INCOME TAX WITHHOLDING Payroll Accounting 2009

Payroll Accounting 2009
Bernard J. Bieg and Judith A. Toland
Developed by Lisa Swallow, CPA CMA MS
Coverage Under Federal Income Tax
(FIT) Withholding Laws
 EE-ER relationship must exist
 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 wages
 Bonuses
 Taxable fringe
 Tips
 Cash awards
Noncash fringe benefits treated as compensation
ER must withhold FIT unless specifically excluded
 Examples 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 4-1 (page 4-3)
Specifically excluded fringe benefits include
De minimis and working condition fringe
 Reduced tuition, qualified transportation fringes, meals & lodging
if for ER benefit
 Complete list found on page 4-6
Value and withhold like supplemental wages
(flat 25%)
ER must figure value of fringe benefits no later than
Also a special period rule that uses 10/31 as cutoff
Value and add to regular pay - treat as one
paycheck and withhold accordingly
Flexible reporting - can add $500 on 4 paychecks or
entire $2,000 with one paycheck and withhold, for
Employee must report tips to ER by 10th of
each month
 Employer must withhold FIT and FICA
based on this information (called “reported
 Employer is not required to withhold on
allocated tips (see chapter 3) - only reported tips
Tip allocation can be done one of three methods
What if taxes withheld > hourly wages to
be paid?
For example blackjack dealer reported tips = $2,000
for one week; her FIT/FICA withholding will
exceed her paycheck
 EE gets no paycheck and pays quarterly estimated
tax payments
 Can pay balance of tax with 1040 tax return
Travel reimbursements but only if made
under an “accountable plan”
An accountable plan is an IRS-approved plan
 If there is not a plan in place, travel
reimbursements are made under a non-accountable
plan and considered wages
 Therefore ER must withhold 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
Qualified moving expense reimbursements
See page 4-6 for comprehensive list of exemptions
Contribution to flex plans or cafeteria plans
(known as Section 125 plans)
These are salary reductions whereby EE 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
Health Savings Accounts (HSA)
If EE has high-deductible health insurance, can
contribute annually to an HSA pretax to meet out of
pocket medical bills
Archer Medical Savings Accounts apply to small
employers (50 or fewer employees)
Contributions to tax-deferred retirement accounts
Types of retirement plans
401(k), 403(b), 457 or SIMPLE plans
Contributions are made pretax for FIT purposes
However, ER must still withhold and match FICA
Additional ‘make up amounts’ allowed to be
contributed if over 50 years old
Individual Retirement Accounts [IRAs]
For certain taxpayers, the lesser of $5000 or 100% of
earned income may be contributed pretax to a
retirement account
Conditions must be met for deductibility
Roth IRAs accommodate nondeductible contributions
 Best
for EE if FIT withholding = tax liability
(goal is no refund and no tax due)
 Employee completes W-4 S
See Figure 4-3
 Employee’s Withholding Allowance Certificate
 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
Choose “Single” or “Married” or “Married, but
withhold at higher single rate” box
Why would an EE choose the option listed above? (line 3)
 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 $900 (including more than $300 unearned
Some individuals are automatically exempt
*Note: Never advise employee as to how many allowances to claim
 If
EE doesn’t provide a completed W-4, ER
withholds as if single and 0 (highest rate)
 EE can change W-4
 When
ER receives amended W-4, has 30 days to change
 EE must change within 10 days for decrease in # of
 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
Employers are not required to verify
 If form is altered, ER cannot accept invalid
 Can
then ask for new W-4 to be submitted
 Or, if a new hire, withhold at “single and 0” rates
Pensions (W-4P) in excess of $19,000 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
(W-4V) – this request is voluntary
 Use
either wage-bracket method (easiest)
 Percentage method (only use if one of the following
 Highly
compensated or
 10+ allowances or
 Compensated annually, semiannually or daily
 Need to know
 Single/married
 How often paid
 Gross pay
 Number of allowances
 Or
can use quarterly averaging, annualizing wages
or part-year employment method (rarely used)
FACTS: Annual salary is $40,144 - paid weekly –
Married 4 - what is FIT withholding?
