Payroll Accounting 2012
Bernard J. Bieg and Judith A. Toland
CHAPTER 4
INCOME TAX WITHHOLDING
Developed by Lisa Swallow, CPA CMA MS
Learning Objectives
 Explain
coverage under the Federal Income Tax (FIT)
Withholding Law
 Explain types of withholding allowances that may be
claimed and purpose/use of Form W-4
 Compute amount of FIT withheld using various
methods
 Explain completion of many quarterly and year-end
information returns and impact of state/local income
taxes on payroll accounting process
Coverage Under FIT Withholding Laws

Employee-employer relationship must exist for FIT
withholding to apply
See Chapter 3 for how to determine status
 Statutory nonemployees (direct sellers and qualified real estate
agents) have no federal taxes withheld


Taxable wages for FIT withholding purposes
Wages/Salaries
 Vacation
 Supplemental payments
 Bonuses/Commissions
 Taxable fringe benefits (see next slide)
 Tips
 Cash awards

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Fringe Benefits

Noncash fringe benefits treated as compensation
 Employer must withhold FIT unless specifically excluded

Examples of noncash fringe include
Tickets to athletic events
 Athletic club membership
 Personal use of corporate car
 Frequent flier miles
 Stock options (when option exercised)
 Complete list found in Figure 4-2 (page 4-6)

 Specifically excluded fringe benefits include
 Qualified employee discounts
 Reduced tuition, meals & lodging if for employer benefit
 Complete list found on page 4-4
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How to Withhold FIT on Fringe Benefits

Value and withhold like supplemental wages (flat
25%)
 Employer
must figure value of fringe benefits no later than
1/31

Value and add to regular pay - treat as one paycheck
and withhold accordingly
 Flexible
reporting – option of treating benefits as being paid on
any basis.
 For example, can add $500 on 4 paychecks or entire $2,000
with one paycheck and calculate withholding accordingly.
Note: Employer can choose not to withhold FIT
on employee’s personal use of corporate car
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FIT Withholding on Tips
 Employee
must report tips to employer by 10th
of each month
 Employer must withhold FIT and FICA based on
this information (called “reported tips”)
 Employer is not required to withhold on
allocated tips - only reported tips
 Tip
allocation can be done one of three methods –
hours worked, gross receipts or good faith agreement
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FIT Withholding on Tips
 What
if taxes withheld > hourly wages to be
paid?
 For
example blackjack dealer in Lake Tahoe reports tips =
$2,000 for one week; her FIT/FICA withholding will
exceed her paycheck
 In that situation, she gets no paycheck and pays quarterly
estimated tax payments
or
 Can pay balance of tax when she files1040 tax return
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Traveling Expenses
 Travel
reimbursements made to an employee,
paid under an “accountable plan”, are not
subject to FIT withholding
 An
accountable plan is an IRS-approved plan (must meet
three rules)
 If there is not a plan in place, travel reimbursements are
made under a non-accountable plan and considered
wages
 Therefore
employer must withhold FIT
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What is Exempt from FIT
 Law
excludes certain payments including
 Ministers’
wages/salaries
 Advances
 Educational assistance
 If maintains/improves job status
 $5,250 per year of employer provided assistance for undergraduate or
graduate is tax-free (also applies to down-sized employees)
 Qualified
moving expense reimbursements
 Transportation in a commuter highway vehicle/transit pass
up to $230/month value
See page 4-6 for comprehensive list of exempt payments
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Pretax Salary Reductions are
Exempt from FIT
 Contribution



Employee can choose between cash (pay) or qualified (nontaxable)
benefits (list on page 4-7)
Contribution to Flexible-Spending Accounts

The employee puts pretax dollars into a trust account to be used
for health care, certain insurance premiums and dependent care

These dollars do not have FIT or FICA withheld on them

Forfeited if not used!!
Health Savings Accounts (HSA)


to cafeteria plans
If employee has high-deductible health insurance, can contribute
annually to an HSA to meet out of pocket medical bills
Archer Medical Savings Accounts

