Taxation of Moving Expenses – What You Need to Know
By Ryan Byrd, CPA, CFE and Mia Bautista, CFE, PMP | October 11, 2018
Effective January 1, 2018, moving expenses are taxable income to an employee.
All moving expenses either paid by an organization to a vendor (for example, paid to a moving or storage company, or to an airline) or reimbursed to an employee, are Form W-2 taxable wages to the employee. In addition, the employee may not deduct the moving expenses on their federal individual income tax return. There is no longer a distinction between “qualified” and “non-qualified” moving expenses – all are taxable compensation. The employee will owe federal income tax, Social Security and Medicare tax and state tax, if applicable, on the moving expenses which are added to Form W-2 taxable wages.
This rule applies to domestic and international moves. For employers with US employees living and working overseas, this rule applies to all international moves by US employees – both moves to and from the US, and moves between two foreign locations.
This rule applies only to expenses paid or reimbursed for moves which took place in 2018 and future years (IRS Notice 2018-75, September 21, 2018).
If an employee qualifies for the Foreign Earned Income and Housing Exclusion (Form 2555) the employee may deduct the moving expenses included as taxable compensation, up the total annual income exclusion amount ($103,900 in 2018). If the employee’s total compensation eligible for the exclusion is over the annual exclusion amount, the employee will pay federal income tax on the moving unless they have Foreign Tax Credits available to offset the federal income tax.
Should the employee or the organization pay the tax on the moving expenses added to the W-2?
Whether the employer or the employee should be responsible for the tax on the moving expenses depends on your organization’s relocation policy, tax policy, if applicable, compensation philosophy, finances and funding. The decisions other organizations in your sector make may also influence your approach because it may impact your ability to attract and retain employees.
Previously “qualified” moving expenses, which in general were the “big ticket” items such as the shipment of household goods, the cost of the employee and their family’s travel to the new work location and, in some cases storage, were tax free to the employee. For more than twenty years, when these expenses were paid to a vendor on behalf of an employee, or reimbursed to an employee, these expenses were not included in an employee’s Form W-2 taxable income. In addition, in certain situations, the employee was allowed to deduct moving expenses on their US federal income tax return ensuring that the employee would not pay federal income tax on “qualified” moving expenses.
Therefore, many relocation or tax policies do not specifically address whether the employer or the employee is responsible for the tax on “qualified” moving expenses. For the same reason, offers, assignment letters and other employer/employee communication has been silent on this issue. For many organizations, this issue will now need to be addressed as soon as possible.
What steps should I take to address the issue at my organization?
The first step is to determine if existing policies, offers, assignment letters or employee representations reference whether the employer or the employee is responsible for any tax on moving expenses to determine what your responsibility is to this group of employees.
Once an organization has determined who is responsible for the tax on the relocation under existing policies, offers, assignment letters or other communication, an organization can review the outcome in light of their compensation philosophy, budgets, etc. and make a determination whether the employer or employee should be responsible going forward.
Foreign Tax (if applicable)
As part of the review, organizations with personnel overseas should carefully consider the foreign tax implications of the moving expenses, if their employees are subject to foreign individual income tax. Remember that for many years, moving was not included in Form W-2 taxable wages, which is often the basis for the calculation of the foreign income tax. Your foreign tax vendor may not be aware of this change in US tax law and therefore may continue to use Form W-2 taxable wages, even if the moving is not subject to tax in the foreign location.
You should evaluate if the moving expenses are taxable compensation in the foreign jurisdiction and account for any additional foreign tax in their budgets, if moving has not been taxed in the past. In addition to foreign income taxes, there may be foreign social taxes, payroll taxes, and pension contributions based on the moving income to be considered.
You organization should also review how you (or your employees) communicate their taxable income to the foreign tax vendor to eliminate the possibility of the moving incorrectly being taxed by the foreign vendor. In a country with a 40% tax rate and a mandatory social security and/or pension contribution of 10%, the foreign tax cost may total 50% of the moving paid on behalf of, or reimbursed to, an employee. In other words, a $20,000 move added to a US Form W-2 could incur $10,000 in foreign taxes.
What changes to processes and procedures should you consider implementing?
Employer responsible for tax on moving expenses:
- Domestic moves – gross ups should be considered. The tax rates for gross ups should be reviewed and most likely decreased to reflect the new tax brackets. The timing of gross ups should also be considered to take into account the employee reaching the Social Security cap.
