CHICAGO CHAPTER OF THE AMERICAN PAYROLL

ASSOCIATION

SPRING 2014

Principles of Paycheck Calculations

Income and Employment Taxes DefinedWhen employee compensation is described as “taxable,” this means:•it is subject to federal income tax and the employer must withhold the tax from the employee’s pay and remit it to the Internal Revenue Service, and•it is subject to social security and Medicare taxes under the Federal Insurance Contributions Act (FICA), as well as federal unemployment tax under the Federal Unemployment Tax Act (FUTA) – these taxes are often referred to as employment taxes.

Gross IncomeCompensation for services,

including fees, commissions, fringe benefits, and similar items.

WagesAll remuneration for

employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.

Fringe Benefits“Fringe Benefits” or “Perks” are

generally included in income and subject to income and employment tax withholding, deposit, and reporting requirements unless the IRC says otherwise.

Fair Market Value

IFBA = FMV – (EPA + AEL)

IFBA = Includable Fringe Benefit Amount

FMV = Fair Market Value

EPA = Employee-Paid Amount

AEL = Amount Excluded by Law

Fair Market ValueExampleHarry’s employer pays for Harry’s parking space in a commercial parking lot next to the employer’s premises. The employer’s cost for the space is $300 per month in 2013 which is the same fee charged to all monthly payers. Harry pays nothing for the parking space and has access to it every day. Up to $245 per month of employer-provided parking is excluded from income by law in 2013. Harry’s taxable income from the parking benefit is determined as follows:IFBA = $300 – ($0 + $245)IFBA = $300 – 245IFBA = $55 per month

Special Valuation MethodCommuting Valuation

This method allows an employer to value an employee’s personal commuting use of an employer-provided vehicle at $1.50 per one-way commute and $3.00 per round trip if the following conditions are met:1.The vehicle is owned or leased by the employer and is provided to the employee for use in connection with the employer’s trade or business.

2.The employer, for non-compensatory business reasons, requires the employee to commute to and/or from work in the vehicle.

3.The employer has a written policy prohibiting the employee (and the employee’s spouse and dependents) from using the vehicle for personal use other than commuting or de minimis personal errands, and the policy is enforced.

4.The employee is not a control employee. In the private sector, a control employee who:Is a corporate officer earning at least $100,000 in 2013 (indexed annually to the next lowest multiple of $5,000);Is a director;Earns at least $205,000 in 2013 (indexed annually to the next lowest multiple of $5,000)l or Is a 1% owner.

In the public sector, a control employee is an employee who:Is an elected official; or Earns more than a federal employee at Executive Level V ($145,700 through April 6, 2013; $146,400 after April 6, 2013).

Annual Lease Valuation MethodUnder this method, the fair market value of an employee’s personal use of a company-provided car is determined by multiplying the annual lease value of the car (as found in Table 3.1 following) by the percentage of personal miles driven. Here are the steps the employer must take:1.The employer must determine the fair market value of the car as of the first day it was made available to any employee for personal use. For employer-owned vehicles, this is the total cost of the car to an individual in an arm’s length transaction (including sales tax and title fees.) For employer-leased vehicles, the value can be determined by using a nationally recognized pricing source, such as the “blue book.” Whether the car is owned or leased by the employer, its value must be recalculated after four full calendar years. If the vehicle is transferred to another employee, the annual lease value may be recalculated based on the car’s fair market value on January 1 of the calendar year of the transfer.2.Find the car’s fair market value in Table 3.1. 3.Calculate the percentage of personal miles driven during the year (personal miles driven ÷ total miles driven).4.Calculate the fair market value of the employee’s personal use of the car that must be included in the employee’s income (annual lease value x percentage of personal miles.

Annual Lease Value ExampleEmployee Gilbert drives an employer-provided car that he uses for both business and personal driving. Gilbert drove 17,000 miles during the year – 12,300 business miles and 4,700 personal miles. The car’s fair market value is $16,200. The amount of the car’s fair market value that must be included in Gilbert’s income for the year is calculated as follows:

ALV of $16,200 car (from table)

$4,600

% of personal miles = $4,700 ÷ 17,000 = .2765

27.65%

FMV of personal use = $4,600 x .2765

$1,271.90

Vehicle Cents-Per-Mile

Under this method, the fair market value of an employee’s personal use of a company-provided vehicle is determined by multiplying the IRS’s business standard mileage rate by the number of personal miles driven. The business standard mileage rate in 2013 is $.565 (56.5 cents) per mile (indexed annually). To use this method for standard passenger automobiles, the following conditions must be met:1.The employer must expect the employee to regularly use the vehicle while conducting the employer’s business, or the vehicle must actually be driven at least 10,000 miles annually 9including personal use) and be used primarily by employees.2.The fair market value of the car cannot exceed $16,000 for cars placed in service in 2013 (indexed annually). The maximum values of cars placed in service in earlier years are: (Please reference Page 3-23)

Vehicle Cents-Per-MileExampleEmployee Margaret drives a qualifying car 16,000 miles during 2013, including 7,600 personal miles. If Margaret’s employer pays for the gasoline for the car, the fair market value of her personal use of the car is calculated as follows:FMV of personal use = 7,600 personal miles x $0.565 = $4,294.00

If Margaret pays for the car’s gasoline, the fair market value of her personal use of the car is calculated as follows:FMV = 7,600 x ($0.565 - $0.055) = $7,600 x $0.51 = $3,876.00

Group Term LifeThe value of employer-provided group-term life insurance up to $50,000 is excluded from an employee’s income.The value of coverage in excess of $50,000, minus any amount paid for the coverage by the employee after taxes, must be included in the employee’s income.The value of the excess coverage is subject to social security and Medicare taxes, but is not subject to federal income tax withholding or federal unemployment (FUTA) tax.