Weekly gross $40,144/52 = $772.00
 Can use wage bracket tables to look up
married, weekly and 4 allowances
 FIT withholding = $38
FACTS: Annual salary is $84,400 – paid
semimonthly – Married 1 - what is FIT
Semimonthly gross is $84,400/24 =
 Must use percentage method
 To Do:
Subtract (# of allowances x amount for each
allowance) from gross:
 $3,516.67 - (1 x $145.83) = $3,370.84
 FIT equals $368.55 + (.25)($3,370.84 – 3,006.00) =
FACTS: Monthly salary is $3,000 - paid
semimonthly – Single 2 - what is FIT withholding?
Annualize salary $3,000 x 12 = $36,000
 Semimonthly gross $36,000/24 = $1,500
 Can use wage bracket tables to look up
single, semimonthly and 2 allowances
 FIT withholding = $150
FACTS: Annual salary is $336,000 - paid monthly Single 2 - what is FIT withholding?
Monthly gross is $336,000/12 = $28,000
 Must use percentage method
 To Do:
 Subtract (# of allowances x amount for each
allowance) from gross:
 $28,000 - (2 x 291.67) = $27,416.66
 FIT equals $3735.45 + (.33)(27,416.66 -17,308.00) =
FACTS: Annual salary is $485,000 - paid
semimonthly - Married 4 - what is FIT
Semimonthly gross is $485,000/24 = $20,208.33
 Must use percentage method
 To Do:
 Subtract (# of allowances x amount for each
allowance) from gross:
 20,208.33 - (4 x 145.83) = $19,625.01
 FIT equals $4,032.32 + (.35)(19,625.01 – 15,213.00)
= $5,576.52
Examples include:
 Vacation
Pay (treated differently than other
supplemental wages)
 Severance pay, bonuses and commissions
 Exercised nonqualified stock options
 Retroactive increases
 How to withhold
 With
regular pay (treat as one paycheck and
withhold accordingly)
 Paid Separately
 Method
A – Add supplemental and regular wages from
recent payroll. Calculate FIT and then subtract tax
withheld from regular wages.
 Method B - 25% flat supplemental withholding (35% for
amounts in excess of $1,000,000)
If want to give $700 bonus check (net), employer
must ‘gross up’ this amount
Divide net check by total of [1.00 – tax rates]
= .25
 OASDI = .062
 HI
= .0145
 $700/[1.0
– (.25 + .062 + .0145)] = $1039.35 grossed up
bonus less taxes = $700 net bonus
Note: in many states there is a required withholding
rate for state income tax!
Earned income credit [EIC] is intended to offset
living expenses for eligible employees
To get advanced EIC on each paycheck, file
Form W-5
Can only get advanced earned income credit if have at least
one qualifying child
 Can get up to $4,824/year with 2 qualifying children
Advanced EIC does not change amount
employers must withhold from wages
Sometimes EIC payments exceeds withheld taxes –
employer can handle one of two ways
 Reduce
each advance EIC payment proportionately or
 Fully pay and treat as advance payment of company’s
employment payroll taxes
EE may only have one certificate on file at a time
If married, both spouses can have certificate
 Have to file a new certificate each year
 Have to revoke in 10 days if ineligible
On Form 941 advanced EIC shows up as a reduction from
total taxes to calculate net taxes due for quarter
Advanced EIC is treated as having been paid to the IRS
 Form
 Hard
copy to EE by 1/31
 Can post on secure web site so EE can access individual
 Send to SSA by 2/28
 If issuing 250+ W-2s must use magnetic media and have
until 3/31 to electronically file
 Can request extension of time via FIRE at
 W-3
is transmittal form
 941s must tie to W-3
 Various penalties for filing incorrect or late W-2s
 W-2c and W-3c (if correcting)
 Employers
must file information returns for
compensation paid to independent contractors (IC)
 1099-MISC with 1096 as transmittal
See Figure 4-16 (page 4-33)
 Must issue to IC paid over $600 that aren’t incorporated
 Backup
 IC
must submit taxpayer identification number (TIN) on
 If W-9 not on file, hiring agent must withhold federal
income tax = 28% of payments made
In states with state income tax and localities with
local income tax, generally the payroll department
File periodic withholding returns - report wages and
Prepare reconciliation returns – compare deposits to
File annual statements – annual wages paid and state tax
Issue information returns – used to report payments to
individuals not subject to withholding
Three different methods of withholding
*Note: all but nine states have a state income tax