**Relocation Taxation Basics -- 2005 Tax Year**

*Authored by: David S. Oltman, CRP and Robert L. Giese, CRP*

> *Orion Mobility, 88 Danbury Road, Wilton, CT 06897*

*(203) 563-2102 doltman@orionmobility.com*

*January 12, 2005*

**Purpose**

This paper discusses the taxation basics of relocation-related
expenditures and the tax consequences thereof for individuals relocating
their family and personal belongings at the request of their employer.

**Overview**

An organization may relocate, or move, an employee to fill an open
position in another location that otherwise may not have local
candidate, and/or any qualified personnel to adequately meet the
requirements for that position. The company may provide the employee
(transferee) with benefits to help offset the costs associated with the
relocation through the company's relocation policy. These benefits may
be taxable to the transferee when paid by the company either directly to
the transferee or on behalf of the transferee to a service provider.

**Relocation Qualification**

Certain relocation-related expenditures may be deductible based on to
the qualification of the relocation. IRS Publication 521 -- Moving
Expenses clarifies this qualification using three tests: 1) Related to
Start of Work; 2) Distance; and 3) Time. In meeting all three of these
tests, transferees may deduct (or have excluded from income by their
employer) several relocation expense types as discussed in [Relocation
Expenses]{.underline} later in this paper, which reduces the tax burden
to the transferee as a result of relocating.

*[Related to Start of Work Test]{.underline}:*

A transferee must relocate to the new location within one year from the
date he/she first reported to work unless reasonable circumstances
prevented the transferee from meeting this time frame. Such
circumstances would include allowing a child to complete high school. As
a rule of thumb for such exceptions, the move should be completed within
two years to meet the qualification tests.

*[Distance Test]{.underline}:*

> The transferee's travel distance to the new job location must increase
> at least 50 miles from the current home in comparison to the distance
> from the current home to current job location. This distance is
> calculated along the most direct travel route.
>
> *[Time Test]{.underline}:*
>
> The transferee must work full-time for at least 39 weeks during the
> first 12 months after arriving in the new location.

**Relocation Expenses**

Relocation expenses are categorized into several taxation categories.
These categories and the corresponding expenditures include:

*Non-Taxable/Excludable*

> Such expenses are reimbursed directly to the transferee and are
> reported on the transferee's W-2 Form in Box 12, coded with a "P".

-   Shipment of household goods and pets

-   Any period of 30 consecutive days of storage for personal belongings
    for domestice moves, whereas for international moves, there is no
    limit on the days of non-taxable storage.

-   Travel and lodging expenses for the final trip and en route costs
    (via the most direct route) to the new location for the transferee
    and his/her relocating family members

-   For 2005, the first \$0.15 per mile for personal car mileage -- this
    rate may change annually or more frequently

# Non-Taxable/Business Excludable

> These expenses follow the **Non-Taxable/Excludable** expenses noted
> above [except]{.underline} are paid to a service provider or vendor on
> the transferee's behalf by the company. Such expenses are not reported
> on the transferee's W-2 form but continue to be reported by the
> employer on IRS Form 940.

# Non-Taxable/Non-Reimbursed

> Non-Taxable/Non-Reimbursed expenses follow the two categories above
> but were [not]{.underline} reimbursed by the company. In this event,
> the transferee may file IRS form 3903, with his/her Federal tax return
> to claim these expenses as a direct reduction of income on line 27 of
> the Federal tax return (form 1040).

# Non-Taxable/Business 

> Employee business expenses paid by the company are not generally
> considered taxable. However, if a spouse or other individual
> accompanies the employee on a business trip and these expenses are
> reimbursed, the non-employee expenses would be considered taxable
> income to the employee. In addition, expenses associated with the sale
> of the transferee's home (Revenue Ruling 72-339), when handled in
> accordance with the Employee Relocation Council's (ERC) Eleven Key
> Elements and Procedures for Amended Value Option, could be considered
> business expenses and not taxable to the transferee nor added to
> his/her W-2 form. The Amended Value process is currently under review
> by the Internal Revenue Service for compliance. A field paper has been
> published but no guidance has been issued by the IRS as of yet.

# Taxable/FICA-Only

> Expenses in this category are those that are federally deductible
> (Schedule A) by the transferee when filing his/her Federal tax return
> form 1040. These expenses are also deductible in all but 10 states
> (Connecticut, Illinois, Indiana, Massachusetts, Michigan, New Jersey,
> Ohio, Pennsylvania, West Virginia and Wisconsin \[Wisconsin allows a
> 5% credit\]) with the exception of the states which have no state
> income taxes. These expenses must be reported in boxes 1, 3, 5, 16,
> and 18 (if applicable) of the transferee's W-2 as taxable income when
> paid by the employer even though they are deductible. The employer may
> choose whether to tax assist these expenses or not as a part of the
> relocation benefit. However, these expenses are fully taxable for all
> taxing authorities at the time of payment as noted in IRS Publication
> 15 (Circular E) for payroll purposes. These expenses include:

-   Mortgage Points and Interest -- (HUD-1 Form Lines 801 & 802)

-   Mortgage Interest Differentials

-   Real Estate Taxes

# Taxable

> All other expenses are considered taxable to the transferee and must
> be imputed as income to his/her W-2 form, boxes 1, 3, 5, 16 and 18 (if
> applicable) in the tax year in which they were paid. These expenses
> create the most significant tax burden to the transferee. The employer
> may chose to offset this tax burden with an additional benefit "tax
> assistance" which, itself, is also taxable to the transferee. Taxable
> expenses should be reported as income to the transferee, in the pay
> period in which they were paid, and taxed accordingly for all taxing
> authorities. These expenses include:

