The situation: an employee was given an advance by either check or materials charged to the company for personal use. The employee is unable to reimburse the company in a reasonable perior of time for the advance and the employee's final paycheck does not cover it.

I'm unsure whether to run this through payroll as wages with insufficient amounts for FICA/Medicare and how to report it on the 941 (if that is possible). I checked Circular-E (Pub 15) and found no guidance for this particular senario nor has the IRS been able to get me an answer. This is a situation which occurs from time to time and In my opinion this should be treated as additional "wages" similar to bonus for the employee. I vaguely remember reading that somewhere it can be treated in this manner. It may go into box 14 of the w-2 but again I have been unable to find enough information to account for it in any manner with current payroll reports. I know there are codes A and B for box 12 of the W-2 dealing with wages received insufficient to pay FICA/Medicare. Can someone please give me a run down on how to account for this type of transaction. Note, if you are not answering the question asked, please don't respond.

You could probably get away with treating it as wages, but since it was never actually earned, it really isn't. And, in actuality, there is no such thing as an "advance". What that employee received was a loan, with future labor promised as repayment, and automatic payroll deduction authorized. If he or she cannot (due to termination, etc.) repay what was loaned, then you have a bad business debt. If the I.R.S. examined the transaction - or if the former employee objected to tax withholding or Social Security/Medicare deductions, they would surely side with the fmormer employee, that this was a (probably uncollectible) bad debt.

GaryArt thank you for your reply. I'm aware of the loan and bad debt treatment. In this particular instance it did not seem appropriate for bad debt treatment. Honestly, I don't see why the IRS would care. The IRS might prefer treatment as wages (its either that or a 1099).

The company gets an expense for the transaction whether it was a wage or a bad debt. The only thing they would be disallowing is the overpayment of payroll taxes. The company is paying an additional 7.65% (Social Security and Medicare Taxes employer portion) on the bonus that would not occur if it was treated as a bad debt.

The major difference I see is one way it is reported as income (via the W-2)to recipient (which it is) and the other way it is not unless a 1099 is filed and the dollar amount is over the reporting threshold (which it isn't). If we treated it as a bad debt, as you suggest the IRS would require if there where a complaint, the employee received a payment (cash) from our company that it is not reported anywhere. Perhaps this is a new De minimis fringe benefit.

There are several governmental agencies, each with their own regulations, it would surprise if one of them didn't side with the employee and want the payment classified as a bad debt and not reported to any over governmental agency.

However, reclassifying it as a hiring bonus I think more fairly reflects the essence of the transaction, makes a minimal difference on our financial statements and acurately reports income to the recipient employee. Unless there is some kind of documentation, court case, letter ruling, revenue ruling or procedure that clearly spells out these circumstances (and I've been looking for one) I'll just take my chances with common sense (A dangerous thing to do the IRS?). Thanks for your reply.