CHAPTER 4 CHAPTER 4 INCOME TAX WITHHOLDINGINCOME TAX WITHHOLDING

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

Payroll Accounting 2012Payroll Accounting 2012Bernard J. Bieg and Judith A. TolandBernard J. Bieg and Judith A. Toland

Learning Objectives Explain coverage under the Federal

Income Tax (FIT) Withholding Law Explain types of withholding allowances

that may be claimed and purpose/use of Form W-4

Compute amount of FIT withheld using various methods

Explain completion of many quarterly and year-end information returns and impact of state/local income taxes on payroll accounting process

Employee-employer 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 FIT Withholding Laws

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Fringe Benefits

Noncash fringe benefits treated as compensation Employer must withhold FIT unless specifically

excluded Examples of noncash fringe 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 LO-1

How to Withhold FIT on Fringe Benefits

Value and withhold like supplemental wages (flat 25%) Employer 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 and calculate withholding accordingly.

Note: Employer can choose not to withhold FIT on employee’s personal use of corporate car

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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 tipsTip allocation can be done one of three

methods – hours worked, gross receipts or good faith agreement

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FIT Withholding on Tips

What if taxes withheld > hourly wages to be paid? For example blackjack dealer in Lake Tahoe

reports tips = $2,000 for one week; her FIT/FICA withholding will exceed her paycheck

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

or Can pay balance of tax when she files1040

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

(must meet three rules) If there is not a plan in place, travel

reimbursements are made under a non-accountable plan and considered wages Therefore employer must withhold FIT

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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 exempt payments

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Pretax Salary Reductions are 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 The employee 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 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 LO-1

Tax-Deferred Retirement Contributions Exempt from FIT

Contributions to tax-deferred retirement accounts 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)

Individual Retirement Accounts (IRA) For certain taxpayers, the lesser of $5,000 or 100% of

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

Roth IRAs are used for nondeductible contributions LO-1

How Does Employer Know 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 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

See IRS Publication 919 How Do I Adjust My Tax Withholding

if an employee needs to calculate his/her FIT withholdingLO-2

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 employee doesn’t provide a completed W-4, employer

must withhold as if single and zero allowances (highest rate)

Employee can change W-4 When employer receives amended W-4, has 30 days to

change Employee must change within 10 days for decrease in #

of allowancesLose 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 Employer can establish electronic W-4 system, but must

provide paper option if employee requests

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FIT Withholding on Other Income Sources

Pensions (W-4P) in excess of $19,200 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

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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 or semiannually y

Need to knowSingle/married, how often paid, gross pay and # of

allowances

Note: also other methods, rarely used,

for withholding (see page 4-18) LO-3

Example #1 Calculating FIT Withholding

FACTS: Noni’s annual salary is $40,144 – she is paid biweekly and her W-4 shows “Married with 4”. What is her 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 = $69

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Example #2 Calculating FIT Withholding

FACTS: John earns an annual salary of $84,400 and is paid biweekly. His W-4 shows “Married with 1”. What is his FIT withholding?

Biweekly gross is $84,400/26 = $3,246.15 Must use percentage method To Do:

Subtract amount of allowances* (biweekly allowance for1) from gross $3,246.15 - $142.31 = $3,103.84

FIT equals $365.40 + (.25)($3,103.84 – $2,958.00) = $401.86

*From 2011 Table of Allowances found in AppendixLO-3

Example #3 Calculating FIT Withholding

FACTS: Maggie earns an annual salary of $336,000 and is paid monthly. Her W-4 shows “Married with 2” . What is FIT withholding?

Monthly gross is $336,000/12 = $28,000 Must use percentage method To Do:

Subtract amount of allowances (monthly allowance for 2) from gross $28,000 - ($308.33 x 2) = $27,383.34

FIT equals $3,959.52 + (.33)($27,383. 34 - $18,350.00) = $6,940.52 LO-3

Example #4 Calculating FIT Withholding

FACTS: Belinda earns a monthly salary of $3,000 and is paid biweekly. Her W-4 says “Single with 2”. What is her 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 = $137LO-3

Example #5 Calculating FIT Withholding

FACTS: Ferhart’s annual salary is $485,000 – he is paid semimonthly. His W-4 says “Married with 4”. What is his FIT withholding?

Semimonthly gross is $485,000/24 = $20,208.33

Must use percentage method To Do:

Subtract amount of allowance (semimonthly allowance for 4) from gross $20,208.33 – ($154.17 x 4) = $19,591.65

FIT equals $4,273.91 + (.35)($19,591.65 – $16,127.00) = $5,486.54

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Supplemental Wages Withholding

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)

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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! LO-3

Wages and Tax Statement (W-2)

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

or Can post on secure web site so employee 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)

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Returns – Quarterly & Informational

Quarterly reports of taxable wages required (see Figure 4-11 on page 4-29 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 4-13 on page 4-31Must 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

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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/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 reciprocityLO-4