Payroll Accounting 2013
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 critical 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
laws to apply
•
•
•
See Chapter 3 for guidance on determining status
Statutory nonemployees (direct sellers and qualified real estate agents)
have no federal taxes withheld
Taxable wages for FIT withholding purposes – gross amount of
following items are taxable
•
•
•
•
•
•
•
•
Wages/Salaries
Vacation pay
Supplemental payments
Bonuses/Commissions
Taxable fringe benefits (see next slide)
Tips
Cash awards
See Figure 4-1 on page 4-3 for other types of taxable payments
LO-1
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
De minimis fringe benefits (like personal use of corporate cell phone)
Complete list found on page 4-4 or consult Circular E, Employer’s Tax Guide
LO-1
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
(except if use special period rule)
• Value and add to regular pay - treat as one paycheck and
withhold accordingly
•
•
Flexible reporting – option of treating benefits as being paid on one or more
dates in the same calendar year, even if benefit received at one time
For example, can add entire $2,000 value of country club
membership or add $500 on each of 4 paychecks – then calculate
withholding accordingly
Note: Employer can choose not to withhold FIT
on employee’s personal use of corporate car
LO-1
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
LO-1
FIT Withholding on Tips
What if taxes withheld > hourly wages to be paid?
•
•
•
•
For example blackjack dealer in South Lake Tahoe reports tips =
$2,000 for one week; her FIT/FICA withholding will exceed
her gross 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
LO-1
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
•
•
•
•
Business connected
Adequate accounting within reasonable time period
Employee returns advanced cash in excess of substantiated
expenses
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
LO-1
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 taxfree (also applies to down-sized employees)
Qualified moving expense reimbursements
Transportation in a commuter highway vehicle/transit pass up to
$125/month value
See Figure 4-2 on page 4-6 for comprehensive list of exempt payments
LO-1
Pretax Salary Reductions are Exempt
from FIT
• Contribution to cafeteria plans
•
Employee can choose between cash (pay) or qualified (nontaxable) benefits
(list of potential benefits found 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)
•
If employee has high-deductible health insurance, can contribute annually to
a HSA to meet out of pocket medical bills
• Archer Medical Savings Accounts
•
For small employers that have high-deductible insurance plans
LO-1
Tax-Deferred Retirement Contributions
Exempt from FIT
•
Contributions to tax-deferred retirement accounts are monies set aside
from current paychecks that will be paid out to employee upon retirement
•
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)
•
In 2013, depending upon certain conditions, an employee can contribute lesser of
$5,000 or 100% of earned income pretax to a retirement account
•
•
If made through payroll deductions, generally employer does not need to comply with
ERISA
Roth IRAs are used for nondeductible contributions
LO-1
Problems
 4 – 1 A, 4 – 7 A,
4 – 11 A
How Much 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 (page 4-11)
•
The W-4 identifies number of withholding allowances; employee can take:
•
One allowance for self (if not claimed by other person) and one allowance for
each dependent
•
Special allowances such as itemized deductions, other compensation, tax
credits, etc. - use worksheet on back of W-4 to calculate
Employer must retain W-4 as long as its in effect and for four years
thereafter
See IRS Publication 919 How Do I Adjust My Tax Withholding
if an employee needs to calculate his/her FIT withholding
www.irs.gov/pub/irs-pdf/p919.pdf
LO-2
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
LO-2
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
•
•
•
•
•
Additional/voluntary withholding agreements
•
•
•
•
•
When employer receives amended W-4, has 30 days to change
Employee must change within 10 days for decrease in # of allowances
If there’s an increase in # of allowances, can change or leave in effect
Can effect additional FIT withholding by either reducing number of withholding
allowances or request specific additional amount be withheld on line 6
Employer can establish electronic W-4 system, but must provide paper option if
employee requests
Unauthorized changes/additions invalidate W-4
Employers should submit W-4s to IRS only when requested; penalties imposed for
willfully filing false Form W-4s
LO-2
FIT Withholding on Other
Income Sources
Pensions (W-4P) in excess of $19,680 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
benefits, by completing a W-4V
•
•
This request is voluntary
LO-2
Employer Calculates FIT Withholding
Textbook used 2012 tax tables for FIT rates
• 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
Need to know
•
•
Single/married, how often paid, gross pay and # of allowances
Note: also other methods, rarely used,
for withholding (see pages 4-17 - 4-18)
LO-3
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 = $65
LO-3
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
Steps to percentage method:
Subtract allowance amount * (biweekly allowance for1) from gross
$3,246.15 - $146.15* = $3,100.00
FIT equals $374.40 + (.25)($3,100.00 - $3,031.00) = $391.65
*From Table of Allowances found in Appendix
LO-3
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
Steps:
Subtract allowance amount (monthly allowance for 2) from gross
$28,000 - $633.34 = $27,366.66
FIT equals $4055.42 + (.33)($27,366.66 - $18,796.00) =
$6,883.74
LO-3
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 = $136
LO-3
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
Steps:
Subtract allowance amounts (semimonthly allowance for 4) from gross
$20,208.33 – $633.32 = $19,575.01
FIT equals $4,377.63 + (.35)($19,575.01 - $16,519.00) = $5,447.23
LO-3
Supplemental Wages Withholding
• Examples include
•
•
•
Vacation pay (treated differently than other supplemental wages)
Severance pay, bonuses and commissions
How to withhold
•
With regular pay (treat as one paycheck and withhold accordingly)
•
•
Except if amount indicated separately (then use flat rates – see below)
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)
LO-3
Gross-Up Supplemental Wages
If want to give an employee the intended amount of supplemental
check, must “gross up” this amount
• For example, an employer wants Dov, an employee, to receive a $700
net bonus check
• To do: Must divide desired net check by [1.00 – tax rates]
•
•
•
•
•
•
FIT tax rate
OASDI tax rate
HI tax rate
= .25
= .042
= .0145
$700/[1.00 – (.25 + .042 + .0145)] = $1,009.37 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!
LO-3
Problem
 4 – 3A, 4 – 4 A, 4 – 8 A , 4 – 9 A, 4 – 10 A
Wages and Tax Statement (W-2)
Employers required to furnish Form W-2 to employees (and also
must send copies to federal and state/local governments
•
•
•
•
•
•
•
•
•
•
Reports wages and withholding taxes
Instructions for completing in Figure 4-8 (pages 4-22 and 4-23)
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 and have until 3/31
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)
LO-4
Returns – Quarterly & Informational
Quarterly reports of taxable wages required (see Figure 4-11
(pages 4-27 and 4-28) for major required returns)
•
Payroll income tax withholdings reported on Form 941
•
Employers must file information returns for compensation
paid to independent contractors (IC)
•
1099-MISC with 1096 as transmittal - See Figure 4-13 (page 4-29)
•
•
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 this is not done, then hiring agent must withhold federal income tax =
28% of payments made
Nonpayroll items (like withholding on independent contractors, pensions,
IRAs, etc. ) reported on Form 945
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
withheld
Issue information returns to report payments to individuals not subject
to withholding
• Three different methods of withholding SIT – full taxation,
leftover taxation and reciprocity
•
Most states require employers to withhold tax from both nonresidents
and residents, unless a reciprocal agreement is in place
LO-4
Problems
 4 – 12 A, 4 – 13 A