How to handle overpayment by ex employer

[Anonymous]

My Georgia ex employer suddenly woke up after a year and tells me that their payroll provider made an error and paid me an extra $5000 in 2020 (gross). I've already filed my 2020 taxes and resigned in March 2021 (for which they have sent me a W2 but didn't correct any overpayment in that). Now they want me to refund the entire gross amount. I'm stuck because now I've already paid the federal, GA state and FICA taxes but the employer want the entire gross amount. What are my options here:

1. Do I need to file an amended return for the 2020 year to claim my state, federal and fica taxes?

2. Can I claim credit on the 2021 years return for the federal, GA state and FICA taxes paid back to the employer?

3. Can I ask them to send me a corrected W2 for 2021 which shows an adjustment of the gross amount repaid to them in 2022 for the 2020 overpayment? (in this case because my 2021 W2 would be lowered and so it'll automatically come back to me a tax refund for overpayment of taxes, is that correct?)

4. Any other options?

I can ask I ask the employer to eat the taxes paid or any losses I incur during this process (filings costs, CPA, taxes etc)?

What's the easiest and cheapest way to handle this?

Also, does the same principle also apply to joining bonuses paid which need to be repaid back or is that different because this an employers error and the joining bonus repayment is a contractual agreement.

[LenaH]

No, you do not have to file an amended return for the 2020 year nor should you ask them for a corrected W-2 for 2021. You could use a "claim of right" Section 1341 credit since the repayment was more than $3,000. This is a federal tax credit for taxpayers who reported income in the previous year, but have to repay the income because it was paid in error. The Section 1341 credit is found on your 1040, Schedule 3. 

For the method on how to calculate your amounts for Schedule 3, please see Publication 525 and go to page 36. Please keep in mind that these Section 1341 credits do tend to get audited, so it is important to keep all of your documentation in order in case the calculations get questioned. 

To enter on your tax return, please follow the instructions below:

1. Open your return.
2. Click on Federal.
3. Click on Deductions and Credits.
4. Scroll down to Other Deductions and Credits and Click Start next to Other Deductible Expenses.
5. Answer Yes to the question Did you have any of these other expenses?
6. Enter the amount in Claim of repayment over $3,000.

I have attached screenshots below for additional guidance. 

What is a claim of right repayment?

[Anonymous]

Thanks. Does also also cover GA state taxes and FICA taxes?

I was also reading posts from another user who suggested that we could also claim it as a special itemized deduction (uncommon deduction)? Is that easier and have less chances of an audit (just a major headache and expensive to use the services for a CPA - especially since this entire debacle is caused by my employers screw up).

[DianeW777]

Perhaps.  The gross amount of repayment should include all of the taxes that were originally withheld.  Those taxes are already part of the gross income.  If they are providing net earnings and the showing the withholding taxes separately, then you would add them together.  Be careful not to duplicate the amount of repayment.

The itemized deduction is strictly for repayments less than $3,000 and is no longer available for tax years 2018-2025 under the Tax Cuts and Jobs Act (TCJA) of 2017.

[Opus 17]

This is a claim of right.  See here.

https://ttlc.intuit.com/community/unemployment-taxes/help/what-is-a-claim-of-right-repayment/00/2153...

1. No.  Use the claim of right procedure for whenever you actually make the repayment (sounds like you made the repayment in 2022 so you will claim the credit on your 2022 tax return). 

2. No. Use the claim of right procedure on your 2022 tax return.  For FICA and Medicare, you need to file a separate form 843.  For Georgia, you will have to look up their procedure. (see below)

3. No. Your 2021 W-2 shows what you were actually paid during the 2021 calendar year and can't be changed by something that happens in 2022.

4. No.

"I can ask I ask the employer to eat the taxes paid or any losses I incur during this process (filings costs, CPA, taxes etc)?"

You can ask anything.  Whether you have a right to compensation depends on your contract and state employment law. 

"What's the easiest and cheapest way to handle this?"

You will need to use Turbotax installed on your own computer for 2022 (PC or Mac, from a CD or download) and not the online version.  Any version of the desktop program that is appropriate for your other tax situations will allow you to make a claim of right. 

"Also, does the same principle also apply to joining bonuses paid which need to be repaid back or is that different because this an employers error and the joining bonus repayment is a contractual agreement."

There are two ways to claim a wage repayment over $3000, as a special itemized deduction on schedule A, or as a tax credit that represents the amount of tax you would not have paid if the money had not been included on your prior tax return.   Generally, if your income or tax rate is higher now, take the deduction, if your income or tax rate is lower now than when you paid the tax, take the credit. 

Anyone can take the deduction for a wage repayment.  However, you can only take the claim of right tax credit if you had a reasonable belief at the time you received the money that you had an unrestricted right to the funds.   This obviously depends on each person's circumstances.  For example, if you got a bonus that was contingent on working 3 years, and you knew you were leaving after 2 years, then you knew that you did not have an unrestricted right to the money.  Or, if someone gets overpaid and they know it, and they keep quiet hoping the employer won't notice, then they knew they did not have an unrestricted right to the money.  

For Georgia, they probably have a claim of right procedure, but I don't know it since there are so many states with different rules.  You have a year to figure it out since you will claim this on your 2022 tax return.

