Welcome to Unit 5 Welcome to Unit 5 AC122 Payroll AC122 Payroll Accounting –Accounting –

Income Tax Income Tax WithholdingWithholding

CHAPTER 4 CHAPTER 4

INCOME TAX WITHHOLDINGINCOME TAX WITHHOLDING

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

Payroll Accounting 2011Payroll Accounting 2011Bernard J. Bieg and Judith A. TolandBernard J. Bieg and Judith A. Toland

EE-ER relationship must exist for FIT withholding to apply

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

FringeFringe BenefitsBenefits

Noncash fringe benefits treated as compensation ER must withhold FIT unless specifically excluded

How to Withhold FIT on How to Withhold FIT on Fringe BenefitsFringe Benefits Value and withhold like supplemental

wages (flat 25%) 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 Can add $500 on 4 paychecks or entire $2,000

with one paycheck for withholding purposes, for example

FITFIT Withholding on TipsWithholding 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 – hours worked, gross receipts or good faith agreement

FIT Withholding on TipsFIT Withholding on Tips

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

In that situation, EE gets no paycheck and pays quarterly estimated tax payments

or Can pay balance of tax when file1040 tax

return

Traveling ExpensesTraveling 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

What is Exempt from FITWhat 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

What is Exempt from FITWhat is Exempt from FIT

Contribution to cafeteria plans Contribution to Flexible-Spending Accounts

Health Savings Accounts (HSA) Archer Medical Savings Accounts

What is Exempt from FITWhat is Exempt from FIT(Pretax salary reductions)(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

Individual Retirement Accounts [IRAs] For certain taxpayers, the lesser of $5,000 or 100% of

earned income may be contributed pretax to a retirement account $6,000 annual contribution allowed if age 50 or older

Roth IRAs accommodate nondeductible contributions

How Does an Employer How Does an Employer Know Know Amount to Withhold for FIT?Amount to Withhold for FIT?

Best for employee if FIT withholding = tax liability Goal is no refund and no tax due

Employee completes W-4 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

Completing Form W-4Completing 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

Other Situations on W-4Other Situations on W-4If 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

Validity of W-4Validity 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

FIT Withholding on Other FIT Withholding on Other Income SourcesIncome Sources

Pensions (W-4P) in excess of $24,960 per yearWithhold 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

Employer Calculates Employer Calculates FIT WithholdingFIT WithholdingUse 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 knowSingle/married, how often paid, gross pay and

# of allowances

Example #1 Example #1 Calculating FIT Withholding 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 = $48

ExampleExample #2 #2 Calculating FIT Withholding Calculating FIT Withholding

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

Semimonthly gross is $84,400/26 = $3,246.15

Must use percentage methodTo Do:

Subtract amount of allowances* (biweekly@1) from gross$3,246.15 - $140.38 = $3,105.77

FIT equals $336.95 + (.25)($3,105.77 – $2,913.00) = $385.14

*From 2010 Table of Allowances found in Appendix

Example #3 Example #3 Calculating FIT Withholding Calculating FIT Withholding

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 = $123

ExampleExample #4 #4 Calculating FIT Withholding 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 $3,485.69 + (.33)($27,391.66 -$14,492.00) = $7,742.58

ExampleExample #5 #5 Calculating FIT Withholding 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 – ($152.08 x 4) = $19,600.01

FIT equals $4,211.99 + (.35)($19,600.01 – $15,892.00) = $5,509.79

Example – Calculating FIT Example – Calculating FIT #6#6

Ken Gold married with 3 allowances. He has total earnings of $2,080.00, paid weekly. Due to Ken’s high earnings you must use the percentage method.

Using the table on page 4-16 in the text you will see that for a weekly payroll the amount for each exemption is $70.19

3 X $70.19 = $210.57 withholding amount$2,080.00 - 210.57 = 1,869.43 Gross wages minus

withholding amount$1,869.43 – $1,809.00 = $60.43 Using the

percentage tables on page T-3 locate the weekly payroll period.

$60.43 X .27 = $16.32$16.32 + 256.60 = $272.92

SupplementalSupplemental Wages Wages WithholdingWithholding

Examples includeVacation 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)

Gross-Up Supplemental Gross-Up Supplemental WagesWages

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!

Wages and Tax Statement Wages and Tax Statement (W-2)(W-2)

Form W-2 informs employees of wages and withholding taxes Hard copy to EE on or before 1/31, to SSA before 2/28

or Can post on secure web site so EE can access individual W-2 If issuing 250+ W-2s must use magnetic media - have until

3/31 to electronically file Can request extension of time via FIRE at http://fire.irs.gov

W-3 is transmittal form and 941s must tie to W-3Various penalties for filing incorrect or late W-2sMust file W-2c and W-3c (if correcting)Must report exempt wages/tips and benefit of EE

health insurance to comply with HIRE and HCERA Acts

Returns – Quarterly & Returns – Quarterly & InformationalInformational

Quarterly reports of taxable wages required (see Figure 4-13 on page 4-30 for major returns that must be completed)

Employers must file information returns for compensation paid to independent contractors (IC)

1099-MISC with 1096 as transmittalSee Figure 4-14 (page 4-31)Must issue to IC if paid at least $600 and aren’t

incorporatedIC must submit taxpayer identification

number (TIN) on W-9 to hiring agentIf TIN not supplied orally, in writing or on W-9,

then must withhold federal income tax = 28% of payments made

Withholding State & Local Withholding State & Local Income TaxesIncome 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 –

full taxation, left over taxation and reciprocity

Any Questions?