Hi everyone,

I'm a first time poster here and to be brutally honest, i'm not even sure if i am writing in the correct category. If not, perhaps someone can direct me.

Okay - now for my question:

My wife recently picked up an hourly job. She works approximately 32 hours (minimum) per week.

The employer (small business of approximately 15 employees) apparently went through a lot of prior employees who quit after a short period of time, so in order to promote longevity of his employees, he has decided to withhold 5% of their hourly pay.

The 5% is put into a savings account of some sort where it will accrue interest (though I'm sure it is a very minimal interest rate, but that's besides the point).

Here are the stipulations:

After 1 year, she is entitled to half of the withholdings.
After 2 years, she is entitled to take everything.
If she leaves before the 2 years are finished, she is not entitled to any of the money that she has not yet received.


After receiving her first pay stub, I decided to look and see how they were handling taxes with this 5% withholding situation.

All taxes are taken out of her gross-pay. The remainder, the net, is then reduced by 5%. In other words, they take this withholding AFTER taxes.

This sounds incredibly suspicious to me. Unfortunately, the big problem is that whenever i talk to someone about it, most everyone responds with "wow, that doesn't sound legal". But we have no certainty if it is legal or not.

Even if it is legal to withhold part of her paycheck, I am surprised that the withholding occurs after taxes (so if she leaves her job before 2 years, this means she has paid taxes on money she never received).

Also - please note, all of the contract documents and forms that she has signed explicitly say that a withholding will occur from her pay. It is not worded in any way to say that at the end of two years, she will receive a bonus (which I think would have been smarter on their part). :)

Does anyone have any idea?

Thanks,
Brian

I understand what they are doing, but don't like how they are doing it.

You are correct when you comment that there is money on which she has paid taxes but, potentially, she will never see.

The better way of doing this is to offer longevity bonuses.

You get a lower rate of pay now, but, when you meet the different targets, you get a bonus.

This is the company acting as a "savings account" for the employee with no insurance on the account. In actuality, it's no different from a forced, nonqualified payroll savings plan. The reason the deductions are taken "after-tax" is exactly because this plan doesn't qualify for tax-deferred status under the IRC.

My main problem with this is, what happens if the company goes under or can't pay it all when they promised to? Does the employee have any legal recourse? She might want to have an attorney review the details of the "plan" for an opinion.

Thanks to both of you. That's a good point about legal recourse if they don't or can't pay up. And it's so strange for them to do this as a withholding, rather than a "bonus". It's almost as if the owner is punishing his employees rather than rewarding them for good work.

I didn't bother to comment on a few other "legally suspicious" items at her job, but while i'm at it, there is a comment in the handbook that says that the office has the right to terminate an employee if they become disabled, either physically or mentally. That sounds like discrimination to me. But i really don't know 100%.

He also does not appear to offer sick/holiday/personal time. I know these are not "rights", but it all is adding up. A good percentage of the workers there are undocumented. I believe this is why he has gotten away with these tactics in the past.

Can anyone tell me though if the 5% withholding is legal or not though?

Thanks again.
-brian

If I thought it might have been illegal, I would have said so. As long as she authorized the deduction, it's legal.

I understand. Thanks for the information.

I'm not sure she actually had much of a choice about agreeing to let them withhold the money. If she didn't sign the contract, she wouldn't get the job.

But then I also wonder about the legality of them withholding and not returning money that she has already payed tax on if she leaves before her 2 year vesting period. If she leaves and they do not pay her, wouldn't they have to (at the very least) adjust her W2 to show that she made less income (adjusted for the 5% withholding)?

See, here's my point. This deduction is being taken after-tax. It's really no more than a nonqualified savings plan. It's very likely it isn't vested, invested on behalf of the participant, etc. But, again, did she sign anything authorizing them to take this deduction?

I guess my problem with this is, that regardless of the legality of witholding the money in an account, it it legal to report (and collect taxes on) wages that you may not receive? I'm sure this amount will show up on the W-2, and you would be required to pay taxes. But how will the employer handle the case where he keeps the wages you paid taxes on?

With a 401K, before you are fully vested you will loose only the part contributed by the employer, but the part you paid is yours regardless of when you leave the company. Of course with the 401k there are specific laws governing it and it is pre-tax.

I think, even if it's legal, it's creating a legal mess for the employer. Say you work October to May. You loose your 15%, but it's spread across 2 tax years. Will the employer go back and amend last year's W-2? And you will in turn have to go back and ament your 1040? It doesn't sound at all like he is handling it like a fee/cost for benifits (legal) and turning around and giving a bonus after a period of service (also legal)

-Tim

Tim - that's exactly one of my biggest questions with this plan. If she leaves before the 2 year vesting period and she does not receive her 5% back, will her W2 be amended to reduce true income? Obviously that's a rhetorical question because i'm sure nobody here would know. But it would be interesting to learn.

I'm also peeved because i learned that the "so-called" interest in this account only earns 1.24%. I could atleast get closer to 4% if i had it in my money market or savings.

You're not getting what I'm saying. This is NOT a qualified tax-deferred plan. Therefore, the deduction CANNOT be made on a pre-tax basis. Whether the money is given back later or not. There is no W-2 amendment to be done. The employer is acting as savings bank. Nothing more.

No - i understood. But see? Doesn't that sound really sketchy to you then? The idea that she could be paying tax on income she never received? A savings account that may never give you YOUR money back? Sounds like Fleet/Bank of Boston to me! :D

Regardless, the job is working out okay for her now, but if at some point she becomes disgruntled, I'll be making a couple phone calls to the MA Dept. of Labor.

