Good Morning. My name is Melissa Davis Hartranft from Fidelity Investments and I m

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1 Prepared Testimony of Melissa Davis Hartranft Assistant General Counsel, Fidelity Investments On Behalf of American Benefits Council IRS Hearing on Supplemental Wage Withholding June 9, 2005 Good Morning. My name is Melissa Davis Hartranft from Fidelity Investments and I m speaking today on behalf of the American Benefits Council. First, I d like to take this opportunity to thank you for providing us with this opportunity to further discuss the proposed regulations regarding the new supplemental wage withholding requirements that were enacted as part of the American Jobs Creation Act of On the surface, the proposed regulations appear to implement a relatively straight forward new requirement: once the amount of supplemental wages exceeds the $1 million threshold, withhold from such payments using a 35% rate. Unfortunately, as the Council indicated in its April 11, 2005 comment letter, employers are facing quite a challenge trying to implement this seemingly simple new requirement. Broad and Immediate Impact of Rules/Required Systems Changes One reason for this challenge is because, even though only a small percentage of the employee population will actually be impacted by the rules, employers must nevertheless make changes to their payroll practices that are applied across the entire employee population in order to ensure compliance for that small segment of the population whose supplemental wage payments will exceed $1 million in a given year. A second reason for the significant challenge is that prior to the passage of the JOBS Act, a fair number of employers used the aggregate withholding method

2 and, thus, did not distinguish between regular and supplemental wages that were paid to their employees. That certainly isn t to say that all employers relied on the aggregate withholding method and, thus, did not separately identify supplemental wage payments. Some employers did elect to use the flat withholding method for certain supplemental payments. However, it was not a common exercise to assign a classification (e.g., either regular wages or supplemental wages) to each and every type of payment an employer paid to its employees. Under the new rules, however, this is precisely what employers must do. Unfortunately, the distinction between regular wage payments and supplemental wage payments is not always clear, and employers would benefit from additional guidance in this area, especially with respect to different types of payments made to retirees. Even with respect to those types of payments that some employers may have identified as supplemental wage payments, such as bonus payments, employers never have been faced with the need to track, on an aggregate basis, the amount of supplemental wages paid to each employee over the course of a year. However, that s exactly what employers are now faced with doing as a result of the new rules. Unfortunately, employers currently do not have processes, methodologies or systems in place to do this. The matter is further complicated by the fact that employers cannot simply develop a method to track all supplemental wages paid to their employees from various sources and aggregate such amounts as of a single point in time (e.g., at the end of the year) because the new rules require the mandatory 35% withholding rate as soon as an employee exceeds the $1 million threshold. Page 2 of 7

3 Currently, there is no systematic way for employers to identify and track, on a real-time basis, the amount of supplemental wages that have been paid to an employee as of any given point during the year. Instead, employers are using manual efforts, such as creating excel spreadsheets, as part of their reasonable, good faith efforts to attempt to comply with the new rules. As with any other manual process, this temporary solution is far from perfect and is prone to errors, especially in light of the fact that this is a new requirement upon which employers are awaiting further guidance and for which there is no past practice on which to rely. In addition to developing ways to identify and track supplemental wage payments, employers also must change their payroll systems to accommodate multiple withholding methodologies for a single payment type. In the past, the payroll system simply was programmed to withhold pursuant to a single methodology: the W-4 on file or the flat supplemental withholding rate. On a going forward basis, however, the systems must be able to accommodate two types of withholding methodologies with respect to a single payment type. In order to achieve this result today, manual intervention is needed. Control Groups and Third-Party Agents Employers are further challenged by the fact that the identification and tracking of supplemental wage payments must be carried out not only within the employer s organization itself, but also across members of the employer s control group. As a result, this means that supplemental wage payments must be tracked on a real- Page 3 of 7

