The following Questions and Answers were provided by the Internal Revenue Service (IRS). For further guidance/clarification on these issues, agency representatives may contact IRS (Federal, State and Local Governments) at (202) 283-9665.
A1. Yes. The repayment is includible in the employee's gross income and in wages for Federal employment tax purposes, notwithstanding the agency's repayment of the loan directly to the lender.
A2: The agency must–
Pay the employer's share of social security and Medicare taxes on the loan repayment;
Withhold and pay Federal income tax withholding (and appropriate State and local income tax withholding) on the loan repayment;
Withhold and pay the employee's share of social security and Medicare taxes on the loan repayment; and
Report the loan repayment and taxes withheld and paid as required under Federal law and applicable State and local laws.
A3: The loan repayment must be reported as wages in Box 1 of Form W-2, Wage and Tax Statement, and as Medicare wages in Box 5 of Form W-2. If wages paid to an agency's employee are subject to social security taxes, the repayment is also reported as social security wages in Box 3 of Form W-2. The repayment is includible in social security wages, however, only to the extent that the repayment together with other wages previously paid during the calendar year does not exceed the social security wage base for that year.
A4: The repayment is reported as wages on line 7 of Form 1040 or, alternatively, on line 1 of Form 1040EZ.
A5: One of two methods may be used–(1) the regular method or (2) the flat rate method. These methods apply because the loan repayments are supplemental wages paid in addition to regular wages. These two methods are described below and, more specifically, in Publication 15, Circular E, Employer's Tax Guide.
A6: To use this method the agency follows these steps:
The Federal agency calculates the correct amount of employment tax withholding on all wages paid during the payroll period by treating the supplemental wages and the regular wages as a single wage payment for the payroll period.
The Federal agency calculates the correct amount of employment tax withholding on the regular wages paid to the employee during the payroll period.
The Federal agency subtracts the amount determined in step 2 from the amount determined in step 1 to calculate the amount of any employment tax withholding due with respect to the supplemental wages.
A7. The correct amount of income tax withholding is calculated by taking a flat 25 percent of the supplemental wages. Social security tax and Medicare tax withholding are calculated at the usual rates and are in addition to the 25 percent income tax withholding.
A8. The flat rate method of withholding on supplemental wages may be used if income taxes have been withheld from the regular wages of the employee. Consequently, if income taxes have been withheld from an employee's regular wages, an agency may use the flat rate method to determine the correct amount of income tax to be withheld with respect to the loan payment. The resulting employment taxes may be withheld from either the employee's regular wages, the loan repayment, or a separate tax payment made by the employee. (See Questions 10, 12, and 15.)
A9: An agency may use any of the following methods. Different methods may be used for different groups of employees. The agency may–
Withhold employment taxes from regular wages paid to the employee as described in Question 10;
Withhold employment taxes from the loan repayment as described in Question 12; or
Require a separate tax payment from the employee as described in Question 15.
A10: To use this method, the agency must–
Determine the correct amount of employment tax withholding on all wages paid to the employee during the payroll period, including both the loan repayment and regular wages. (The agency may use either the regular method described in Question 6 or the flat rate method described in Question 7 to calculate the correct amount of employment tax withholding on the loan repayment);
Deduct the total amount of employment tax withholding from the employee's regular wages; and
A11: The agency making the loan repayment is responsible for transmitting the necessary information to the payroll agency and for ensuring that the withholding is properly implemented. If the agency processing the payroll is unable or unwilling to implement withholding, the agency repaying the loan must use one of the alternative withholding methods listed in Question 9.
A12: To use this method, the agency must–
Calculate the correct amount of employment tax withholding on the loan repayment using one of two methods–the regular method described in Question 6 or the flat rate method described in Question 7;
Deduct the amount of employment tax withholding from the loan repayment; and
Deposit the amounts withheld and report the employment tax withholding and wages on Forms 941 and W-2 in accordance with normal deposit and reporting procedures.
A13: No. The deduction for employment tax withholding reduces the maximum loan repayment.
A14: Yes. However, the amount of income tax withheld is credited against the employee's income tax liability for the year.
A15: An agency is obligated to pay amounts required to be withheld from an employee's wages even if those amounts are not actually withheld. Federal tax law requires agencies, like other employers, to withhold employment taxes from employees' wages. The repayment of student loans, however, may be subject to such terms, limitations, or conditions as the agency and the employee may mutually agree. Consequently, an agency's repayment of the student loan may be made contingent on an employee's payment of employment taxes (including income taxes and the employee's portion of social security and Medicare taxes) to the agency. In this case, to fulfill its tax obligations, the agency must–
Determine the correct amount of employment tax withholding on the loan repayment using either the regular method described in Question 6 or the flat rate method described in Question 7;
Obtain a check or other payment from the employee for the amount determined above;
Make the loan repayment and deposit and report on Form 941 an amount equal to the payment received from the employee in accordance with normal deposit and reporting procedures; and
Report the income, social security, and Medicare tax components paid by the employee in the appropriate boxes of Form W-2. These amounts are not included as income or wages in Boxes 1 , 3, and 5 of Form W-2.
A16: No. The rules for withholding on noncash fringe benefits do not apply to an employer's repayment of an employee's loan obligation.