Thanks for all of your help.

I understand it's after taxes and isn't a valid pre-tax deduction. However, it's not a savings plan, and you haven't received payment (therefore it shouldn't be on the W-2) if the employer keeps your 'savings' if you leave before 2 years. Can the employer report and collect taxes on wages he hasn't paid? And as an employee, do you have to pay taxes on wages or benefits you have never received, nor will in the future?

Crummy business practice in any case. A bonus, raise, etc. would work out the same without looking like a penalty or raising any legal issues.

-Tim

Tim - I'm not really sure what the details are and to be honest, I doubt the employer even knows the details that well himself. I think this is something he pulled out of his *** fairly recently.

do you have to pay taxes on wages or benefits you have never received, nor will in the future?
From what I can tell, it looks like this is the case... that she is paying taxes on wages she may never receive (if she leaves before 2 years).

Your question did just make me think of another point....

For this example, let's just forget about the potential taxes you may need to pay on interest accumulated in the savings account. But... let's say an employee leaves and does not collect the savings. I assume this must then go back to the employer... tax free??? Since the employee already paid tax on it... right? Hmmm.

I didn't say I liked it. I think it stinks. But it's an after-tax deduction from pay. If she doesn't get it back, it's not that she paid taxes on wages she didn't get; she got the wages (the before-tax part). It's that she did not receive the refund of the deduction from NET pay.

Trust me, I've been doing payroll and payroll taxes for nearly 30 years and there is NO W-2 amendment involved here, whether she gets the money refunded or not.

What does the agreement say will happen to the money if the employee leaves before two years? Goes under? Just decides not to pay?

I don't think it's that simple. With deductions, tax brackets, deductions that are phased out when income reaches a certain level, and other tax breaks that kick in or out at certain levels of income, it's possible that it she did pay too much of the portion she did receive.

Example: assume 10,000 income, 5000 standard deduction and 15% tax bracket.
If all the money is received: 5000 is taxable for $750 in taxes or a witholding rate of 7.5%, 5% of 10,000 is 500 and $37.50 will be witheld from that 500 that goes into the saving plan.

If the 500 is never received, 4500 is taxable for $675 in taxes @15%. For a differenct of $25 from the above. But she paid $37.50 extra in taxes, not $25.

Oversimplified I know, but since the 5% counts against her deductible, you end up paying too much tax ($12.50 more) than you should have if you never receive the $500. The disparity increases as the deduction increases.


While it may be legal to withold payment like this. I see two potental problems. Can you withold for a benefit, then refuse the employee the benefit (patty brings up a good point about the companies responsibility. And is this 'account' held under the company name and subject to liabilities/forclosure of the company?) And 2nd, depending on the details of how taxes are witheld, reported, and the amount kept is handled it could cause problems. May be a good question for a tax attorney.

-Tim

I've been following this thread closely and I'm a bit confused also.

Pattymd, you keep insisting that this is not a tax thing and that it's more of a contract thing. I'm trying to understand this, and I think I do. I'm going to try to word it in dumbed down language for myself. Please tell me if I'm right.


A: Deductions from pay are legal if authorized (as long as it doesn't bring you below minimum wage)

B: Some companies require losses (uniforms, tools, etc.) to be deducted from that employees pay

C: These deductions occur after taxes are withdrawn. (ie: employees are basically purchasing replacements with their own money)

D: Some companies who require uniforms or industry specific equipment may withhold the value of the item from an employees pay (again if authorized), and only when the item is returned is the withholding returned to the employee


If A, B, C and D are true then a company (if authorized in writing) should be able to deduct a percentage of a new employee's pay claiming that he/she is paying for the POTENTIAL cost of finding, hiring and training another employee.

Should this employee remain longer than the pre-determined minimum time frame, the funds would be released to them along with accrued interest. (the interest at this point could even be considered as a generous gesture rather than just returning the withheld amount)


If what I'm saying (and what I think I understand from the thread so far) is true then taxes never come into play because the employee is basically paying for a replacement item (or person). The cost to the employer is an after tax expense so it would logically follow that the employee would pay after taxes also.



Am I getting the idea?

I'm not a lawyer in any way, so please don't take what I say as ANY FORM OF legitimate. I'm just trying to see if re-wording it helps make some sense of it.

Thanks in advance for any answers (and don't be afraid to tell me I'm dead wrong, I won't be insulted)

A. Correct, in your state.

B. Correct, if the employee authorizes it in writing (some states are more strict that others, however, about the reasons for the deductions; some states allow for deductions for breakage, for example, some do not, written authorization not withstanding). Some states state that deductions may ONLY be made for something to the employee's benefit. I'm sorry, I can't find a Massachusetts statute on the AG's web site. It's not terribly user-friendly. (aside: cbg, when is MA going to get an actual DOL?) :(

C. Yes. Same effect as paying out-of-pocket.

D. Not in your state nor 48 others. Only in South Dakota and only under limited circumstances.

Honestly, I don't know WHAT this deduction is intended to cover. And frankly (I've used "honestly" too much here), I'd have to be pretty desperate for a job to accept such a deduction that (it appears) I must authorize to get the job with NO legally-binding agreement that I'm going to get that money back, with market-rate interest, and with some legal recourse if they did not pay.

cbg, when is MA going to get an actual DOL?

Maybe never. But I'll add that to the list of questions I'm going to present to our new AG when I get to meet her. (And I will - it's not if, it's when)