- Foreign moves – gross ups should be considered, but what taxes should be grossed up is more complicated. The timing of Social Security gross-ups may take into account the employee reaching the cap. Medicare has no cap and should be grossed up. Federal and State income tax gross-ups may be appropriate for expatriates who have exceeded the annual Foreign Earned Income and Housing Exclusion and who do not have Foreign Tax Credits available. The tax rates for gross ups should be reviewed and most likely decreased to reflect the new tax brackets.
- Tax Equalization Programs - Hypothetical tax (the tax the expat would owe on the income earned if living and working in the US) should be recalculated based on the new tax rules including the change in tax brackets. It is possible that less hypothetical tax will be collected from the employees on an annual basis, thereby increasing the organizations cost of their tax equalization program.
- Budgets should be revised, and funding should be reviewed with regards to passing on additional costs.
- Relocation policies, tax policies, offer letter, assignment letters and other routine documentation should be reviewed and changed to reflect the organization’s policy decisions based on the new law.
Employee responsible for tax on moving expenses:
- Withholding should be implemented on moving reimbursements made to employees.
- A communication strategy should be developed and implemented for all employees who have moving expenses paid on their behalf, or who are reimbursed moving expenses, to apprise them of the tax implications.
- In situations where the organization pays a relocation vendor directly, a process should be put in place to apprise the employee of the amount that will ultimately be included in Form W-2 compensation, so the employee may plan for the resulting taxes.
- Employees should be notified that they may increase the amount of their payroll withholding to take into account the tax on their moving expenses.
Are there any options which my organization should consider?
- Cash allowances for moving – provide employees cash moving allowances and withhold appropriate tax from the cash payment. The assumption is that the employee will utilize the cash allowance efficiently.
- Short Term Business Trips – when appropriate, utilize short term business travel rather than employee relocations.
Is there any possibility that this law will be changed?
The new rules with regards to moving expenses are in place through December 31, 2025. These rules currently apply to all moves except “qualifying” active duty military.
The only known effort to change this law relates to federal government workers. Nine organizations representing federal government workers recently signed a letter that was sent to the General Services Administration (GSA) stating that the additional tax on the moving that is added to the employee Forms W-2 is so large that it essentially negates the total value of one or multiple employee paychecks. These organizations have asked the GSA to consult with the IRS and the Treasury Department to develop a solution for federal workers.
Cost Allowability of Moving Expenses and Income Tax Differential Pay
Relocation costs are costs incident to the permanent change of assigned work location for a period of 12 months or more. Types of relocation costs include:
- Cost of travel of the employee and members of the immediate family (see FAR 31.205-46).
- Transportation of the household and personal effects to the new location.
- Cost of advance trips to locate living quarters, and temporary lodging.
Relocation costs must meet the following criteria to be considered allowable:
- The move must be for the benefit of the employer.
- Reimbursement is in accordance with established company policy or practice.
- Amounts reimbursed shall not be in excess of actual costs.
- Lump-sum amount for miscellaneous costs, not to exceed $5k, are permissible.
- Lump-sum basis may be allowed for the following costs when adequately supported by data on the individual element:
- Finding a new home
- Travel to new location
- Temporary lodging
- When reimbursement on a lump-sum basis is used, any adjustments to reflect actual costs are unallowable.
Income tax differential pay allowability is determined based on whether the assignment is foreign or international.
- Differential allowances for additional income taxes resulting from foreign assignments are allowable.
- Differential allowances for additional income taxes resulting from domestic assignments are unallowable.
- Payments for increased employee income or Federal Insurance Contributions Act taxes incident to allowable reimbursed relocation costs are allowable under 31.205-35(a)(10).
- Moving expenses do not become “salary” just because it’s reported on the employee W2 as part of total compensation. Evaluate allowability of each component of W2 compensation and based on the applicable cost principles:
- U.S. Payroll Salaries
- Employee Relocation
- Temporary Quarters Allowance
- Evaluate policies and procedures as well as employment agreements as to reasonableness and compliance with cost principles.
- No presumption of allowability will exist where the organization introduces major revisions of existing compensation plans or new plans
- Evaluate disclosed cost accounting practices associated with compensation, moving costs, income tax differential pay, and associated fringe.
The allocation methods should be reviewed to determine that the proper costs are being charged to the benefiting final cost objective.
This article was prepared in close cooperation with our partners Patty Brickett, JD, LLM and Danielle Petroff-Gobeille, CPA of Brickett Consulting