Group Term LifeCalculating Excess Group-Term Life InsuranceThe value of group-term life insurance in excess of $50,000 must be included in income.It is determined by using IRS Section 79 Table 1 and the uniform premiums it provides, rather than the actual cost to the employer. Table I lists the value of each $1,000 of group-term life insurance coverage per month, broke down in five-year age brackets.

Group Term LifeCalculating Excess Group-Term Life Insurance

Here are the steps an employer must take in computing the monthly value of excess group-term life insurance to include in an employee’s income.1.Determine the total amount of the employee’s group-term life insurance coverage under the employer’s plan (including coverage purchased by both the employer and the employee). Most plans figure coverage as a multiple of the employee’s base salary, which may increase during the year if the employee gets a raise. That is why many employers use the employee’s base salary as of January 1 of each year as the base amount for determining life insurance- coverage. Many companies also have a maximum amount of employer-provided coverage.2.Calculate the excess benefit over $50,000.3.Divide the excess insurance amount by $1,000.4.Determine the employee’s age as of December 31 of the calendar year during which the benefit is taxable.5.Use IRS Table I to calculate the fair market value of one month of excess insurance per $1,000 and multiply it by the answer obtained from Step 3.6.Deduct any after-tax contributions by the employee from the value of the insurance.7.Add the excess amount to the employee’s income, withhold and pay social security and Medicare taxes, and report the amount as required.

Group Term LifeExample

Valerie was born April 23, 1954. Her employer’s non-discriminatory group-term provides her with coverage equal to 2x her annual salary as of January 1., and her salary as of 1-1-3-13 was $65,000. Her employer’s plan has a maximum coverage amount of $125.000. Valerie contributes $25 per month in after-tax dollars toward the insurance premiums.

Step 1: 2 x $65,000 = $130,000

maximum coverage amount = $125,000

Valerie’s coverage = $125,000

Step 2: $125,000 - $50,000 = $75,000

Step 3: $75,000 ÷ $1,000 = 75

Step 4: Valerie will be 59 years old on 12-31-13

Step 5: $.43 x 75 = $32.25

Step 6: $32.25 - $25.00 = $7.25 per month of taxable income in 2013.

If Valerie did not pay anything for the group-term life insurance, or paid with only pre-tax dollars, the entire $32.25 would be included in her income each month.

Gross-Up

Gross-Up Regular Gross Up• Generosity, Inc. wants to give

employee Linda a $6,000 year-end bonus in 2013. To ensure that Linda receives $6,000, Generosity agrees to pay her federal and state income and social security and Medicare taxes on the bonus, which is treated as supplemental wages (see Section 6.4-4). Here is how the employer would calculate the gross payment to Linda and the amounts that must be withheld, assuming Linda has been paid $50,000 so far in 2013 and the state supplemental wage withholding rate is 3.5%:

Gross-UpRegular Gross-Up Answer

Gross-UpGross-Up When Crossing the Social Security Wage Base

Assume the same facts as in Example 1, except that, at the time the bonus is paid, Linda has already been paid $111,700 during 2013. Here is how the employer would calculate the gross payment to Linda and the amounts that must be withheld:

Gross-UpWhen Crossing the Social Security Wage Base

Social Security Wage Base for 2013 = $113,700; Tax Rate = 6.2%

Amount of Bonus Subject to SS tax = $113,700 - $111,700 = $2,000

SS tax on $2,000 = $2,000 x .6.2% = $124.00

Total amount for gross-up calculation = $6,000 + $124.00 = $6,124.00

Total tax % = 25% FITW + 3.5% SIT + 1.45% MED = 29.95%

Gross-up rate = 100% - 29.95% = 70.05%

Gross earnings on $6,124 = $6,124 ÷ 70.05% = $8,742.33

Gross-UpGross-Up With 401(k) Plan Salary Reduction From Bonus

Assume the same facts as in Example 1, Also, Linda has elected to defer 5% of her wages into Generosity, Inc.’s §401(k) plan, so she should end up with a net payment of $5,700 ($6,000 x 5% = $300; $6,000 - $300 = $5,700).

Gross-UpGross-Up With 401(k) Plan Salary Reduction From Bonus

Amount deferred into §401(k) plan = $6,000 x 5% = $300

Amount subject to SS and Medicare taxes = $6,000

Amount subject to federal and state income taxes = $5,700

SS tax on $300 = $300 x 6.2% = $18.60

Medicare on $300 = $300 x 1.45% = $4.35

Total amount for gross-up calculations = $5,700 + $18.60 + $4.35 = $5,722.95

Total tax % = 25% FITW + 3.5% SITW + 6.2% SS + 1.45% MED = 36.15%

Gross-up rate = 100% - 36.15% = 63.85%

Gross earnings subject to FITW AND SITW = $5,722.95 ÷ 63.85% = $8,963.12

Gross earnings subject to SS and MED = $8,963.12 + $300 = $9,263.12