Email Explains Difference Between Filing a Claim and an Adjusted Return on Payroll Withholding Issues

The problems of attempting to develop summary explanations for training purposes (like this article) of tax material was discussed in Chief Counsel Email 201822028.  A person inside the IRS was raising questions about IRS training materials related to the question of when an employer may “claim” an “adjustment” for income tax withholding and additional Medicare tax.

Specifically, the email begins by noting the matter that had led to the request for clarification:

Your initial inquiry was whether certain training materials were correct in stating that “[a]n employer CANNOT claim an adjustment for [Income Tax Withholding] and additional Medicare taxes after the close of the calendar year for the employee.” The training materials cite to § 31.6413(a)-2(c)(2).

One key issue with writing training materials is that often words that have a common meaning in the English language are imbued with a very specific and potentially quite different technical meaning by provisions of the law.  That was part of what lead to the confusion that was addressed in this email.

As the email continues:

In answering your question, it became clear that there is wide-spread confusion concerning the actions an employer must take by calendar year end and what actions are permitted after the calendar year end. The confusion is due in large part to the imprecise use of terms, including “claim” and “adjustment.” Of note, it is misleading to use the phrase “claim an adjustment” given that the claim process and the adjustment process are different.

In reality, the author of the materials was using “claim” as a common English language term, while the term adjustment maintained its detailed technical definition.  But, as the email notes, in the tax law a claim is also a specific action—so saying one “claims” an “adjustment,” where it is not clear which of the two terms is being used in its official technical sense, leads to a significant level of confusion.

A claim is a specific reference in tax law to a taxpayer asking for money from the government due to a purported overpayment.  As the email notes, claims are very limited in the payroll tax context:

An employer cannot file a “claim” for income taxes except for administrative errors — in which the amount reported on Form 941, line 3 (Federal income tax withheld from wages, tips, and other compensation), does not agree with the amount the employer withheld. See § 31.6414-1.

So, for instance, if ABC Company has a single employee from which it withheld $1,000 for the year, but it had erroneously reported on Forms 941 a total amount of taxes withheld of $1,250, ABC could file a claim for the excess $250 that it paid over what had actually been withheld.  The time period for filing this claim is tied to the standard periods for claiming a refund of overpaid taxes.

But what if ABC has erroneously withheld $1,250 of FICA taxes when, in fact, the actual amount of FICA that should have been withheld from the employee’s check was $1,000.  ABC again had reported the amount of taxes withheld on Form 941 as $1,250.  In this case, ABC cannot file a claim for the overpayment—this was not the type of administrative error for which a claim is allowed.

But there is still a way to fix the matter, by looking to an adjustment if certain requirements are met.  As the email continues:

But, the employer can file an “adjusted return” if the error is discovered in the same calendar year employer paid the wages and if the employer also repaid or reimbursed the employees in the same year. See §§ 31.6413(a)-2(c)(2)(i) and 31.6413(a)-1(b).

Note that the adjustments have a secondary time limit—the error must be discovered in the same calendar year as the wages were paid and the employer must also make the employee whole (by repaying him/her) in order to file an adjusted return.  But if discovered before December 31, that does not require the adjusted return itself to be filed before December 31.

The email uses Situation 2 from Revenue Ruling 2009-39 to help illustrate the matter:

Situation 2: Employer S timely filed its 2011 third quarter Form 941 on October 10, 2011, and timely paid all employment tax reported on the return. On December 2, 2011, Employer S ascertains that it overwithheld and overpaid ITW in the third quarter of 2011 and reported the overpayment on its 2011 third quarter Form 941. Employer S repays the overcollected amounts to its affected employees on December 29, 2011. Employer S files Form 941-X on January 6, 2012, to correct the overpayment using the adjustment process.

Because Employer S repaid its employees the amount of the overcollection of ITW in the same year that the wages were paid, Employer S may correct the overpayment of ITW using the adjustment process even though the adjusted return is filed in a year after the wages were paid. Employer S may not use the refund claim process to correct the error because the ITW was actually withheld from the employees' wages.

As indicated in Situation 2, the employer is NOT required to file Form 941-X using the adjustment process by the end of the calendar year. However, the discovery of the error and the repayment/reimbursement must occur by the end of the calendar year.

A key skill that needs to be developed by a seasoned tax practitioner is to take care to take “inventory” of any terms in the area you are researching for which Congress (in the IRC) or the IRS (in regulations) have created area specific definitions for.  If you aren’t careful, you can easily fall into the trap that befell these materials. 

It’s very possible the confusion was introduced when someone, attempting to make the document easier to understand, decided to use the wording “claim for adjustment” to make the materials easier to understand.  The problem, of course, was that a party doing that runs the risk of accidentally using a specially defined word in a non-specially defined manner.