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I completed a W4 form when I started my full-time job and received direct deposit payment for 6 months in 2014. Due to a payroll error, I was paid as a 1099 employee (no taxes withheld) even though HR's system shows me as a W2 employee. The HR department is currently looking into options, but what corrective actions can be taken? Has this happened to anyone else?

  • Yes, you are correct; I made that change in my post. Thanks! – lineplay Jan 20 '15 at 20:43
  • The title was correct as W2, not W4 - the only change was the 'W4 form'. Unless you change it to 'Filed W4 form', but that really has less meaning than the 'W2 employee' in the HR system. – Joe Jan 20 '15 at 20:51
  • Did you receive benefits as if you were a W-2 employee: Health insurance, 401K, life insurance? Did they correctly take out state taxes? – mhoran_psprep Jan 21 '15 at 11:25
  • @mhoran_psprep I did receive benefits as if I were a W-2 employee. – lineplay Jan 21 '15 at 17:26
  • That could be important when proving you should have been a W2 employee. We have had people ask questions becasue they didn't know the difference, and were surprised in April. – mhoran_psprep Jan 21 '15 at 17:38
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If you were paid without withholding taxes - it is a problem both for you and for the employer.

Your problem

  1. Underpayment - clearly you have now underpayment on your hands, since you didn't have enough withheld and you probably didn't file quarterly estimates. With underpayment comes penalty (and interest). While you can try and blame your employer asking for a compensation (as you should, most definitely), from legal perspective it is your responsibility and you're expected to pay it. Technically speaking you should have notice that withholding on your paycheck doesn't match your W4 and sound an alarm much earlier. It was very convenient for you not to.

  2. Incorrect taxes - if you're paid as 1099 contractor, you're liable for the employer's portion of the FICA taxes ("Self Employment tax"), which is about 7.5% of your pay. That in addition to your own portion of the FICA taxes - another 7.5% of your pay. So the immediate difference between W2 taxes and 1099 taxes is 7.5% not in your favor. So, you need to make sure the employer reports your earnings on W2, not on 1099 (even if nothing was withheld).

Employers problem

Not that you care much, but employer is going to be hit with quite a penalty for this. They don't really care about you, and for them the best solution would be to issue you 1099 and report you as a contractor, otherwise they get penalized. Don't let them do that.

Solutions

  1. Employer issues you W2 with the fields for withheld amounts filled with "$0". That is the correct solution to the problem, which will be the best for you. You will only be paying the underpayment penalty in addition to your regular taxes due.

  2. Employer issues you 1099 and you file as a contractor. That would cost you additional 7.5% of your pay as taxes, and additional penalty (penalty is calculated based on the amount underpaid). You may ask the employer to compensate you for that and that will make everyone happy. Keep in mind that this compensation will be taxable income to you.

  3. Employer issues you 1099 and then corrects it to zeros and issues you a W2. The end result for you is the same as #1. Don't file while you're waiting for W2, and don't amend anything. Push the employer to provide you W2 ASAP and you may even threaten them with this (see below) if they delay.

  4. Employer issues you 1099 and refuses to correct, you don't want to file as a contractor. In this case, you cannot just "correct" the tax due. You need to file the form SS-8 (that I linked to in #3), and request the IRS to decide that you were indeed an employee. That would cause troubles for the employer, including legal troubles. So I suggest talking to an attorney specializing in employer relationship issues, and a tax adviser (EA/CPA licensed in your State). This will likely lead to you not working there any more, but will probably alleviate the tax issue.

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I assume one of the others will have a more detailed explanation, but in short:

  • If you file prior to resolving the issue, file the paperwork, initially, exactly as it was given to you. If it says you were paid 1099, file it as a 1099.
  • If it can be reasonably done, make the corrections on your 1040 (if needed, on paper!) to the 'tax due' side of things - include a deduction for the difference in the amount, and include a written explanation. This could involve a paper return rather than online (as the online software likely won't allow much fudging here). You may be audited, or have a discrepancy report, which may delay things, but this is better than mis-stating the 1099's amounts (which will certainly generate a discrepancy given the computers know only what they're told).
  • If needed, file as reported (so as 1099) and then file an amended return, which can be up to several years later if it takes that long to resolve. It should eventually allow you to get your taxes back.

If possible, though, resolve this with the company first. They can file an amended 1099 (and W2) to correct things on their side, of course including paying their portion of employer taxes and probably requiring you to pay your portion of employee taxes (ie FICA/Medicare), possibly with a check.

Now, this said, you will still likely have an issue with the IRS for not prepaying your income (1040) taxes, and I think you will ultimately bear the responsibility for that. While it's understandable that you might not have noticed FICA being withheld, the 25% or so that should be withheld for federal taxes really should've been something you notice at some point in the year. You could attempt to negotiate this with your employer, but if it were me I'd bite the bullet and pay the penalty for not prepaying, as I'd think it were my fault for not paying attention.

I suggest this Equifax article as a pointer to start with - it has much of the same advice.

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  • Yeah, I just never looked but the payroll error is NOT my fault. – lineplay Jan 20 '15 at 21:02
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    @lineplay, the initial error isn't your fault, but you should have been looking at your paystubs to ensure you were being paid correctly and noticed that no tax was being withheld. Or is this your first real job and you weren't familiar with what paystubs should look like? – cjm Jan 20 '15 at 22:05
  • Not my first real job, I just neglected to look so, yes, it was my fault for not looking. – lineplay Jan 20 '15 at 22:10
  • No, no no no. No "corrections" of tax due, it doesn't work that way! – littleadv Jan 21 '15 at 4:31

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