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Employer reveals they've been inadvertently underpaying me for years
April 17, 2014 5:41 AM   Subscribe

Due to an accounting error, my employer has not been paying me my full salary for the last several years. I'm in sales, and I get paid on commission, so my paycheck fluctuates month to month - I never even noticed my paycheck was always secretly slightly less than what it should have been. My employer just discovered their error and told me immediately. Which I hugely respect. We have a good employment relationship and we'd all like it to continue. They're saying they now owe me about $145k plus interest, and are prepared to write me a check, but they know this raises some tax issues for me.

I'm aware of some of the US tax implications here: I asked both a tax attorney and an accountant, and both agreed that I will owe 2014 taxes on this sum, and that it will put me in the highest tax bracket (39.6%) for year 2014. However, if I had been paid on time-- that is, in all those the prior years in which I actually earned the pay-- my overall tax burden would have been less than what it will be next year. Or to put it another way: I've been in the 33% tax bracket during the entire period of my employment, and would have still been in the 33% bracket all along if they had not made the accounting mistake.

My employer understands how this will complicate my current tax situation, and has offered to either pay me something on top of the back pay I'm owed plus interest, in order to make up the tax difference, and/or to pay into an retirement account for me - or a trust, or some other valid means of lawfully avoiding/delaying taxation. So far they're extremely willing to work with me to correct their mistake. What should I be asking for? How do I even begin to calculate this to make sure we all have the numbers right? What else would you do in my shoes?
posted by anonymous to Work & Money (20 answers total) 5 users marked this as a favorite
 
How secure is your job there? Can you have the amount paid to you (added to your check in increments) for the next 3 years or so?
posted by getawaysticks at 5:43 AM on April 17 [1 favorite]


I would ask for 102% or so of the amount to be paid directly into your retirement account, as long as that large of a lump sum would not cause you any penalties. You should have been saving for retirement anyway, right?
posted by Night_owl at 5:48 AM on April 17 [9 favorites]


This is an amount of money that is worth paying a competent tax attorney to advise you on.
posted by empath at 5:55 AM on April 17 [31 favorites]


You know how much you've been underpaid and the rate at which this would have been taxed so you can work out how much extra you would have had after tax over this period. You then add that figure to your annual after tax income, add on the total tax for this amount and get your employer to pay you that as this year's salary. This should be pretty straight forward for an accountant or even your employer's payroll to do and will be easy for you to check against an online tax calculator.
posted by ninebelow at 5:55 AM on April 17 [2 favorites]


Another wrinkle is that had you been paid on time, you could have earned interest. Instead, they have (presumably) earned interest instead. Given that, I'd feel good about asking for enough to at least pay the full amount of extra taxes.
posted by insectosaurus at 5:56 AM on April 17 [6 favorites]


Ignoring state income tax, you'll owe $57,420 on the $145K they'll pay you this year, but you would have only paid $47,850 on a 33% marginal rate. The difference is $9,570, but they need to pay you more than this, as some of it will be taxed. If they pay you 9570/(1-.396)=$15,844.37 extra, after taxes you'll have the same nominal income as before.

However, this also ignores the fact that money earned several years ago could have been invested, and would now be worth more than $145K. For example, under a 5% annual rate of return, if you were underpaid by about $24,000 in each of the last 6 years, then you're really short about $163,000, not $145,000, and could justifiably ask for this. Accounting for the bump up in tax bracket would take another $17,800, for a total of about $181,000.

Talking to an attorney who handles torts is not a bad idea. I doubt a court will care about the tax bracket implications, but I think they would care about the lost investment income (that is, they would apply some interest rate to the late payments, though I've no idea if it would be 5%).

I'd start with a request for $36K extra, and ask for as much as possible to be paid directly into your retirement fund, as the annual limits are different for money provided by the employer (there is a limit, though, so you'll have to take some as after-tax money). I personally would be happy with half this amount, though much less than that and you have a real chance of getting a court to award you more.
posted by deadweightloss at 5:57 AM on April 17 [2 favorites]


I don't think they can pay you all of the money into your retirement fund(s), because there are limits for those -- even on the employer's side. Also, there may be Safe Harbor provisions they need to comply with on their side or other factors that could limit their contributions to your account.

