also assist in planning for potential extensions of any applicable statute of limitations. The audit plan should provide for official opening and closing conferences, as well as interim status meetings. The opening conference is the first formal meeting between the taxpayer and the Service's examination team, and should be attended by the key decision-makers at both the IRS and the company. The closing meeting should function as the final critique of the completed audit. During the interim-status meetings, progress in relation to the established timeline should be discussed. Along with the timeline process, milestones should be created to keep the audit on target, to make sure that both the Service and the taxpayer can monitor the progress of the audit at any point in time. A discussion of the audit's progress in relation to the pre-determined timeline should be included as part of every meeting between the taxpayer representative and the IRS team manager. Discussions about the status of IDRs and any proposed adjustments should also be part of the audit plan and included in the status meeting. The taxpayer should take into consideration its prior audit experience, available staff and specific industry issues before agreeing on IDR procedures. Reasonable response times, such as 30, 45 or 60 days for most IDRs, should be established; if international operations are relevant, a longer response time may be needed. The taxpayer should establish whether IDRs would be submitted by entity or by issue. Failure to clearly outline the IDR process is the main reason that examinations get off-target. Additional items to consider in developing an audit plan are the company's internal controls, peculiarities in the accounting systems, data storage and industry practices. The audit plan is the only official opportunity for the taxpayer to have input into how the examination is to be conducted. The audit plan is the taxpayer's only opportunity to plan with the IRS team manager the scope, duration and procedures used during the examination. A thoroughly developed audit plan will improve the overall efficiency of the audit, reduce the overall cycle time and help keep the taxpayer current in its audits. Although development of an audit plan is time-consuming, it will lead to a more efficient audit. In addition, the audit plan can be the start of mutual cooperation and candid communication between the Service and the taxpayer representative. From Tom DeGeorgio, Director, Federal Income Tax Audits & Analysis, Shell Oil Company, New York, NY
Simplification of Third-Party Authorization Process Without any fanfare, the IRS has implemented two new avenues for taxpayer representation without the need for a Form 2848, Power of Attorney and Declaration of Representative. The two methods are called Oral Disclosure Consent and Oral Taxpayer Information Authorization. Both methods were effective April 1, 2001. The Oral Disclosure Consent is the most limited. This method allows the taxpayer to call the Service and establish disclosure authority for all types of tax accounts for his designated representative. The taxpayer simply tells the IRS the name of his representative. Once established, the designated person may call the Service to resolve the taxpayer's problem. However, the authority is good only for two weeks, in which time the IRS expects to be able to resolve the taxpayer's issue. The Service has indicated that this authority can be renewed for an additional two weeks. The Oral Tax Information Authorization is for those issues likely to take longer to resolve. This authority will last for one year; the IRS likens this to a paperless Form 8821, Tax Information Authorization. This method also allows the taxpayer to call the Service and establish disclosure authority for all types of tax accounts. But, in this case, the designated representative will have to have a Centralized Authorization File (CAF) number established before the taxpayer calls. The taxpayer must give the CAF number of his designated representative to the IRS to establish this authority. The representative may then immediately call the Service to discuss the taxpayer's issue. Practitioners have long complained about the necessity of obtaining powers of attorney to handle any number of routine taxpayer problems. The advent of these two new methods of communicating with the IRS should reduce the burden on both the taxpayer and practitioner and allow for faster resolution of many problems. The Service also made some changes to the CAF system that should help reduce the need for filing multiple copies of Form 2848 in different locations. In July, the IRS consolidated the 10 stand-alone databases into a centralized database. This should allow for early resolutions of account inquires, and help to ensure that the representative will receive a copy of related letters and notices. As a further enhancement to the CAF system, the Service intends to centralize all processing of Forms 2848 to the Ogden and Memphis Service Centers, with the processing of international issues to the Philadelphia Service Center. Also in 2002, specific issues (e.g., civil penalties) will be added to the CAF system. From Mark A. VanDeveer, CPA, Thatcher & Benson PC, Virginia Beach, VA
Service Issues Limited Waiver from Form 1065 Electronic Filing Requirement Since 1986, the IRS has encouraged various programs for the electronic filing of Form 1065, U.S. Return of Partnership Income. The IRS Andover Submission Processing Center (ASPC) was responsible for receiving and processing partnership returns submitted on magnetic tapes, diskettes and electronic transmissions via the Bulletin Board System (or MITRON). Participants could either file the entire Form 1065 electronically or use the "Paper-Parent Option" method, which allowed the body of Form 1065 and related forms and schedules to be mailed to ASPC and the Schedules K-1 to be transmitted electronically. After several false starts, beginning with tax year 1999 partnership returns, the Service announced that it would no longer accept returns submitted on magnetic media, or transmitted electronically via MITRON or the Bulletin Board System. In addition, the IRS discontinued the Paper-Parent Option. When it was pointed out to the Service that software providers had not as yet built sufficient export facilities to process all of the appropriate and necessary forms to be attached to Form 1065, the IRS relented and said it would not be mandatory to file Form 1065 electronically by 1999. The