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Section 125 Plan - NDT failure and employer out-of-pocket payment


holdco
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Hello, everyone!

Question for you all. We have a company that failed Section 125 ND testing for the year-end 2013. Most of the folks in the plan are highly compensated. To that end, the company plans to go out of pocket and pay the taxes dues on the portion of taxable benefits for each highly compensated employee for the 2013 taxable year.

Subsequent to this, the company would like to ask each employee to reimburse it for the taxes paid on their behalf. This reimbursement will be requested in 2014. If an employee refuses to pay the company back, can the company simply withhold what it paid on that employee's behalf from that employee's next paycheck?

This feels a bit wrong...the company may have to eat the tax payment, or just require all employees to pay their own way? Does anyone have any tax authority or other guidance they could point me too on this issue?

Thanks so much!

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Hello, QDRO!

Thank you. I am aware of that point, but let's say that's not a problem (although it likely is) in our state, or that we obtain any requisite written consent.

From the federal income tax side, is there a prohibition that you are aware of in the context of an employee who agrees to reimburse the company for taxes it advances on that employee's behalf, but then refuses to write the company a check reimbursing those taxes, forcing the company to withhold from the paycheck?

Thanks again.

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Setting aside whether or not this is legal (which I do not know the answer) - Do I have this correct that you are going to give $x to each employee as taxable income and send it is as withholding in 2013 and then make them pay it back to the company in 2014 with after tax dollars from their pay check?

This seems nutty to me if I have that correct.

It seems like there would be better way to accomplish what you are trying to do. Either company eats this as a bonus, employees are on their own or company gives to participant a loan (if that is allowed). They way it is currently proposed it sounds like they would have taxable income on the same funds in both 2013 and 2014.

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Hello Lou

Thanks for the reply. The employee has a nontaxable benefit under the 125 plan, a portion of which has now become taxable by virtue of the plan failing NDT testing. Consequently, the employee is responsible for a portion of the FICA taxes due on that benefit amount. The employer will pay its portion of the tax on the newly taxable benefit amount, and will also pay the employee portion for the 2013 taxable year.

In 2014, the employee will cut a check to the employer for the taxes it paid in respect of that previously nontaxable benefit. If the employee doesn't, he will receive his usual paycheck, but in addition to the typical withholding, there will be additional withholding in the amount of the tax paid.

Substance over form, it is a loan. I don't see any federal prohibitions on this. State is another matter.

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Off the top of my head, this smells like deferred compensation to me so you have to consider Code Section 409A. I think the employer will need to do withholding in 2013 rather than waiting to see if the "repayment" is made in 2014.

If the employer is a public company, there is also the risk of a violation of Sarbanes-Oxley's prohibition on personal loans to executives.

You'll definitely want to have counsel advise before committing to this arrangement.

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