Medicare Tax - Need some help

[Frustrated-in-IL]

Taxpayer works for local government and his wages are subject to Medicare but not Social Security.  For several years, amounts were taken out of his W-2 pay pre-income and pre-Medicare for a medical health account (not HSA but works in a similar manner).

In 2023, it was determined that there was an issue with the plan.  The benefits company (not employer) issued a Form 1099 NEC for amounts put into the account over the years.  I questioned the use of a 1099 NEC and was told by the benefits company the reason it was put on the 1099 NEC was because the amount is subject to both income tax and Medicare tax but NOT Social Security tax as the employee wages paid by the local government are not subject to SS tax.

So there are a lot of questions, such as should corrected W-2s for each year involved be re-issued by the employer instead of a 1099 NEC issued by the benefits company, even though this goes back many years.  But lets move past that as I don't want the thread to go there.  Here is my question: is there a way in the program to report this to subject the amount to income tax and only Medicare tax?  The closest I can come to is to report it as tips paid by a government but it clearly isn't tips and I think including a Form 4137 will really muddy the waters as the income would be reported as wages as well.  Which would mean I would need to somehow negate the 1099NEC amount, which I am currently reporting as other income.  I have also looked at Form 8919 but can't see how to get it to just compute Medicare tax without SS tax.

Any ideas would be appreciated.

[IRonMaN]

You should have asked the benefits company how a person is supposed to accomplish that since it was their hair brained idea to send the 1099.  

[rbynaker]

I'm calling BS on that one.  Even if there were a mechanism for just paying Medicare tax, half of that tax needs to be paid by the employer, not the taxpayer.

[Skylane]

<<For several years, amounts were taken out of his W-2 pay pre-income >>

<< I questioned the use of a 1099 NEC and was told by the benefits company the reason it was put on the 1099 NEC was because the amount is subject to both income tax and Medicare tax but NOT Social Security tax >

Sounds like they were trying to offer a cafe 125 plan and screwed it up.  Whatever the problem a  doubt a 1099-NEC is the solution. 

I agree w/ Rick that this is on the ER not the EE.  If this is there solution then the ER should be res[ponsible for the additional tax (especially if it's a public entity).    

[Frustrated-in-IL]

I have just asked my client to ask one of his colleagues who has filed if they were able to file electronically and pay just income tax and Medicare tax.  I have a feeling they are going to find that their preparer subjected it to SS tax as well.

That is a very good point about just paying the employee share of the Medicare tax.  I can accomplish that on Form 4137 but since it is not tips and I would then somehow have to negate the 1099NEC, I am not ready to go that route.

I think a novel size explanation attached to the return of all these moving parts might be in my future.

[IRonMaN]

I think a bunch of overrides and explanations to the IRS are in your future ------ along with paper filing the return.

[Frustrated-in-IL]

Thank you for the bad news, Oh Great Guru of the North Woods.  But if you don't mind I kneel at the altar of the Indomitable Sage of All Things Fireball and am hoping for a different option.😂

[IRonMaN]

If you get enough Fireball in you, you won't care one way or the other about options.

[Frustrated-in-IL]

I'm getting to that point now and unfortunately, I haven't had a drop of Fireball today.

[TaxGuyBill]

Your client did not receive any taxable income from the Benefit Company, so none of it is taxable.

Either (a) ignore it and explain when the IRS sends a notice or (b) enter it and back it back out.

[Frustrated-in-IL]

Well, he did receive a check from the benefit company and I don't think it was a gift.😁

[TaxGuyBill]

Oh, I misunderstood that.  I wrongly that it was merely for the "amounts put into the account over the years".

Was the check for the "amounts put into the account over the years"?  Or less than that?

[Frustrated-in-IL]

I am getting that point clarified, as well as what caused the plan not to qualify.

[BobKamman]

I nominate this for the "Ultimate Trick the IRS Computer Maneuver Award" of this tax season.  @IRonMaN is right that a paper return with attached explanation may be the best solution.  Also, the quickest solution, even counting the time needed to send IRS another copy in 18 months. 

