Employer pays back taxes, employees take deduction.(Brief Article)

Under IRC Section 164(a)(3), individuals may deduct state income taxes from their federal taxable income in the year they pay those taxes (if they itemize). They pay their state tax bill on time, and take a deduction on their federal return. Fair enough.

But what happens when an individual owes back state (and federal) taxes on payments from previous years that his or her employer should have reported--and withheld on--as wages?

In a recent service center advice memorandum, the IRS explains how a company that wants to make amends for its noncompliance can cover employees' back state taxes and report the payments in such a way that employees can claim a …