Paper-Parent Option was, however, no longer available. The choice then was electronic filing or full paper filing. For the 2000 tax year, partnership returns have to be transmitted electronically to the Electronic Management System (EMS) at the Memphis Submission Processing Center. The Service has become aware that some partnerships cannot file electronically, because the necessary software for certain forms is not yet available. Ann. 2001-75 describes how partnerships required to file electronically under Sec. 6011(e)(2) may request a Sec. 6724(a) waiver, for reasonable cause, for failing to file electronically. This announcement is only applicable to waiver requests made by taxpayers required to file forms and schedules not available electronically and that cannot file such forms as attachments to Form 8453-P, U.S. Partnership Declaration and Signature for Electronic Filing. Forms that may be attached to Form 8453-P are listed in the announcement. The IRS will not grant a waiver request for certain forms (e.g., Schedule A (Form 5713, International Boycott Report), and Schedule M (Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations). Ann. 2001-75 is not applicable to other types of waiver requests, such as economic hardship. To initiate a waiver request pursuant to Ann. 2001-75, a partnership must submit the following information to the Memphis Submission Processing Center by Oct. 1, 2001:
To assure that penalties will not be assessed, the required waiver request must be attached to the Form 1065 and a notation in large red letters should be placed on page 1 of the Form 1065: "Waiver Request IRC Section 6011(e)(2)." The waiver request must contain the following information: 1. A notation at the top, "Waiver Request IRC Section 6011(e)(2);" 2. Partnership name, Federal EIN and address; 3. Tax year for which the waiver is requested; 4. A detailed statement that lists: —What steps the partnership has taken to meet its requirement to file its return electronically; —Why the steps were unsuccessful; —What steps the partnership will take to assure its ability to electronically file its partnership return for the next tax year; 5. A statement signed by the tax matters partner (as defined in Sec. 6231(a)(7)), stating: Under penalties of perjury, I declare that the information contained in this waiver request is true, correct and complete to the best of my knowledge and belief. Requests from the partnership's tax adviser do not have to be accompanied by a power of attorney. If a valid power of attorney is not on file, questions about the waiver will be addressed to the partnership. Within 30 days after receiving the waiver request, the Service will notify the partnership if it is denying the waiver request. A denial of the waiver request cannot be appealed. Waiver requests should be addressed to:
Or fax the request to 901-546-2544. From Robert L. Goldstein, CPA, Leipziger & Breskin LLP, New York, NY
Magnetic Media Reporting and Electronic Filing Requirements The Social Security Administration (SSA) has announced that Magnetic Media Reporting and Electronic Filing (MMREF) is now mandatory for 2001 tax-year submissions. Employers generally must use magnetic or electronic media if they file 250 or more W-2s for calendar-year 2001. MMREF-1 is for wage reporting; MMREF-2 is for corrections to previously submitted wage reports. Rev. Proc. 2001-26 provides more specific guidance.
Online Wage Reporting Service (OWRS) OWRS is an online wage-reporting service that can be used by anyone with Internet access to upload wage information to the SSA over the Internet. Those who use this format must register with the SSA for a personal identification number (PIN). OWRS can:
OWRS can be accessed:
On accessing the Internet at www.ssa.gov/employer, employers first select employer services online, and then online wage reporting service. Two filing options have been eliminated: Form W-2 wage reports filed using an value-added network and the dial-up networking option are no longer available. All access to OWRS is now through the Internet.
Advantages of OWRS OWRS has several benefits:
Magnetic Media Filing Employers may submit W-2s on magnetic media electronically. The SSA accepts the following magnetic media for W-2 reporting:
The requirements for businesses choosing to prepare and file wage reports on magnetic media are found in the SSA's Publication MMREF-1, Magnetic Media Reporting and Electronic Filing for Tax Years 2001, Submitting Annual W-2 Copy A Information to the SSA. Employers may obtain this information via the Internet or by calling the SSA at 1-800-772-6270.
AcccuWage Test Software The SSA has announced its free test software (AccuWage) is now available to download. This software checks the MMREF-formatted Form W-2 files for over 200 different errors. The employer has the opportunity to check its files and correct errors prior to submission. Employers can access AccuWage through OWRS.
Registration—Obtaining a PIN/Password Employers who use the SSA MMREF program must register to obtain a PIN and password prior to submitting their information. They can obtain a PIN/password by calling 1-800-772-6270 Monday through Friday 7:00 a.m. to 7:00 p.m. EST or through the Internet site at www.ssa.gov/employer. To obtain a PIN, employers must provide their: 1. EIN of company (third party or employer submitter); 2. Social Security number; 3. Name; 4. Date of birth; and 5. Telephone number and e-mail address. Additional information to be provided includes mailing address, company name, telephone number and address. After matching the individual's Social Security number, date of birth and verifying that he works for the company that will submit the file, a PIN is issued immediately. The password will be mailed within 1014 days.
Request for Waiver The IRS may waive the filing requirement on a show of hardship. To request a waiver, an employer must apply 45 days before the due date of the report, using IRS Form 8508, Request for a Waiver From Filing Information Return on Magnetic Media. Form 8508 can be obtained by contacting the Service at 1-800-829-3676 or on the Internet at www.irs.gov/forms_pub/forms.html .
Conclusion The Filing deadline for magnetic media is Feb. 28, 2002. For files transmitted via OWRS or electronic data transfer, the date is April 1, 2002. Employers or preparers can request an extension prior to the due date by using IRS Form 8809, Request for Extension of Time to File Information Returns. From Nancy Hyde, President, O C & H P.C., Oklahoma City, OK |