This payment should obviously have been reported on a W-2.  (If sick-pay insurers can issue W-2s to non-employees, why can't this benefit company?)  But what do you do when your client doesn't receive a W-2?  That might not be covered the first day of Income Tax 101, but it certainly will be before the last. 

Form 4852.  Amount from the NEC on Lines 7a and 7c.  Nothing on Line b.  

IRS Instructions for 7c—Medicare wages and tips. Enter your total wages and tips subject to Medicare tax. This amount may be required to be entered on Form 8959, Additional Medicare Tax

If you can't do that easily, remember that the employer is responsible when taxes are not withheld, and IRS may have already come after them as far as you know.  Maybe set aside 1.45% in case anyone asks and it doesn't fit easily on the return.  

[Frustrated-in-IL]

I did a little more digging and found out this is a VEBA type account, so the amount shown on the 1099NEC represents all amounts contributed plus the earnings.  Since the taxpayer is not retired, nothing was/could be used at this time.  The employer withheld per employee a specified amount as directed by the VEBA on a class by class basis and turned over the funds to the administrator designated by the VEBA.

Something went afoul of the rules at the VEBA level, necessitating the termination of the plan within the VEBA and the return of contributions and earnings to the members.  As mentioned above, my client received a 1099NEC from the administrator.  

Given this, I don't think this has anything to do with the employer so I don't think the 4852 is the answer.  I am leaning toward including it as "other income" with an explanation that the client is not in a trade or business, and thus not subject to self-employment tax.  While there is the question of Medicare tax, the amount in question is not material so maybe I will just wait to see if IRS comes looking for it.

Is this a good course to follow or is something better, given the obstacles involved with getting the program to just employee Medicare tax something?  The employee only Medicare tax involved is approximately $400. 

[BobKamman]

How can you say "this has anything to do with the employer" but still think it is subject to Medicare (employment) taxes?  And obviously the VEBA administrator acknowledges it is earned income, by using the NEC form.  

[sjrcpa]

But shouldn't a VEBA payout be on a 1099-R?

[Frustrated-in-IL]

@BobKamman said:

How can you say "this has anything to do with the employer" but still think it is subject to Medicare (employment) taxes?

Just to be clear, I said "I don't think this has anything to do with the employer" in the context of the employer not causing/creating/being responsible for an error by the VEBA.  So the reason I believe Medicare tax is part of this discussion is:

a.  Did the foul up have anything to do with the employer? NO.

b.  If the VEBA never existed in the first place, would the wages have been subjected to the employee share of Medicare? YES.

The employer is not my client so I don't care about their share.

[BobKamman]

I would care about whether my client is paying something that could instead be collected from the employer.  

[Frustrated-in-IL]

@sjrcpa said:

But shouldn't a VEBA payout be on a 1099-R?

Good question.  I don't know the answer to that.  And I am getting the feeling the administrator doesn't either.

Would the withdrawal of funds used for retiree medical be on a 1099R?  More to the point in my case, would in effect a return of an excess contribution to a VEBA be on a 1099R?

[Frustrated-in-IL]

Given these circumstances, why do you think the employer is responsible for anything?  Aren't they just following the requirements of a presumably valid VEBA covering a certain set of their employees?  It is not like the employer set this up for the employees.  It was in effect legally foisted upon the employer to withhold according to the terms of the VEBA. 

As for the Medicare tax, there is no doubt that my client would have paid the employee share of Medicare if the VEBA did not exist.  Does he have to pay it now?  Maybe, maybe not.  But trying to stick it back on the employer in a situation like this makes no sense, and quite frankly, is downright stupid so long as the employee is still employed there.

