Federal vs. state employee benefit plan and fringe benefit income tax withholding.

• Author: Scherer, Thomas R.

Over the past few years, Federal, state and local governments have passed or adopted several legislative changes for employee benefits and fringe benefits taxation. In many cases, these changes were first implemented at the Federal level and subsequently adopted by state and local jurisdictions.

While it may be true that a vast number of states and localities follow the Federal guidelines in calculating taxable wages, it is also true that there can be a timing factor as to the effective date of these changes. Many states first require local tax authorities to review and approve Federal changes before changing their statutes. Further, some Federal legislation has a retroactive effective date, yet states adopt the law when it is passed and do not include the retroactive period.

There are still some states and localities that follow only certain Federal provisions in calculating taxable wages. As a result, the state taxable wages may differ from the Federal wages. (Note: This discussion only addresses calculating taxable wages for income tax withholding. FICA, FUTA and state unemployment insurance taxable wages can (and do) have different rules.)

In September 1997, Pennsylvania passed legislative changes retroactive to Jan. 1, 1997, that reduced employees' state taxable income by their contributions to a cafeteria-style benefits plan for hospitalization, sickness, disability or death benefits. This change required employers to reduce the amount of Pennsylvania tax withheld from their employees' remaining payroll checks for 1997 or reflect the correct amount of taxable wages in the state wage box on their employees' Forms W-2 (which would enable the individuals to get a refund directly from the state). If the employer did not comply with either of these alternatives, a Form W-2c was issued to its Pennsylvania employees, if they were supposed to receive their state tax refund.

While this change brought Pennsylvania more in line with the rules on taxable wages that exist for Federal income tax withholding purposes, a number of differences still remain between the Federal and state treatment of fringe benefit and employee benefit plan taxation.

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