4 time basis and communicated among the various members of the control group in order to ensure that the applicable amount is withheld from any given supplemental wage payment. With respect to the control group aspect, it is very common for entities within the control group to maintain multiple payroll systems, including some that are maintained by third-party vendors. Furthermore, all members of a control group do not necessarily use the same third-party vendor. Today, there is no real-time interaction among the systems of the various members of the control group and their agents. In addition to the control group issue, the proposed regulations also provide that supplemental wage payments made by a third-party vendor on behalf of an employer also must be taken into account for purposes of determining whether the employee has crossed the $1 million threshold, thereby triggering the mandatory 35% withholding rate. Historically, the functions performed by third party vendors have been independent of and outside the scope of an employer s basic payroll system. With the exception of a third party vendor that, itself, was providing payroll services, there previously was no requirement to aggregate supplemental wages paid by the vendor with amounts paid by the employer on an on-going basis throughout the year. Furthermore, there was never a need to aggregate one type of supplemental wage payment made by one vendor with a different type of supplement wage payment made by another vendor. However, if the proposed regulations are adopted as written, at a minimum, there will be a Page 4 of 7

5 need to develop and implement a systematic way for real-time communications to occur between employers and their various third party vendors. Recommendations for Relief Given the complexity of the steps that need to be taken in order to comply with the new supplemental wage withholding requirements and the fact that failure to do so may result in liability for missed withholding, as well as reporting, withholding and deposit penalties and related interest, we request that the following changes be included in the final regulations: 1. Delayed Effective Date First, we recommend that the effective date for compliance with the new rules be delayed until at least 180 days after the final regulations become effective in order to provide employers with the time to design, program, test and implement processes that are designed to comply with the new requirements. 2. Permanent Good Faith Relief Second, we recommend that permanent relief be granted from reporting and withholding penalties and interest if employers (or third-party agents) make reasonable good faith efforts to comply with the new rules. 3. Safe Harbor Approaches Third, we recommend that employers and other payors be provided with safe harbor approaches that they may elect to rely upon, in their discretion, in order to comply with the new supplemental wage withholding requirements. Specifically, we recommend that the following alternative safe harbors be included in final regulations: Page 5 of 7

6 Count Regular Wages Toward $1 Million Threshold By allowing the 35% withholding rate to be applied to all supplemental wage payments after an employee s total wages (both regular and supplemental) exceed the $1 million threshold, some administrative burdens of identifying and tracking all supplemental wage payments would be alleviated and such treatment would be consistent with the legislative history indicating that the mandatory withholding requirement is intended to more closely align the amount that s withheld with the individual s overall applicable tax rate. Lookback/Single Payment Approach Under this approach, it would be permissible for the 35% rate to be applied to 1) all supplemental wage payments paid to an employee whose total W-2 compensation for the prior year exceeded $1 million and 2) any single supplemental wage payment to any other employee that exceeds $1 million. This safe harbor approach would alleviate the need to aggregate supplemental wage payments, on a real time basis, throughout the year. In addition, this safe harbor would provide an approach similar to that which is used in determining who is a highly compensated employee for qualified plan and other employee benefit purposes. Separate $1 Million Threshold for Third-Party Agents Under this approach, it would be permissible for third party agents to withhold at the 35% rate based only on the supplemental wage payments made by the third party agent that exceed the $1 million threshold without taking into Page 6 of 7

7 account any other supplemental wage payments made by other third party agents or the employer. This approach would alleviate the need to track and communicate, on a real-time basis, the aggregate amount of supplemental wages that have been paid to an employee at any given time throughout the year between the employer and its various third party agents. Partial Payments The last safe harbor approach that we recommend is to allow employers and third party agents to apply the 35% withholding rate only to full payments after the employee has reached or exceeded the $1 million threshold. This approach would alleviate the difficulty of programming systems to apply two withholding methodologies to a single payment type. In closing, employers are facing considerable challenges and difficulties as they try to implement the new supplemental wage withholding requirements. We thank you for listening to our concerns today and hope you will consider the safe harbors that we have suggested in an attempt to provide practical solutions while still maintaining the intent of the legislation. I would be happy to try to answer any questions that you may have. Page 7 of 7