Diagnostic #403 - Form 2555 W-2 Withholding

[rcr]

Receiving Diagnostic #403 - e-file: Form 2555 - Federal income tax or social security tax withholding cannot be greater than 1/2 of the wages on the W-2.  Taxpayer's federal tax withholding exceeded 50% of W-2 wages. How can this diagnostic be cleared?  Will it prevent e-filing the return?

[itonewbie]

Is your client still legally employed by his/her US employer and seconded overseas for an assignment?  If your client was transferred or locally employed, your client should have no W-2 while working overseas.  Even if your client remained a legal employee of the US employer, exemption would normally be claimed for FIT, which means there would only be FICA withholding.

It would be highly unusual to have FIT exceed 50% of Box 1, particularly for someone who qualifies for foreign earned income exclusion and considered neither the withholding tables nor supplemental rate would get the FIT anywhere near that level.

Something is not adding up...

[rcr]

Thanks for the reply.  My client is legally employed by a US business, and qualifies for the foreign earned income exclusion.  He chose to have a large portion of his W-2 income withheld for federal taxes to cover his tax liability on his other sources taxable income. 

Any ideas on how to resolve so the return can be e-file?   

[itonewbie]

Then your client probably didn't complete the F.673 / W-4 correctly or payroll didn't understand how these should be read.  It should be corrected for 2020 as it wouldn't make sense to have money kept by Uncle Sam without interest.

As for 2019, if you're comfortable that the return is correct as prepared, check the box to ignore the diagnostic and it may just go through.

[BobKamman]

What I am reading is that he did complete the W-4 correctly because he wanted that much tax withheld to cover the rest of his non-excluded earnings (or the amount that exceeds the exclusion).  For all we know at this point, he still owes tax even after withholding.  File a paper return, which may be inconvenient from a foreign address, and chalk up another victory for the e-file police.  

[rcr]

Yes, W-4 was filed correctly and no need for Form 673 as client intended to have the taxes withheld to cover his estimated tax liability.  Clearly, want to avoid the inconvenience of filing  a paper return, given the a foreign address.

I'll contact Intuit technical support to see if I can get a definite answer to whether the e-file will go through with this diagnostic checked off or if there is a workaround to clear the diagnostic.

Appreciate any further insight.

[itonewbie]

Let us know if checking off the diagnostic allows you to e-file without a problem.

It's not clear from your post whether there is a refund due on the return.  What we know is that neither you nor your client are surprised by this level of withholding.  Theoretically, unless your client has a substantial amount of outside income (relative to his/her compensation) plus the compensation is much higher than the §911 exclusions, assuming he/she is in a low/no tax jurisdiction, having over 50% withheld would seem excessive, taking into account the stacking rules.  Depending on the actual outcome, I would still suggest that you revisit the W-4 to make the appropriate adjustments.

The fact that your client has actual US tax withheld tells me your client probably moved to a low/no tax jurisdiction with no local withholding requirements and assignment allowances/benefits may be minimal.  Otherwise, tax equalization or protection may come into play, not the least, to address cash flow concerns - sometimes, only after the close of filing - and needs to be accounted for when the reconciliation takes place.

[rcr]

UPDATE: The e-file would not process with the diagnostic checked off.  Contacted Intuit technical support. They provided the following workaround:

On main screen, select client record, click E-File command (top left of screen above icons). Then e-file Support Tools / Disable e-file Error.  In their words, "not the recommended approach"...certainly, it would be wise to contact them if considering this bypass option.

I was able to e-file and received the IRS e-file acceptance.  Of course, advised client to lower tax withholding and increase estimated payments to cover tax liability from other income sources.