For small employers that have high-deductible insurance plans
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Tax-Deferred Retirement
Contributions Exempt from FIT

Contributions to tax-deferred retirement accounts

Types of retirement plans
401(k), 403(b), 457(b) or SIMPLE plans
 Contributions are made pretax for FIT purposes
 However, employer must still withhold and match FICA
 Additional “make up amounts” allowed to be contributed if age 50 or
older (see page 4-9 for annual contribution amounts)


Individual Retirement Accounts (IRA)

For certain taxpayers, the lesser of $5,000 or 100% of earned
income may be contributed pretax to a retirement account
Conditions must be met for deductibility
 $6,000 annual contribution allowed if age 50 or older


Roth IRAs are used for nondeductible contributions
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How Does Employer Know
Amount to Withhold for FIT?
 Best

for employee if FIT withholding = tax liability
Goal is no refund and no tax due
 Employee
completes W-4
See W-4 (Employee’s Withholding Allowance Certificate) in Figure
4-3 on page 4-11
 Identify number of withholding allowances

One allowance for self (if not claimed by other person)
 One for each dependent
 Special allowances such as itemized deductions, other compensation,
tax credits, etc. - use worksheet on back of W-4 to calculate

See IRS Publication 919 How Do I Adjust My Tax Withholding
if an employee needs to calculate his/her FIT withholding
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Completing Form W-4

Choose “Single” or “Married” or “Married, but withhold at higher
single rate” box
Q: Why would an EE choose the last option listed above? (line 3)
 A: Because possibly other sources of taxable income


Exempt status
Can claim if taxpayer had no income tax liability last year and none
expected this year (line 7)
 Valid for one year and must be reclaimed each year
 Can’t claim exempt if:

Dependent on someone else’s tax return and
 Income exceeds $950 (including more than $300 unearned income)


Some individuals are automatically exempt
Note: Never advise employee as to how
many allowances to claim
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Other Situations on W-4
 If
employee doesn’t provide a completed W-4, employer must withhold as
if single and zero allowances (highest rate)
 Employee can change W-4
 When employer receives amended W-4, has 30 days to change
 Employee must change within 10 days for decrease in # of allowances
 Lose
child as an allowance (custody)
 Become single
 If
there’s an increase in # of allowances, can change or leave in effect
 Unauthorized changes/additions invalidate W-4
 Employer can establish electronic W-4 system, but must provide paper
option if employee requests
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FIT Withholding on Other
Income Sources
 Pensions
(W-4P) in excess of $19,200 per year
 Withhold
as if married with 3 allowances unless
complete W-4P to change amount of tax withholding
 Third
party payer of sick pay (W-4S)
 Government payments such as Social Security
by completing a W-4V
 This
request is voluntary
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Employer Calculates FIT Withholding
 Use
either wage-bracket method (easiest)
or
 Percentage method (only use if one of the following
situations apply)
 Highly
compensated individual
 Compensated annually or semiannually y
 Need
to know
 Single/married, how
often paid, gross pay and # of allowances
Note: also other methods, rarely used,
for withholding (see page 4-18)
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Example #1
Calculating FIT Withholding
FACTS: Noni’s annual salary is $40,144 – she is
paid biweekly and her W-4 shows “Married with
4”. What is her FIT withholding?
 Biweekly
gross $40,144/26 = $1,544.00
 Can use wage bracket tables to look up married,
biweekly and 4 allowances
 FIT withholding = $69
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Example #2
Calculating FIT Withholding
FACTS: John earns an annual salary of $84,400 and
is paid biweekly. His W-4 shows “Married with 1”.
What is his FIT withholding?
 Biweekly
gross is $84,400/26 = $3,246.15
 Must use percentage method
 To Do:
 Subtract
amount of allowances* (biweekly allowance for1) from
gross
 $3,246.15 - $142.31 = $3,103.84
 FIT equals $365.40 + (.25)($3,103.84 – $2,958.00) = $401.86
*From 2011 Table of Allowances found in Appendix
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Example #3
Calculating FIT Withholding
FACTS: Maggie earns an annual salary of
$336,000 and is paid monthly. Her W-4 shows
“Married with 2” . What is FIT withholding?
Monthly gross is $336,000/12 = $28,000
 Must use percentage method
 To Do:

