Payroll in Practice: 6.3.2024

Question: A recent graduate who had no earnings while in school recently entered the workforce. Is there a way to average earnings over the year or part of the year so that the tax withholdings will more closely align with the employee’s tax obligation?

Answer: Congress recognized that the regular withholding methods might not provide the best results in certain situations and provided alternative methods to compute withholding in the Internal Revenue Code.

The alternative methods include withholding on the basis of average wages, annualized wages, cumulative wages, and other methods, which may be used for regular pay and for supplemental pay as long as mandatory flat rate withholding does not apply.

An additional method, the part-year employment method, is not described in IRC Section 3402(h), but is fully detailed as an “other method” in regulation 26 CFR 31.3402(h)(4)-1(b).

This method may be used if three conditions are met. The employee must have part-year employment, must have tax liability determined on a calendar-year basis, and must submit a written request to the employer to use the method.

Under this regulation, “part-year employment” means that all terms of continuous employment with all employers during the calendar year will not exceed 245 calendar days. The term is measured by consecutive calendar days and includes days on which no work is performed.

Continuous employment may be a single term, two or more consecutive terms with the same employer, or may involve more than one employer. There may be more than one term during a calendar year. A term begins on the first day the employee performs compensable services and ends on the last day the employee performs services for the employer during that term. The term is not broken by temporary layoffs of up to 30 calendar days. However, it is broken by an actual termination of employment, even if a new employment relationship begins with the same employer within 30 days. If the employee performs no work for the employer for more than 30 days, the consecutive term ends on the last day the employee performs services for the employer.

The employer may use the method once the employee has provided a qualifying request to use the method. To be effective, the request must be signed under penalties of perjury and inform the employer of the last day of any employment during the calendar yer. and, that the employee is a calendar year taxpayer, The employee must state that they reasonably expect to be employed for 245 or fewer days during the calendar year.

The request ceases to be effective for any wages paid on or after the beginning of the payroll period during in which the current calendar year will end.

If the employee’s anticipation of employment for not more than 245 days during the year becomes unreasonable, the employee should revoke the request before the end of the payroll period during which the request becomes unreasonable. The revocation is effective as of the beginning of the payroll period in which it was made.

Under the part-year withholding method, the employer must first add the wages paid for the current payroll period to the wages already paid to the employee by the employer during the current term of continuous employment. These total wages must then be divided by the number of payroll periods starting from the current payroll period and ending on Dec. 31 or the last date of the employee’s previous term of continuous employment, whichever is later.

This calculation will result in the average wage per period, and the employer must determine the total amount of tax that would have been withheld per period and multiply it by the number of payroll periods used. Subtract from the total withholding any amounts already withheld during the current terms of continuous employment. The difference is the amount to withhold for the current payroll period.

For example, consider an employee who selects single marital status with no other claims on Form W-4, Employee’s Withholding Certificate. The employee has a current term of continuous employment that began Oct. 1 and furnished a qualifying request to the employer requesting part-year employment method withholding. The employee is paid a semimonthly salary of $2,800 with the first payment made on Oct. 15. The employee’s only other term of continuous employment during the year started on March 1 and ended on June 15.

The cumulative wage on Nov. 30 is $11,200 ($8,400 previously paid between Oct. 1 and Nov. 15 plus $2,800 to be paid Nov. 30). For calculation purposes, there are 11 payroll periods, four for the current term of continuous employment and seven from the last date of the employee’s previous term of continuous employment.

The $11,200 in total wages is divided by 11 for average wages per period of $1,018.18. This results in withholding of $41.02 per period, which is $451.22 when multiplied by the 11 payroll periods.

The withholding required for the Nov. 30 payroll period is $295.58, or $451.22 minus prior withholding of $155.64.

For comparison, the percentage method withholding would be $276.06 for each of the four $2,800 payments for a total of $1,104.24.

The part-year method has the advantage of spreading the earnings over the time worked and time not worked during the calendar year. This allows employees, such as seasonal workers or those entering the workforce, to reduce withholding by averaging earnings and taking into account periods when no work is performed. As with most of the other alternative methods, the primary disadvantage is the additional computation required to use the method and the manual workaround that may be required if a computerized payroll system is used.

This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., or its owners.

Author Information

Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

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