CHAPTER 4

CHAPTER 4 CHAPTER 4

INCOME TAX WITHHOLDINGINCOME TAX WITHHOLDING

Developed by Lisa Swallow, CPA CMA MSDeveloped by Lisa Swallow, CPA CMA MS

Payroll Accounting 2010

Bernard J. Bieg and Judith A. Toland

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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

Coverage Under Federal Income Tax (FIT) Withholding Laws

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Fringe Benefits 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

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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

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FIT Withholding 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 allocated tips - only reported tipsTip allocation can be done one of three

methods

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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

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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 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

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What is Exempt from FITLaw 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 exemptions8

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 plans9

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 10

How Does an Employer Know Amount to Withhold for FIT?

Best for EE 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

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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 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-4ER can establish electronic W-4 system but must

provide paper option if employee requests this 13

Validity of W-4

Employers are not required to verify authenticity

If form is altered, employer cannot accept invalid formCan then ask for new W-4 to be submittedOr, if a new hire, withhold at single and zero

withholding rates

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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

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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, 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) 16

Example #1 Calculating FIT Withholding

FACTS: Annual salary is $40,144 - paid biweekly – Married 4 - what is FIT withholding?

Biweekly gross $40,144/26 = $1,544.00Can use wage bracket tables to look up

married, biweekly and 4 allowancesFIT withholding = $41

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FACTS: Annual salary is $84,400 – paid semimonthly – Married 1 - what is FIT withholding?

Semimonthly gross is $84,400/24 = $3,516.67Must use percentage methodTo 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

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FACTS: Monthly salary is $3,000 - paid biweekly – Single 2 - what is FIT withholding?

Annualize salary $3,000 x 12 = $36,000Biweekly gross $36,000/26 = $1,384.62Can use wage bracket tables to look up

single, biweekly and 2 allowances

FIT withholding = $11919


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

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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 21

Supplemental Wages WithholdingExamples include

Vacation pay (treated differently than other supplemental wages)

Severance pay, bonuses and commissionsExercised nonqualified stock options

How to withholdWith regular pay (treat as one paycheck

and withhold accordingly) orPaid 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) 22

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! 23

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

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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 25

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 form941s must tie to W-3Various penalties for filing incorrect or late W-2sMust file W-2c and W-3c (if correcting)

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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

incorporatedIC 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 27

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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Documents

CHAPTER 4