 Subtract
amount of allowances (monthly allowance for 2)
from gross
 $28,000 - ($308.33 x 2) = $27,383.34
 FIT equals $3,959.52 + (.33)($27,383. 34 - $18,350.00) =
$6,940.52
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Example #4
Calculating FIT Withholding
FACTS: Belinda earns a monthly salary of $3,000
and is paid biweekly. Her W-4 says “Single with 2”.
What is her FIT withholding?
 Annualize
salary $3,000 x 12 = $36,000
 Biweekly gross $36,000/26 = $1,384.62
 Can use wage bracket tables to look up single,
biweekly and 2 allowances
 FIT withholding = $137
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Example #5
Calculating FIT Withholding
FACTS: Ferhart’s annual salary is $485,000 – he is
paid semimonthly. His W-4 says “Married with 4”.
What is his FIT withholding?
 Semimonthly
gross is $485,000/24 = $20,208.33
 Must use percentage method
 To Do:
 Subtract
amount of allowance (semimonthly allowance for 4)
from gross
 $20,208.33 – ($154.17 x 4) = $19,591.65
 FIT equals $4,273.91 + (.35)($19,591.65 – $16,127.00) =
$5,486.54
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Supplemental Wages
Withholding
 Examples
include
 Vacation
pay (treated differently than other
supplemental wages)
 Severance pay, bonuses and commissions
 Exercised nonqualified stock options

How to withhold
 With
regular pay (treat as one paycheck and withhold
accordingly) or
 Paid Separately
 Method A
– Add supplemental and regular wages from recent
payroll; calculate FIT as if it were single regular payroll payment
 Method
B - 25% flat supplemental withholding (35% for amounts in
excess of $1,000,000)
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Gross-Up Supplemental Wages



If want to distribute intended amount of supplemental check,
must “gross up” this amount
For example, an employer wants her employee to receive a
$700 bonus check (net)
To do: Divide desired net check by total of [1.00 – tax rates]
 FIT
tax rate
 OASDI tax rate
 HI tax rate
= .25
= .062
= .0145
 $700/[1.00
– (.25 + .062 + .0145)] = $1,039.35 grossed up bonus
 Then subtract taxes to get $700 desired net bonus
Note: in many states there is a required
withholding rate for state income tax!
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Wages and Tax Statement (W-2)
 Form W-2
informs employees of wages and withholding
taxes
 Hard
copy to employee on or before 1/31
or
 Can post on secure web site so employee can access individual W-2
 If issuing 250+ W-2s must use magnetic media - have until 3/31 to
electronically file
 Can request extension of time via FIRE at http://fire.irs.gov
 W-3
is transmittal form and 941s must tie to W-3
 Various penalties for filing incorrect or late W-2s
 Must file W-2c and W-3c (if correcting)
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Returns – Quarterly &
Informational
Quarterly
reports of taxable wages required (see Figure
4-11 on page 4-29 for major returns that must be
completed)
Employers must file information returns for
compensation paid to independent contractors (IC)
1099-MISC with 1096 as transmittal
 See
Figure 4-13 on page 4-31
 Must issue to IC if paid at least $600 and aren’t incorporated
IC
must submit taxpayer identification number (TIN) on
W-9 to hiring agent
 If TIN
not supplied orally, in writing or on W-9, then must
withhold federal income tax = 28% of payments made LO-4
Withholding State & Local
Income Taxes

In states with state income tax (SIT) and localities with
local income tax, generally the payroll department must
 File
periodic withholding returns to report wages and withholding
 Prepare reconciliation returns to compare deposits to
withholdings
 File annual statements to report annual wages paid and applicable
taxes/fees withheld
 Issue information returns to report payments to individuals not
subject to withholding

Three different methods of withholding SIT – full
taxation, left over taxation and reciprocity
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