Penalties Paid to Employee by Employer for Delayed Final Paycheck Are Not FICA Wages.

(Parker Tax Publishing June 17, 2015)

The IRS Office of Chief Counsel advised that penalty amounts paid to an employee by an employer under the California State Labor Code for the employer's failure to timely pay the employee's final wages were not themselves wages for federal employment tax purposes. CCA 201522004.

Background

In CCA 201522004, the IRS Office of Chief Counsel (IRS) responded to an inquiry about whether payments that an employer is required to make under California law to a terminated or quitting employee if the employer fails to pay the employee's final wages within the required time period provided by state law, are wages for purposes of the Federal Insurance Contributions

Act (FICA), the Federal Unemployment Tax Act (FUTA), and federal income tax withholding.

Under the facts of the CCA, a corporation was required to pay late payment penalties when it failed to pay an employee's final paychecks by the due date provided under California state law.

Section 203 of the California State Labor Code provides for a late payment penalty if an employer willfully fails to pay, by the due dates imposed by the CA Labor Code, any wages of an employee who is discharged or who quits. Under Section 203, if the late payment penalty applies, the wages of the employee continue as a penalty from the due date of the final paycheck at the same rate until paid or until an action, such as filing a complaint in court, is commenced.

The penalty under Section 203 of the State Labor Code is based on the employee's daily rate of pay and is calculated by multiplying the daily wage by the number of days that the paycheck was delayed, up to a maximum of 30 days. The 30-day period is calendar days, and includes weekends and holidays and any other days that the employee would not normally work.

Analysis

The term "wages" is defined in Code Sec. 3121(a) for FICA purposes as all remuneration for employment, with certain specific exceptions. Although there are differences in the statutory exceptions concerning what constitutes wages, the general definition of "wages" for FUTA and Federal income tax withholding purposes are similar to the definitions for FICA purposes.

Reg. Sec. 31.3121(a)-1(c), 31.3306(b)-1(c), and 31.3401(a)-1(a)(2) provide that the name by which remuneration for employment is designated is immaterial. Thus, salaries, fees, bonuses, and commissions on sales or on insurance premiums, are wages if paid as compensation for employment.

Rev. Rul. 2004-110 holds that an amount paid to an employee as consideration for cancellation of an employment contract and relinquishment of contract rights is ordinary income and wages for purposes of FICA, FUTA, and federal income tax withholding.

Rev. Rul. 72-268 held that since payments of unpaid minimum wages and unpaid overtime compensation were remuneration for employment, the payments were wages for federal employment tax purposes. However, the ruling further held that payments representing liquidated damages in addition to unpaid wages and overtime were not remuneration for employment and thus were not wages for federal employment tax purposes.

The IRS noted that the late payment penalty under Section 203 of the California State Labor Code is different from severance pay because it is based on the employer's failure to pay final wages on a timely basis. The IRS found the employee had no right to payment of the late payment penalty based on his services as an employee. The IRS also noted that the Supreme Court of California stated in Pineda v. Bank of America, 241 P.3d 870 (2010) that Section 203 is not designed to compensate employees for work performed but is intended to encourage employers to pay final wages on time and to punish employers who fail to do so.

The IRS pointed out the payment of the penalty did not satisfy the definition of wages in Rev. Rul. 2004-110 because the penalty was not part of the terms and conditions of employment, but a separate statutorily imposed penalty. The IRS found that the penalty was similar to the additional liquidated damages in Rev. Rul. 72-268 that were held not to be wages for employment tax purposes.

The IRS noted the Section 203 late payment penalty is a statutorily-imposed penalty for employer misconduct that is in addition to the employee's wages. The penalty varies in amount based on the extent of the employer's misconduct (i.e., the number of days that the employer fails to pay the wages after the due date) rather than the level of services performed by the employee, and is not a substitute for the employer's liability for the payment of wages. The IRS pointed out that in fact, because the penalty is based on calendar days rather than work days, the penalty amount is not the same as the amount of wages the employee would have received if he worked during the period the penalty was imposed.

Because the penalty payment was in addition to the past-due employment wages and not tied to services performed by the employee, the IRS concluded that, based on Rev. Rul. 72-268, the payment of the late payment penalty was not wages for federal employment tax purposes.

OBSERVATION: The IRS cautioned that its conclusion does not apply to the meal and rest period payments made under CA Labor Code Section 226.7. Under that provision, if an employer fails to provide an employee a meal period or rest period in accordance with state requirements, the employer must pay the employee one additional hour of pay at the employee's regular rate of compensation for each day that the meal or rest period is not provided. Because these payments are essentially additional compensation for the employee performing additional services during the time the meal and rest periods should have been provided, the IRS notes it appears those payments would be wages for federal employment tax purposes.

For a discussion of payments subject to withholding, see Parker Tax ¶ 212,110.(Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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