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CHAPTER 4

Payroll Accounting 2010 Bernard J. Bieg and Judith A. Toland. CHAPTER 4. INCOME TAX WITHHOLDING. Developed by Lisa Swallow, CPA CMA MS. Coverage Under Federal Income Tax (FIT) Withholding Laws. EE-ER relationship must exist for FIT withholding to apply

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CHAPTER 4

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  1. Payroll Accounting 2010 Bernard J. Bieg and Judith A. Toland CHAPTER 4 INCOME TAX WITHHOLDING Developed by Lisa Swallow, CPA CMA MS

  2. Coverage Under Federal Income Tax (FIT) Withholding Laws • EE-ER 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

  3. FringeBenefits • 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 4-2 (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

  4. How to Withhold FIT on Fringe Benefits • Value and withhold like supplemental wages (flat 25%) • ER 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 for withholding purposes, for example

  5. FITWithholding on Tips • Employee must report tips to ER 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 allocatedtips - onlyreportedtips • Tip allocation can be done one of three methods

  6. FIT Withholding on Tips (continued) • 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 or • Can pay balance of tax with 1040 tax return

  7. 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 • 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

  8. 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 exemptions

  9. What is Exempt from FIT • Contribution to cafeteria plans • Employee can choose between cash (pay) or qualified (nontaxable) benefits (list on page 4-7) • Contribution to Flexible-Spending Accounts • 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 • Forfeited if not used!! • 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) and are set up with high-deductible insurance plans

  10. What is Exempt from FIT(Pretax salary reductions) • 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 age 50 or older (see page 4-9 for annual contribution amounts) • 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 • Additional contributions allowed if age 50 or older • Roth IRAs accommodate nondeductible contributions

  11. How Does an Employer Know Amount to Withhold for FIT? • Best for EE if FIT withholding = tax liability • Goal isno 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

  12. 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

  13. Other Situations on W-4 • If EE doesn’t provide a completed W-4, ER withholds as if single and zero allowances (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 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 • ER can establish electronic W-4 system but must provide paper option if employee requests this

  14. Validity of W-4 • Employers are not required to verify authenticity • If form is altered, employer cannot accept invalid form • Can then ask for new W-4 to be submitted • Or, if a new hire, withhold at single and zero withholding rates

  15. FIT Withholding on Other Income Sources • 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 by completing a W-4V • This request is voluntary

  16. 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, semiannually or daily • 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)

  17. Example #1 Calculating FIT Withholding FACTS: Annual salary is $40,144 - paid biweekly – Married 4 - what is 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 = $41

  18. Example#2 Calculating FIT Withholding FACTS: Annual salary is $84,400 – paid semimonthly – Married 1 - what is FIT withholding? • Semimonthly gross is $84,400/24 = $3,516.67 • Must use percentage method • To Do: • Subtract amount of allowances* (semimonthly/1) from gross • $3,516.67 - $152.08 = $3,364.59 • FIT equals $356.25 + (.25)($3,364.59 – $3,152.00) = $409.40 *From 2009 Table of Allowances found in Appendix

  19. Example #3 Calculating FIT Withholding FACTS: Monthly salary is $3,000 - paid biweekly – Single 2 - what is 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 = $119

  20. Example#4 Calculating FIT Withholding 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 amount of allowances (monthly/2) from gross • $28,000 - ($304.17 x 2) = $27,391.66 • FIT equals $3,479.59 + (.33)($27,391.66 -$14,467.00) = $7,744.73

  21. Example#5 Calculating FIT Withholding FACTS: Annual salary is $485,000 - paid semimonthly - Married 4 - what is FIT withholding? • Semimonthly gross is $485,000/24 = $20,208.33 • Must use percentage method • To Do: • Subtract amount of allowance (semimonthly/4) from gross • $20,208.33 – ($304.17 x 2) = $19,599.99 • FIT equals $4,204.13 + (.35)($19,599.99 – $15,863.00) = $5,512.08

  22. SupplementalWages 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)

  23. 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 = .25 • OASDI tax rate = .062 • HI tax rate = .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!

  24. Advance EIC • Earned income credit (EIC) is intended to offset living expenses for eligible employees • Credit can be claimed on 1040 and taxpayer receives lump sum (Can get up to $5,028/year with two qualifying children) or • Can get advance EIC on each paycheck by filing Form W-5 • Can only get advanced earned income credit if have at least one qualifying child • Advance EIC does not change amount employers must withhold from wages

  25. Advance EIC (continued) • 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 • Figure 4-8 on page 4-22 shows Form W-5 • Employers must notify employees who have no income tax withholding that they may be eligible for advanced EIC • Calculate using IRS-provided tables (partial replication on page 4-23) • On Form 941 advanced EIC shows up as a reduction from total taxes to calculate net employer taxes due for quarter • Advance EIC is treated as having been paid to the IRS

  26. Wages and Tax Statement (W-2) • Form W-2 informs employees of wages and withholding taxes • Hard copy to EE on or before 1/31 or • Can post on secure web site so EE can access individual W-2 • Send to SSA on or before 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 http://fire.irs.gov • W-3 is transmittal form • 941s must tie to W-3 • Various penalties for filing incorrect or late W-2s • Must file W-2c and W-3c (if correcting)

  27. Returns – Quarterly & Informational • Quarterly reports of taxable wages required (see figure 4-14 on page 4-31 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 4-16 (page 4-33) • Must issue to IC paid if paid at least $600 & 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

  28. 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

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