In the case of some fringe benefits that are offered to or given to employees, certain benefits can be excluded from an employee’s income because the expenses would normally be deductible on an individual’s personal income tax return. A moving or relocation expense is one such benefit. An individual who relocates because of a change in employment may attach a Form 3903 to his annual Form 1040 to deduct certain qualified moving expenses. And employers may either pay or reimburse an employee’s moving expenses without taxing the payments if the expenses would otherwise have been deductible using Form 3903.
Employers who pay for the relocation expenses of an employee have the freedom to pay for whatever expenses they wish, but only those expenses that qualify as deductible can be excluded from the employee’s income. All other expenses paid or reimbursed are subject to withholding for federal income, social security, and Medicare taxes. The employer is also responsible for including such payments for FUTA taxes, and in most states the expenses are also subject to tax withholding.
So employers must be able to answer the following questions in order to determine if relocation payments are subject to tax withholding:
- Who can deduct moving expenses?
- What moving expenses are deductible?
- How should moving expenses be reported?
The answers to the first two questions can be found in IRS Publication 521, Moving Expenses, so we will only cover the basics in this article, and we will be focusing only on employees whose expenses may be paid or reimbursed by employers. For an employee’s relocation expenses to be qualified moving expenses, the employee must meet three tests:
- The move is closely related to the start of the employee’s work.
- The location of the employee’s new home must meet the distance test.
- The individual’s employment must actually or potentially meet the time test.
Closely Related to the Start of Work
Moving expenses that are incurred within one year of when the employee starts working for your company may be qualified moving expenses. The move must have been necessitated by the new job because the employee is required to live near the place of employment or the employee will spend less time commuting than he would have if he had remained in his old home. If an individual relocated before having obtained a job with your business, his moving expenses may still qualify for tax-free reimbursement as long as he started working for your business within 1 year of his move.
The employee’s move may qualify for special tax treatment if it meets the distance test. The distance test is based on the location of the employee’s former home, the location of his old place of work, and the location of his new place of work. It has nothing to do with the location of his new home. The employee’s new place of work must be at least 50 miles further from his old residence than his old place of work was from his old residence. For instance, suppose that the employee used to travel 18 miles from his old home to his old place of work. His new place of work must be located at least 68 miles (18 + 50) from his old residence.
To meet the time test an employee must work full-time at least 39 weeks during the first 12 months after arriving in the general location of his new job. Full-time does not necessarily mean 40 hours per week. In some areas and in some businesses, full-time may be defined as 30 hours per week as long as the employee is receiving all benefits to which full-time employees of your business are entitled.
The 39 weeks does not all have to be with your company and they do not all have to be in a row. For instance, an individual may move into his new home and start work with one employer for 6 months. He then leaves that job and 2 months later is hired by your company. Your company agrees to pay his original moving expenses if he agrees that he will remain with your company for at least 2 years. So he will have worked at least 44 weeks during the 12-month period after his move, so he could have qualified moving expenses.
Qualified Moving Expenses
The following expenses qualify as moving expenses as long as the employee meets the other tests:
- Moving the employee’s household goods and personal effects (including in-transit storage expenses), and
- Travel for the employee and his family (including lodging but not meals) from the employee’s old home to his new home. So meals are never deductible, and house-hunting trips do not qualify as deductible expenses.
Moving expenses, according to the Internal Revenue Code, must be reasonable, but the definition of reasonable is not defined. However, Publication 521 basically indicates that expenses are reasonable if the cost of traveling from the employee’s former home to his new one is by the shortest, most direct route available by conventional transportation. Where the regulations refer to members of an employee’s household, it refers to any individuals who were living with the employee in his old home and are relocating with the employee to his new home.
The following moving expenses are considered to be reasonable and deductible:
- The cost of packing, crating, and transporting household goods and personal effects and those of members of the household from the former home to the new one. A professional moving company can be used, or the employee may use his own vehicle for moving some items.
- The cost of storing and insuring household goods and personal effects within any period of 30 consecutive days after the employee’s things have been moved from his former home and before they are delivered to the employee’s new home.
- The cost of connecting or disconnecting utilities.
- The cost of shipping an employee’s car or pets to his new home.
- The cost of moving household goods and personal effects from a place other than the employee’s former home, but the deductible portion is limited to the amount it would have cost to move it from the employee’s old home.
- The cost of transportation and lodging for the employee and members of the employee’s household while traveling from the former home to the new home. Lodging expenses include the cost of lodging for one day after the employee could no longer live in his old home and expenses incurred on the day the employee arrives in the area of his new home.
- If an employee uses his own vehicle, or if additional personal vehicles are driven to relocate the employee’s family, the deductible mileage rate for 2007 is 20 cents per mile.
- All expenses are for one trip by the employee and the employee’s household, although the employee and the members of his household do not have to travel together or at the same time.
