1285862074_437508

Bernard J. Bieg and Judith A. Toland

PAYROLL

ACCOUNTING 2015

© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Income Tax Withholding

Chapter 4


Learning Objectives

1.

2.

Explain coverage under the Federal Income

Tax (FIT) Withholding Law by determining:

(a) the employer-employee relationship, (b) the kinds of payments defined as wages, and (c) the kinds of pretax salary reductions.

Explain: (a) the types of withholding allowances that may be claimed by employees for income tax withholding and

(b) the purpose and use of Form W-4


Learning Objectives (cont.)

3.

4.

Compute the amount of federal income tax to be withheld using: (a) the percentage method; (b) the wage-bracket method; (c) alternative methods such as quarterly averaging, annualizing of wages, and part-year employment; and (d) withholding of federal income taxes on supplementary wage payments.

Explain: (a) Form W-2, (b) the completion of

Form 941, Employer’s Quarterly Federal

Tax Return, (c) major types of information returns, and (d) the impact of state and local income taxes on the 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

LO-1


Coverage Under FIT

Withholding Laws (cont.)



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)

LO-1


Coverage Under FIT

Withholding Laws (cont.)

◦ Tips

◦ Cash awards

◦ See Figure 4.1 (page 4-3) for other types of taxable payments

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Figure 4.1

Taxable Payment to Employees

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Figure 4.1(cont.)

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


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

LO-1


Cafeteria Plans, Potential

Benefits

LO-1


Pretax Salary Reductions are

Exempt from FIT (cont.)





◦ 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 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 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)

LO-1


Tax Deferred Retirement

Accounts

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Tax-Deferred Retirement Contributions

Exempt from FIT (cont.)



Individual Retirement Accounts (IRA)

◦ In 2014, depending upon certain conditions, an employee can contribute lesser of $5,500 or 100% of earned income pretax to a retirement account

 If made through payroll deductions, generally employer does not need to comply with ERISA as long as certain guidelines are met

◦ Roth IRAs are used for nondeductible contributions

LO-1


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 of Form W-4)

LO-2


Completing Form W-4 (cont.)

Line 3

LO-2





Exempt status

◦ Can claim if taxpayer had no income tax liability last year and none expected this year

(line 7 of Form W-4)

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Line 7

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◦ 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 $1,000 (including more than $350 unearned income)

 Or if unearned income < $350, but total income

>$6,200

◦ Some individuals are automatically exempt

Note: Never advise employee as to how many allowances to claim

LO-2


Employer Calculates FIT

Withholding

◦ Textbook used 2014 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

LO-3


Example #1

Calculating FIT Withholding

FACTS: Noni’s annual salary is $62,400 – she is paid biweekly and her W-4 shows

“Married with 4.” What is her FIT withholding?





Biweekly gross $62,400/26 = $2,400.00

Can use wage bracket tables to look up married, biweekly and 4 allowances



FIT withholding = $187*

*remember to select “At least 2,400 But less than 2,420”

LO-3


Example #2

Calculating FIT Withholding

FACTS: John earns an annual salary of $144,400 and is paid biweekly. His W-4 shows “Married with

3.” What is his FIT withholding?





Biweekly gross is $144,400/26 = $5,553.85

Must use percentage method



Steps to percentage method:

◦ Subtract allowance amount * (biweekly allowance for

3) from gross

 $5,553.85 – (3 x $151.90)* = $5,098.15

◦ FIT equals $390.80 + (.25)($5,098.15 - $3,163.00) =

$874.59

*From Table of Allowances found in Appendix

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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

LO-3


Gross-Up Supplemental Wages

(cont.)



To do: Must divide desired net check by

[1.00 – tax rates]

 FIT tax rate = 0.25

 OASDI tax rate = 0.062

 HI tax rate = 0.0145

 $700/[1.00 – (0.25 + 0.062 + 0.0145)] = $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!

LO-3


Returns – Quarterly &

Informational

◦ Quarterly reports of taxable wages required

(see Figure 4.11 and 4.12, pages 4-27 and 4-28 for major required returns)

 Payroll income tax withholdings reported on Form

941

◦ Employers must file information returns to report tax liability for nonpayroll items such as backup withholding * and withholding on gambling winnings, pensions, and annuities

Form 945

* Individual receives interest, dividends and certain other payments and fails to provide correct taxpayer identification number.

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Figure 4.11

Major Returns Filed by Employers

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Figure 4.12

Major Information Returns

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Returns – Quarterly &

Informational (cont.)

 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

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Figure 4.13

Form 1099-MISC

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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

LO-4


Withholding State & Local

Income Taxes (cont.)



◦ 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


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