[BobKamman]

What makes you think the employer did not set this up for the employees?  Just because it told you so?  Why would they lie?  The fact is that the employer paid wages to the VEBA instead of to the employees.  IRS has audit guidelines on what to look for, including evasion of employment taxes:

"You determine whether IRC Section 501(c)(9) organizations are meeting their
responsibilities for income tax withholding, FICA and FUTA and reporting on Forms W-2 and W-3 for wages, and IRC Section 6041reporting requirements for other taxable benefits.
If a benefit is taxable, it’ll either be:
 Wages subject to income tax withholding, FICA and FUTA, and reported on
Forms W-2 and W-3 (see IRC Section 3401 and regulations)
 Subject to IRC Section 6041 information return requirements. Generally,
payments by an IRC Section 501(c)(9) organization in excess of $600
constituting taxable benefits (other than wages) must be reported on Forms 1096 and 1099. See Treas. Reg. 1.6041-1(a)(2).

https://www.irs.gov/pub/irs-tege/atg_vebas.pdf 

[Frustrated-in-IL]

Thanks for the info.  One of us is reading this incorrectly.

Page 1 of what you reference explains what qualifies as an IRC Section 501(c) (9) organization.  That is not the employer.

Then, what you cite on Page 8 refers to whether or not the IRC Section 501 9(c) (9) organization is meeting THEIR responsibilities.  That is again not the employer.

So I think you proved my point.  It is clearly not the employer's issue.  

Let's look at what you said.  You asked:

What makes you think the employer did not set this up for the employees?  Just because it told you so?  Why would they lie?

Answer: I told you they didn't.  They didn't tell me so, a collective bargaining agreement said so.  There is no reason for the employer, a local government as mentioned at beginning of thread, to lie, obfuscate, or mislead in this instance.  

You said:

IRS has audit guidelines on what to look for, including evasion of employment taxes.

They do, but it sure looks like what you cite is referring to the VEBA and NOT the employer.

Seriously, I am not trying to be argumentative.  I appreciate you taking the time to reply during our busy time of the year.  I do think this is very instructive.  The problem is not the employer.  It is the VEBA.  Now I do understand why the form came from the VEBA administrator.  That is explained on the bottom of page 8 - top of page 9.  I don't know which of the two options are correct.  If they reported it on a W-2, then to bring this full circle, the Medicare issue would have been resolved.  Since they reported it on a 1099, I think I am right back to reporting it as I suggested earlier today, as other income subject to income tax only, with an explanation that the taxpayer is not in a trade or business subject to SE tax.

[BobKamman]

It has the employer fingerprints all over it, and I lived in Illinois long enough to know how local government works.  There is no VEBA fairy, that waved a magic wand and brought together all the employees with no involvement of the boss.  You're the one who started out wanting to pay Medicare tax, and then others chimed in with Trick The Computer advice.  I know the NEC for a large amount -- it must be at least $25,000, if you're saying the Medicare tax is around $400 -- will generate a CP 2000 asking for SE tax.  My solution is the 4852, but it's your client.  Let us know in a couple years what worked.  

[sjrcpa]

@Frustrated-in-IL The VEBA is a 501(c)(9) organization.

[Frustrated-in-IL]

Yes exactly, that was the point of my post.  The 501(c)(9) refers to the VEBA, not the employer.

[Frustrated-in-IL]

I know the NEC form is new but I have had a number of these instances with Form 1099MISC when something was coded as subject to SE tax when it was not.  I had always paper filed with a statement explaining why the payment was not subject to SE tax.  In only one instance did the IRS respond with a notice.  In that case, I basically copied what was sent with the return originally and that one went away as well.

I had hoped to file electronically and yes, pay the Medicare tax as suggested by the administrator.  But as I said yesterday, I will suggest to my client that we paper file with a statement claiming the payment is not trade or business income and see what happens.

[sjrcpa]

For giggles - who exactly issued this 1099?

The employer - using same EIN as W-2?

Or Employer VEBA with a different EIN?

[Frustrated-in-IL]

The administrator of the VEBA,  EIN is not that of employer.

[IRonMaN]

You should have just referred the client to Jim.  I'm sure he could have prepared that return in 8-1/2 minutes - 10 at the most.😜