-   Travel, lodging and meal expenses when searching for a new home

-   Lodging and meal expenses incurred during the interim period when a
    new home has not been found and after the transferee has started
    work in the new location

-   Return trips to the old location after starting the new job

-   Meals during the final trip to the new location

-   Closing costs for the new home

-   Lease breaking costs and costs associated with finding a lease in
    the new location

-   Closing costs on the prior location home when the expenses are
    directly reimbursed to the transferee or the home sale program does
    not conform to the ERC Eleven Key Elements

-   Non-receipted lump sums

-   Tax Assistance

-   Final trip car mileage reimbursement in excess of \$0.15 per mile

**Payroll Withholding**

Relocation expenditures are taxable in the pay period in which they are
paid and payroll taxes must be withheld (IRS Publication 15-Circular E).
These taxes may be offset or paid by the employer on the transferee's
behalf (tax assistance) or withheld from the transferee's reimbursement
amount. At a minimum, a "supplemental" amount of tax must be withheld
for Federal withholding purposes. The Federal supplemental tax rate is
25% of the total taxable amount (35% for employees with supplemental
payments in excess of \$1,000,000).

States may also have a supplemental tax rate. For example, California
has a schedule of tax rates ranging from 0 to 10.3% of taxable income.
The California supplemental tax rate is 6%. However, in the state of
California, if a company reports this taxable income as bonus wages
rather than supplemental wages, the withholding rate must be increased
to 10.3% (this applies only to California at this time).

Social Security (OASDI) and Medicare taxes must also be withheld at this
time. Social Security must be withheld at a flat 6.2% of taxable wages
through \$90,000 (for 2005) of earnings. Likewise, Medicare must be
withheld at a flat 1.45% of all taxable income without limit.

**Tax Assistance (Gross-up)**

Where payroll withholding is a requirement at the time of payment with
specific minimum withholding requirements, **Tax Assistance** is not a
requirement and, if provided by the employer, may be calculated in any
way that suits the company's requirements. However, it should be noted
that this tax assistance is also taxable and must be included in the
transferee's wages. Several common calculations include:

*[Flat Rate]{.underline}*

> This calculation provides a flat rate percentage of the taxable
> payment to assist in offsetting the tax burden. It may or may not
> cover the transferee's entire tax liability as a result of the
> relocation payments. The calculation is as follows where the tax
> assistance rate is selected by the employer as part of policy:
>
> Taxable Amount of Expense \$1,000
>
> Tax Assistance (20% tax assistance rate) [\$ 200]{.underline}
>
> Total Taxable Wages \$1,200
>
> Less: Payroll Withholding (25% Federal) \$ 300
>
> Payroll Withholding (3% IL State) \$ 36
>
> Payroll Withholding (6.2% OASDI) \$ 74
>
> Payroll Withholding (1.45% Medicare) [\$ 17]{.underline}
>
> Net Payment \$ 773
>
> In the example, the transferee shared in part of the relocation tax
> burden in the amount of \$227 whereas the employer contributed \$200
> towards the total tax requirement of \$427.

# Inverse Rate

> This calculation provides a tax-on-tax rate calculation of the taxable
> payment to assist in offsetting the entire tax burden at the time of
> payroll withholding. The calculation is as follows where the tax rate
> is selected by the employer:
>
> Taxable Amount of Expense \$1,000
>
> Tax Assistance (55.4% tax assistance rate) [\$ 554]{.underline}
>
> Total Taxable Wages \$1,554
>
> Less: Payroll Withholding (25% Federal) \$ 389
>
> Payroll Withholding (3% IL State) \$ 47
>
> Payroll Withholding (6.2% OASDI) \$ 96
>
> Payroll Withholding (1.45% Medicare) [\$ 22]{.underline}
>
> Net Payment \$1,000
>
> In the example, the employer paid the entire payroll withholding tax
> burden including the withholding required for the tax assistance
> amount. The 55.4% tax assistance rate is calculated as:
>
> Sum of tax rates / (1 -- Sum of tax rates) **OR** 35.65% / 64.35% =
> 55.4%
>
> This method is commonly used to offset the total relocation tax
> liability while meeting the payroll withholding minimum requirements.
> However, it should be noted that this method may cause the transferee
> to receive a tax refund or tax shortage when filing the Federal and/or
> State tax returns as the transferee will be able to deduct from
> taxable income the standard deduction (at a minimum) and may be able
> to itemize their Federal tax deductions allowing them to deduct the
> state gross-up including all state withholding dollars placed in W-2
> Box 17 as well as family exemptions to reduce the actual taxable
> income, possibly moving the transferee into a different tax bracket
> above or below the 25% income tax bracket. Additionally, when filing
> their State tax returns, many states allow the Federal gross-up paid
> by the company including all Federal withholding included on the W-2
> in Box 2 to be deducted. As a result, a true-up or year-end adjustment
> may be applied.
>
> The true-up is an additional year-end calculation to assist the
> employer in recouping any overpayment of tax gross-up or assisting the
> transferee further when a shortage of taxes occurred as a result of
> relocation. To accommodate this difference, a recalculation may be
> conducted using the transferee's real tax filing information including
> exemptions, standard or estimated Schedule A deductions and total
> company income both with and without the taxable relocation expenses
> to determine the difference owed to/from the transferee. If an
> additional amount is calculated and the company decides to pay this
> excess, it should be noted that this additional tax assistance amount
> is also taxable and a tax-on-tax calculation may, again, be
> incorporated.
>
> **Conclusion**
>
> Most relocation-related expenses paid by an employer are considered
> taxable income to the transferee and should be imputed to the
> transferee's wages as income. The information discussed in this paper
> is general in nature and exclusions to one or more of the discussion
> topics do exist. A more in-depth discussion to identify these
> exclusions may be necessary and/or additional documents may be
> required.