With unemployment reaching historic lows, companies are increasingly using “sign-on” bonuses to win over prospective talent. These are typically one-time payments offered to potential hires, used to incentivize them to join your company. Most are contingent upon the new employee working for the company for a minimum amount of time, typically a year.
For employees, it’s a warm and fuzzy feeling being welcomed with open arms (and pocketbooks). But all good things must come to an end—some sooner than others.
So, what happens when an employee leaves the company prematurely? Quite simply, the employee must pay back the bonus. The process of getting these funds back is often called “clawback.” Below are a few common scenarios a company might encounter when trying to claw back a sign-on bonus.
Same Year Departures
Let’s say an employee joins in April. Their $2,000 sign-on bonus is paid, under the agreement that the individual will stay for at least a year. Fast forward to October, and the individual has left the company. Now what?
The first item to consider is gross payment versus net received. For this example, let’s assume this is a state with no tax and only federal taxes were taken. Social Security and Medicare taxes (FICA) taken would be $153. And we’ll use the supplemental rate for federal (25%), so deduct another $500. When all’s said and done, the employee cuts a check to the company for $1,347.
The company can now file a 941-X (Adjusted Employer's Quarterly Federal Tax Return or Claim for Refund) for the 2nd quarter (or the quarter the bonus was paid in), reducing wages by $2000, federal taxes by $500, and Social Security and Medicare by $153 for the employer and $153 for the employee (it’s a shared tax).
The employer will then receive a refund from the IRS for the $806 overpaid in taxes. At this point, the employer would be whole—they’ve received the net back from the employee and the taxes back from the IRS. If the employee left in the same quarter (so in this case, May or June), then a 941X would not be needed, just a proper filing of the reduced wages.
It’s worth noting that a sign-on bonus would have been one of the first payments received by an employee—meaning that it’s likely that Federal Employment taxes (FUTA) was calculated on that amount. If the employee stayed long enough to earn over the $7,000 FUTA wage base (without the bonus), then there would be no need for a refund. If the employee earned less than $7,000 after the removal of the bonus, then they could reduce the wages and file their 940 at the end of the year appropriately. Any overpayment would be refunded after filing.
Subsequent Year Departures
What happens if a new hire joins in April, receives a $2,000 sign-on bonus, and stays employed all the way through February of the next year? The employee pays back the net pay of $1,347.
The employer must still file a 941-X, but because this is a subsequent year, the employer can’t collect federal income taxes. Employers are unable to reduce federal tax withheld in a prior year (this is true for state taxes as well). Therefore, no correction can be made for income taxes withheld. The employer can only claim the overage on Social Security and Medicare.
In order to do this, the IRS requires the employer obtain a written statement from the former employee stating that he or she won’t claim a refund or credit for the over-collection. Basically, if the refund is going to the employer, the IRS does not want to also send an overpayment to the employee.
In this case, the employee will receive a W-2c (Corrected Wage and Tax Statement) showing a reduction of $2,000 in wages, minus the Social Security and Medicare taxes. Here, the employer is still short $500, since the employee returned only the net pay.
If the employer instead required the gross pay be returned when the employee left, the employee would repay the entire $2,000. In this case, the employer should return the FICA portion ($153) to the employee since they’ll receive both potions with the Form 941-X. Now the employer has the net amount of $1,347, federal tax of $500, and both portions of FICA after filling the amendment.
Note: this all works only if the company is able to obtain the written statement mentioned above. Without it, employers can still apply for a refund of the employer portion of FICA only.
While sign-on bonuses seem simple to offer, they can cause a tremendous payroll headache down the line. Any sign-on bonuses you offer should clearly outline expectations in the event the employee terms early. Depending on the employee’s salary and amount of notice, their final payment could cover the bonus repayment if the employee agrees to it. As the age-old HR saying goes, “document everything.”
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