June 4, 2015

Apply the Four-Year Rule Before Discarding Old Payroll Records

By Iguehi Rajsky, Senior, Tax & Business Services

Apply the Four-Year Rule Before Discarding Old Payroll Records

The rule of record retention, including record type and duration, is one that every business should adhere to. It is not unheard of for businesses to face steep penalties from regulatory bodies, including the IRS, when unable to produce requested records that should have been kept for a mandatory period. In a joint publication of the Social Security Administration and the IRS, the issue of old employer payroll files retention and the application of the four-year retention rule are addressed.

The four-year rule should be applied to the following record types:

  • Records relating to Income, Social Security, and Medicare Taxes:
    1. This applies to employers that withhold and pay federal income, Social Security, and Medicare taxes. The records must be kept for at least four years after the due date of the employee's personal income tax return for the year the payment was made.
    2. The records should include:
        • All the information contained on the standard employee W-2.
        • The pay period covered by each payroll disbursement.
        • The employee's Form W-4.
        • The employee's beginning and ending dates of employment.
        • Employee statements reporting tips received.
        • Records and substantiation of fringe benefits provided to the employee.
        • Adjustments or settlements of taxes.
        • Amounts and dates of tax deposits.
    3. The four-year rule should be applied to records relating to wage continuation for an employee by the employer or third party under an accident or health plan.
    4. Employer statements to employees regarding tip allocation should be kept for at least three years after the due date of the return.
  • Claims for refund of withheld tax:
    • Records should be retained for at least four years after the filing date for a refund, credit, or abatement of withheld income and employment taxes.
  • Fringe benefit records:
    1. Employees should retain whatever records are needed to determine whether the plan meets the requirements for exclusion from income.
    2. Although the Internal Revenue Code does not specify how long these types of records should be kept, in compliance with the general rule, they should be kept for four years. (However, in compliance with ERISA, they could be kept for six years).
  • Unemployment tax records:
    1. Under the “records in general” rule, unemployment tax records should be retained for four years after the later of the Form 940 due date or the date the required FUTA tax was paid.
    2. Records substantiating the following should also be retained at least that long:
      • The total amount of employee compensation paid during the calendar year.
      • The amount of compensation subject to FUTA tax.
      • State unemployment contributions made, with separate totals for amounts paid by the employer and amounts withheld from the employee.
      • All information shown on Form 940.

Employers should be reminded that record retention requirements are also set by the Federal Department of Labor and stage wage-hour unemployment insurance agencies. The inability of an employer to provide these records when requested by the IRS or in an employment-related lawsuit could lead to penalties and settlement awards.