Also, the main benefits to putting the money in a non-taxable account are on their side, not yours! You get to pay (likely lower) taxes in the future, yes, but they get to avoid paying you the additional money to cover your additional taxes.

One consideration I don't see raised: Where do *you* want this money, and what would/will you do with it?

If you want to save it for retirement/college fund/long-term savings, I'd ask them to maximize the amount they can put into any tax-advantaged accounts, and then cover your excess taxes on the remainder.

If you need an emergency fund or a downpayment fund, ask them for a lump sum with money to cover your excess tax burden.
posted by pie ninja at 6:10 AM on April 17 [1 favorite]


You already have a tax attorney and accountant. Ask them.

But I think you should also consult with a local employment attorney. Your employer has committed--even if inadvertently--a pretty serious violation of wage/hour laws. State legislatures and departments of labor really don't like this sort of thing. Depending how big a percentage of your compensation we're talking about here, you could be entitled to additional liquidated damages as a penalty, and possibly the recovery of attorneys' fees on top of that.

You have a legitimate claim that the employer has acknowledged. It seems like this should be pretty easy to settle, but you'll need an attorney to make sure you aren't inadvertently selling yourself short. You can MeMail me for resources for identifying a local attorney, if you like.
posted by valkyryn at 6:26 AM on April 17 [6 favorites]


It also occurs to me that it may be possible structure the payment of this money over a handful of years, which could be advantageous for tax reasons, assuming it's allowable in your jurisdiction.

Again: consult an attorney.
posted by valkyryn at 6:30 AM on April 17 [1 favorite]


you can't pay more than 17.5k it into a 401k + what ever their existing match is.

You should ask them to gross it up for the difference in marginal tax rate over time (although not on the interest). Should be pretty easy to figure out.

So long as they are cool with that then you should not need an attorney. If they do not agree, then yes get a lawyer.

A lawyer represents leakage of your money. Sometimes that leakage is worth it. Sometimes it isn't. If they are willing to make you whole, then avoid it.
posted by JPD at 6:34 AM on April 17 [2 favorites]


The company is willing to pay interest and gross you up for tax! That's terrific. But remember that the gross up amount is also subject to all federal and state taxes -- in other words, the gross up itself needs to be grossed up. Probably about a 20% premium all in given the higher marginal rates, the Obamacare medicare tax rate increase, the new deduction phase outs, with a bit of give back because they interest they are paying you would have been taxed and presumably won't be.
posted by MattD at 7:00 AM on April 17 [1 favorite]


Just FYI, and *important*, remember we have progressive income tax in the US. Also, most people's taxable income is usually different from their actual income because of deductions and exemptions -- so, as people have noted you really need to consult a tax attorney or accountant; we can give you advice about what you might ask of your employer as restitution, but no actual calculations can be made without knowing your specific situation.

Anyway, what this boils down to is that you should NOT pay attention to back-of-the-envelope calculations such as deadweightloss's that presume the entire $145K will be taxed at the highest rate. Only the portion of your taxable income that puts you over the limit will be taxed at that rate in any given year, including the years you were underpaid. Until an actual accountant looks at your actual tax situation, you do not know whether the top portion of your income would still have been taxed at 33% even with the extra money. It could be that if you had been paid correctly in prior years, you would have missed out on some deduction or credit, making your taxable income higher than you think, resulting in the top portion of your income being taxed at 39.6% anyway. Again, we can't know without looking at all your details.

All that said (considering IANYL and IANYA), since you cannot avoid reporting back pay as wages for the current year you're paid, I would ask my company (and I would offer, if I were an employer who had made this sort of gigantic mistake) to pay for an external accountant of my choice to handle this. If I were your employer, I would also want to increase the amount of back pay to cover the difference in the amount of taxes you will pay -- which would involve calculating your actual taxes for all the years you were underpaid as if you'd been correctly paid, and also taking into account the standard interest rate between each pay period and now. That is a mess of numbers.

I don't believe your company as any obligation to pay for an accountant for you or to pay the difference, and their attorneys will probably advise them not to, but it sounds like they consider you a valuable employee and want to make this right with you, so I think it's worth at least trying to negotiate for, especially paying for an accountant to look at your actual tax situation without guessing so you can at least see where you really stand financially.
posted by lesli212 at 7:18 AM on April 17 [3 favorites]


Erm... an external accountant of YOUR choice, not your employer's choice.
posted by lesli212 at 7:30 AM on April 17


Anyway, what this boils down to is that you should NOT pay attention to back-of-the-envelope calculations such as deadweightloss's that presume the entire $145K will be taxed at the highest rate. Only the portion of your taxable income that puts you over the limit will be taxed at that rate in any given year, including the years you were underpaid.

