It is standard for companies to retain the best talent by incentivizing their employees. A good example is the popular sign-on bonus, which is typically given to new employees immediately after they accept to join the organization. The sign-on bonus is oftentimes offered on one condition – don’t quit the company within an agreed period or else you must give back the bonus. Meanwhile, the tax treatment of the repayment of this bonus can be a complex affair. Many clients reach to us asking for assistance in the repayment of taxes relating to this bonus, and we gladly help them through.
Once you receive the bonus, it is considered paid which means you must declare it on your income. As an employee, you need to pay tax the same year you receive the bonus.
If you quit your job and return the bonus to your employer during the same year, you will be required to ask for a corrected W2 from the employer so that the repayment of this bonus can be reflected. In the event you delay and pay it back in any other calendar year, you have two options at your disposal. Firstly, you can claim a refund of the overpaid taxes by amending your original tax return. Secondly, you can request credit for taxes you paid the same year you are repaying the bonus.
Let’s take a glance at the summary:
Taxpayer Gets a Bonus in The First Year and Is Taxed Accordingly
The taxpayer must repay the full bonus within 2 years. But, you might ask: why return the full bonus when you have already paid tax on top of it?
Calm down, you have 2 options to choose from:
It is standard for the employer to provide you with the W2C form for the initial tax year you received your bonus. From here, you can amend your initial tax year to get back the total amount of the overpaid tax.
What if your employer declines to issue the W2C for the same year you got the bonus? In that case, the only thing you can do is wait for the year to run down until the end when the company will likely issue another bonus, to which you should respond by filing for “claim of right” or section 1341 for your overpaid tax.
There exists a 3rd option that is beyond the scope of this post as it doesn’t qualify as a taxpayer’s benefit. A benefit normally involves claiming an overpaid tax, often on schedule A. However, this doesn’t result in the usual dollar-for-dollar credit arrangement that would be a fair deal in this case.
As mentioned above, option two is the most popular route for most individuals because employers almost always decline to issue W2C. This means most people are forced to wait for the year to end for them to file for returns under section 1341 credit. The credit is determined based on the total amount of tax the employee overpaid from the last year. The larger this credit is, the likelier it will be audited. For that reason, make sure your filings are backed up for future references.
Available Credit for Both State and Federal Levels
Section 1341 of the US Tax Code permits taxpayers to lodge a claim for a refund of taxes they paid before the tax periods as a result of a decline in their gross income. If that’s what you are after, you are in the right company – we’ve had clients with the same problem and accumulated plenty of expertise in this area as well.