Treasury Clarifies ARPA Tax Withholdings, Reporting

The U.S. Department of the Treasury released additional clarification Wednesday evening on how cities and individuals should handle premium pay and other American Rescue Plan Act (ARPA) provisions to meet income tax reporting requirements. Employees must pay taxes on premium pay, although support payments authorized through ARPA do not qualify as taxable.

Many Kentucky city officials have discussed providing premium pay – either in lump-sum payments for past work or on a going-forward basis for future work – for their employees who perform essential work. Treasury defines essential work as involving regular physical interaction with coworkers or the public or the regular handling of items also handled by coworkers or the public. Employees would not qualify for premium pay for any amount of time spent teleworking.

Cities can provide premium pay up to $13 per hour, not to exceed a total of $25,000 for an employee. Because premium pay correlates with hours worked, employees must report the pay as taxable income, and cities must withhold from employees’ wages all required federal taxes, including income, Social Security, Medicare, and possibly unemployment. Although Congress approved ARPA in response to the COVID-19 pandemic, Treasury has determined that premium pay represents compensation for services. As a result, the pay is fully taxable.

The taxability issue makes it more challenging for employers to calculate back pay. Kentucky cities cannot provide bonuses to their employees; however, employees will likely view lump-sum payments associated with back pay as a de facto bonus. City officials must associate an hourly rate of pay, determine a period of work (e.g., work performed on or after July 1, 2021), recalculate any overtime worked, and adjust withholdings based on taxes and pay-related benefits.

KLC staff recommends setting an hourly rate of pay with an overall cap. For example, a city could approve premium pay for eligible workers who performed essential work at an hourly rate of $3 per hour not to exceed $2,000 total. Because the city must apply taxes and other withholdings, each employee may receive a different net amount.

Treasury also clarified that payments to cover utility bills, account arrearages, or childcare costs do not qualify as taxable income, so no Internal Revenue Service (IRS) forms are required. Treasury views these items as qualified disaster relief, which the IRS Code exempts from taxation. Cities would not report these relief payments as income through Form 1099-MISC for the taxpayer.

Go here to read more about providing premium pay in Kentucky cities.

Go here to review Treasury’s new taxability and reporting questions.