For social security and medicare tax, you need to file a separate form 843.  You will need proof of the overpayment/repayment, and you will need a letter from your former employer where they state that they will not be refunding the excess social security and medicare.  You can file form 843 at any time, it is not part of your regular tax return and is not included in Turbotax.

https://www.irs.gov/forms-pubs/about-form-843

[Opus 17]

@LenaH 

Note that in this case, the repayment was made in 2022 (the customer kind of buried that fact) so the claim of right would be included on their 2022 tax return, not 2021.  The concept and basic instructions will be the same, of course. 

[Opus 17]

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@Anonymous wrote:

Thanks. Does also also cover GA state taxes and FICA taxes?

I was also reading posts from another user who suggested that we could also claim it as a special itemized deduction (uncommon deduction)? Is that easier and have less chances of an audit (just a major headache and expensive to use the services for a CPA - especially since this entire debacle is caused by my employers screw up).

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If you had a reasonable belief at the time that you had an unrestricted right to the money, you can use either the deduction or the credit.  If you knew you did not have an unrestricted right to the money, you can only use the deduction.

Generally, the deduction is better if your income and tax bracket will be higher in 2022 than the year the wages were paid, and the credit is better if your income and deductions will be lower.

I don't think anyone here really knows what triggers an audit, so that's hard to say.

I describe the situation with GA and FICA in my other, longer answer.  

[Opus 17]

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@DianeW777 wrote:

The itemized deduction is strictly for repayments less than $3,000 and is no longer available for tax years 2018-2025 under the Tax Cuts and Jobs Act (TCJA) of 2017.

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For amounts less than $3000, this is a miscellaneous itemized deduction subject to the 2% rule, which was eliminated by the TCJA.

For amounts more than $3000, this is a special itemized deduction not subject to the 2% rule, and it still exists.  Qualifying taxpayers are allowed to choose the credit or the deduction. 

[Anonymous]

@Opus 17 

It looks like the payroll vendor made a mistake and paid me an extra paycheck in 2021. So this a slightly different than my original question where I assumed it was a 2020 error, but it's a 2021 error.

They are suggesting that I refund them the extra paycheck (gross) and they can send me a corrected W2 for 2021 which will show the corrected wages paid but will still show the additional taxes paid by me for the extra paid paycheck which I can then claim a refund for excess taxes paid (Fed, State and FICA) in my 2021 returns (due in April 2022). That sounds like a reasonable fix. Am I missing something?

[HelenC12]

No, you're not missing anything. That sounds like a good fix. Just verify that your employer will be withholding taxes when they report the income in tax year 2022. 

[Anonymous]

sorry I missed something there. You said 2022. I thought they can correct the 2021 W2 by reducing the wages box (all else remains the same) and I can claim a refund when I file my 2021 tax returns. 

do note that this is an ex employer and I quit in 2021 so there is no more payroll or witholding. Why would 2022 be involved in it?

[Vanessa A]

If the payment error occurred in 2021, you pay them back what they overpaid you, but they do not make any tax adjustments and they send you a corrected W2 (W2-C) then you will have lower income and more taxes withheld than you needed on the income you actually received.  

When you enter your W2-C, your taxes withheld from them will be added to your taxes withheld from your other employer to increase the total amount that you have already paid which will either result in a larger refund or a lower tax due. You will not see the extra amount withheld listed separately anywhere. However, in the end, returning the overpayment, with no tax adjustments will result in a better tax situation for you when you file your return.  

[Anonymous]

Got it, so basically by refunding them the gross overpayment and getting a 2021 W2-C from them in return all the tax issues can be handled without any issues or extra filings within the 2021 returns cycle itself. Is that correct? 

[Vanessa A]

Correct, as long as you don't file your 2021 return until you receive the W2-C there will be no extra filings for the 2021 tax year.

[Opus 17]

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@Anonymous wrote:

@Opus 17 

It looks like the payroll vendor made a mistake and paid me an extra paycheck in 2021. So this a slightly different than my original question where I assumed it was a 2020 error, but it's a 2021 error.

They are suggesting that I refund them the extra paycheck (gross) and they can send me a corrected W2 for 2021 which will show the corrected wages paid but will still show the additional taxes paid by me for the extra paid paycheck which I can then claim a refund for excess taxes paid (Fed, State and FICA) in my 2021 returns (due in April 2022). That sounds like a reasonable fix. Am I missing something?

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This is the best situation, but there is still something that needs clarification.

They can issue a corrected W-2C that changes the box 1, box 3, box 5, and box 16 (state) wages.  They can't refund your box 2 (federal tax withholding) or box 17 (state tax withholding) because those amounts were already sent to the IRS or the state.  You will get credit for those withholding amounts on your tax return, which will reduce your tax owed or increase your refund.

However, it is different with the box 4 and box 6 taxes (social security and medicare).  If they reduce your box 3 and box 5 income, they should reduce your box 4 and box 6 taxes and give you that money back directly.  (Or you should repay the gross minus those taxes.)  They will have to file an amended form 941 anyway, to change your gross wages and correct the W-2, so it's not much extra work to refund or credit you with the social security and medicare tax.  If they don't refund the SS and medicare tax (or let you pay the gross minus those taxes) then you will still have to file a form 843 to get a refund of those taxes, since there is no refund procedure for those taxes on your federal tax return.