I think OP is aware of how marginal taxation of income works. OP is asking for a framework of thinking about what to ask his employer for. Yes, if his income with the one-time payment will be $1 into the 39.6% bracket, that eliminates the problem of the extra tax burden. The fact that he is asking this question suggests that is not the case. Bounding what is reasonable to ask for is a useful exercise, and not an especially complicated one. Since I'm not aware of credits that kick in at higher income levels (?!), I don't see it in OP's interest to examine past year's credits/deductions.
posted by deadweightloss at 8:01 AM on April 17


Underpaying you (and for years!) is a serious violation of federal labor law. Your employer is so quick to cut you a check now because they do not want you going to an employment attorney about this issue. However, I'd bet you that entire check that your employer will hand you a document to sign with that check to release all and future claims related to the underpayment. Please check in with an employment attorney who is experienced in these matters ASAP. I am not saying that you should sue your employer, but the attorney should help guide you through this. An experienced employment attorney will know how other companies have structured these types of payments in the past.

Also - if you have an accountant and a tax attorney at your disposal, why are you coming to Metafilter for advice on how to structure the payment? That is something that an accountant and tax attorney would be able to work out for you.
posted by stowaway at 8:51 AM on April 17 [4 favorites]


Just to clarify, I am saying that if OP had been paid correctly, s/he might not have been eligible for an deduction or credit that s/he did take. I'm not saying that if OP had been paid correctly, s/he would have been eligible for more credits.

What if OP, let's say, bought a house last year and took the credit, and it just so happens that the extra income would have made OP ineligible. It could turn out that this year's taxes on the portion of the $145K from last year's income are actually less than the homebuyer credit, in which case his employers mistake was to OP's financial benefit for 2013. Not only would it be unfair to ask the employer for a full 39.6% of the portion of the $145K earned in 2013, it would even be unfair in this case to ask the employer for a reimbursement of whatever percentage of the 2013 portion of the $145K OP is actually paying over his/her normal tax rate for 2014. My point is that we can't even come close to making reasonable guesses as to numbers without knowing OP's exact situation.

I'm pointing all these details out because it seems like OP and the employer really want to be fair to each other -- I don't think OP is out to get them for all s/he can get them for, and it doesn't seem like the employer is trying to be stingy. Seems like both are trying to settle this between themselves in a "fair" way (different from a "legal" way, which could result in the employer paying more and/or the OP getting less).
posted by lesli212 at 9:00 AM on April 17 [1 favorite]


I've been in a similar situation, in which my employer also did not want me disadvantaged (yay!). Folks here are correct when they say you should get a grossed-up amount, and you will be taxed on the total, which means you need to gross-up the gross-up. When it happened to me, I checked with my accountant and my lawyer. The lawyer wasn't helpful, and the accountant for whatever reason would not give me a direct numeric answer (too many variables, blah blah). I ended up just doing a rough gross-up based on my tax bracket, and then grossing up the additional amount over the base, rounded very generously up. So let's say the amount was 10K. I made it 14K based on the gross-up, and then added another 3K for grossing that up plus hassle. I was transparent with the company about how I arrived at the number.

My employer was happy to pay that amount, and I was fine with the outcome. Done! That said, I don't enjoy thinking about this stuff, and I was and am okay with the possibility of forgoing a little cash if that meant spending less time on it. YMMV.
posted by Susan PG at 9:11 AM on April 17 [1 favorite]


Talk to your tax professional about what would be the most adventageous thing to do. It may be a structured pay-out, in combination with contributions to your retirement account.

Each state is so different, and your tax pro will have good answers for you.
posted by Ruthless Bunny at 10:09 AM on April 17 [1 favorite]


Here's an oddball idea. Sue them for it. The results of legal settlements are not taxable, I think.
posted by mbarryf at 5:04 AM on April 18


A legal settlement over a matter like this is taxable
posted by JPD at 8:28 AM on April 19 [1 favorite]


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