If an employer pays back wages deferred from previous years, will the employee end up at a higher bracket?

Question

Through no fault of either the employee or employer, some wages could not be paid during certain months over the past years. Now the employer wants to repay all of those wages. Will those wages be taxed as this years income, and will that income bump up the employee into a really high bracket? What is the mechanism to properly report this to the IRS? ( I saw previous answers to this question, but not very complete, any new ideas?)

Answer 1

Income is taxable in the year you receive it, not the year in which you earn it, so yes it will just be more "ordinary income" in the year it's paid to you and tacked on to whatever other income you have that year. You should insist that it be paid to you on a regular W-2 just like normal wages so that the employer has to pay one half of the Social Security & MediCare that is due on wages paid, otherwise the Gov't will take almost 15% of the income right off the bat for SS & MediCare contributions. Be sure they withhold taxes as they would normally do with wages you are paid keeping in mind that taxes are due as income is paid, not just at the end of the year. If you plan to get the extra income throughout the year without taxes being withheld and paid to the IRS at the time you are paid, you are required by law to make quarterly advance tax payments during the year and not just wait until April 15th to settle up. If you wait until then to pay, you can be subject to penalties and interest for not paying taxes as you get the income. It is impossible to predict the tax consequences it will cause in the year it's paid due to the fact that it will be combined with whatever other income you receive that year and your total income will determine taxes due, so the best thing to do is to tell you that many people defer receiving income on purpose if it isn't immediately needed so that they can have it paid to them after they retire when their income naturally goes down which naturally puts them in a lower tax bracket. My suggestion would be to get the money while you can before something else happens "involuntarily" to the employer, have it paid on W-2's with SS, MediCare and taxes withheld, and just pay the damn taxes. The Gov't never takes all of it..........

Answer 2

Most taxpayers report their wage income on the cash basis, not based on the year when the wages were earned. If the employer is paying the wages this year based on income earned in a previous year, then the income will be taxed this year.

If the employer pays the back income in one lump-sum, and does not code the wages properly, the percentage withheld for income taxes will probably be dramatically higher than a normal check (especially if the amount of the back pay covers more than the normal one-pay-period). Most payroll calculations are based on a periodic payroll... and if the employer doesn't indicate this is a one-time catchup (or annual payment), the amount withheld (on a percentage basis) will probably exceed 20%.

The overall question about which tax bracket you will fall into by receiving the wages this year is hard to answer, because the tax bracket for paying your taxes at year end is based upon your full year income, not just the income for a single pay period.

If you want more information about how the calculations are performed, I'll be happy to answer your questions.

Answer 3

If this was done on the up and up, then the deferred wages would have been deferred through a deferred comp plan. IRS 457 would be an example. When the employee receives distributions (payouts) of deferred compensation, it is taxed as normal income and would have the impact of raising the tax bracket of the employee receiving the distributions. Until the employee receives these distributions, the withheld money is is held in an account that would be invested or interest bearing.

It would actually be illegal for an employer to withold wages outside of one of these plans. The employee would be entitled to interest or investment income.

If you are the employee, report your employer to the department of labor. If you are the employer, you could be in trouble.

Answer 4

Through no fault of either the employee or employer, some wages could not be paid during certain months over the past years.

The above statement CAN NOT be true.

Individual tax payers are taxed on income in the year it is received, not the year it is earned. As far as tax bracket are concerned, it is probably not as bad as you think. Entering a higher tax bracket does not increase your rate on ALL income. It only increases the rate on income ABOVE the new tax bracket. See the tax rate schedule linked below.

Answer 5

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