Employers can handle an employee’s moving expenses in two different ways.
Employers may pay all or some of the employee’s moving expenses directly, such as paying a moving company to move the employee’s household goods and personal effects. Or the employer may choose to reimburse the employee for all or some of his moving expenses. Payments that are made directly to a third party do not have to be reported to the IRS, but all reimbursements to the employee do.
How to Report Moving Expenses
Both qualified and non-qualified moving expenses have to be reported on Form W-2. Non-qualified moving expenses are subject to withholding at the time the reimbursements are made. Qualified moving expenses should be reported on the Form W-2 in Box 12 with Code P. Non-qualified reimbursements must be included in the employee’s wages in Boxes 1, 3 and 5. All qualified moving expenses, including payments made to a third party, must be included on Line 1 of Part I of Form 940 for FUTA tax reporting, but the entire amount should also be reported on Line 2 of Part I as excludable wages.So let’s take a look at a practical example. Suppose that an employer pays all of the moving and house-hunting expenses to relocate an employee to a new district office.
The distance from the employee’s old home to his new one is 850 miles and he makes only one house-hunting trip and the overnight lodging expense is $168. On the day the employee moves his family his lodging expenses, including one night near his new home while he is closing on the purchase of his new home is $187. The company chooses to reimburse the employee for 20 cents per mile for both trips and his total meal expenses are $235. The company pays a moving company directly $4,200 to move the employee’s household goods.
Calculate the total costs reimbursed to the employee:
- Mileage reimbursement. (3 x 850 mi x $0.20/mi = $510.00)
- Lodging costs. ($168 + $187 = $355.00)
- Meal costs. ($235.00)
- Total costs reimbursed to employee. ($510.00 + $355.00 + $235.00 = $1,100.00)
Calculate the qualified moving expenses reimbursed to employee:
- Mileage reimbursement for one trip only at $0.20/mile. (850 mi x .20/mi = $170.00)
- Lodging for moving his family. ($187.00)
- Total qualified moving expenses reimbursed to employee. ($170.00 + $187.00 = $357.00
- Total non-qualified moving expenses reimbursed to employee. ($1,100.00 - $357.00 = $743.00)
Calculation of tax withholding:
- Federal income tax. ($743.00 x 25% = $185.75)
- Social security tax. ($743.00 x 6.2% = $46.06)
- Medicare tax. ($743.00 x 1.45% = $10.77)
Reporting of fringe benefit:
- Include $10.77 in Box 6 of Form W-2.
- Include $185.750 in Box 2 of Form W-2.
- Include $10.77 in Box 6 of Form W-2.
- Include $10.77 in Box 6 of Form W-2.
- Report $357.00 in Box 12 with Code P. (Note: Qualified moving expenses paid directly to a third-party should not be reported anywhere on Form W-2.)
- Include total qualified expenses of $4,557.00 ($4,200 + $357) on Line 1 of Part I for Form 940.
- Report $4,557.00 on Line 2 of Part I of Form 940 as excludable wages.
Employers are no longer required to provide employees with a copy of Form 4782, Moving Expenses. However, employers should provide employees with some kind of statement breaking down all payments and reimbursements. Every individual who receives moving expense reimbursements must complete Form 3903 and attach it to his Form 1040. If the employee has been reimbursed for all of his qualified expenses, then he has to report that fact and he will not be able to deduct the expenses on his personal income tax return. If, however, the employee later relocates and invalidates the time test, the qualified expenses report on Form W-2 in Box 12 have to be included in income in the year the employee invalidates the time test. The employee will then have to file an amended Form 1040 for the year in which he received the original reimbursements.
Reimbursement of an employee’s moving expenses is often a valuable fringe benefit, and many companies use the promise of such reimbursements as an incentive in the hiring process. Companies that relocate employees to other company locations often provide this benefit. But employers can avoid the snares and pitfalls that often surround the taxation and reporting of this benefit if the follow the guidelines provided above and the guidelines provided in the appropriate IRS publications.
Robert W. Ditmer, CPP, is the owner of RWD Financial Support Service, located in Raleigh, North Carolina. Ditmer provides support and consulting services in the areas of bookkeeping, accounting, payroll and human resources. With over 25 years of experience Ditmer has worked in a wide variety of industries, and he worked as a Controller in four different businesses including a land planning/landscape architecture firm in Philadelphia, PA, a private dining and catering facility in Wilmington, DE, an IT support company in Glastonbury, CT, and a commercial construction management firm in Columbia, MD. Ditmer has also spoken at conferences and provided training on various issues, and he has written a number of articles in the field of payroll and payroll taxation. He is a member of the American Institute of Professional Bookkeepers and the American Payroll Association, and qualified as a Certified Payroll Professional in 2000. He can be reached at firstname.lastname@example.org.