Chapter Seven

PAYROLL AND INCOME TAX

Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

LEARNING UNIT OBJECTIVES

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LU 7-1: Calculating Various Types of Employees’ Gross Pay1. Define, compare, and contrast weekly, biweekly,

semimonthly, and monthly pay periods.2. Calculate gross pay with overtime on the basis of time.3. Calculate gross pay for piecework, differential pay schedule,

straight commission with draw, variable commission scale, and salary plus commission.

1. Prepare and explain the parts of a payroll register.2. Explain and calculate federal and state unemployment

taxes.

LU 7-2: Computing Payroll Deductions for Employees’ Pay; Employers’ Responsibilities

LU 7-3: Calculating Taxable Income and Tax Liability

1. Compute taxable income.2. Calculate tax liability.

PAYROLL CYCLES

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HOURLY RATE OF PAY; CALCULATION OF OVERTIME

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Gross pay =

Hourly overtime pay rate =

Earnings for 40 hours + Earnings at time-and-a-half rate

Hours employee worked x Rate per hour

Regular hourly pay rate x 1.5

Gross pay =

HOURLY RATE OF PAY; CALCULATION OF OVERTIME

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Employee M T W Th F S Total

R Valdez 13 8.5 10 8 11.25 10.75 61.5

*Rate is $9.00 per hour.

Hourly overtime pay rate =

Gross pay =

(40 hours x $9) + (21.5 hours x 13.5)

$360 + $290.25 = $650.25

61.5 – 40 = 21.5 overtime hours $9 x 1.5 = 13.50 overtime rate

Regular hourly pay rate x 1.5

Earnings for 40 hours + Earnings at time-and-a-half rate

STRAIGHT PIECE RATE PAY

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Gross pay = Number of units produced x Rate per unit

Ryan Foss produced 900 dolls. He is paid $.96 per doll. Calculate his gross pay.

900 dolls x $.96 = $864.00

Example:

DIFFERENTIAL PAY SCHEDULE

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Gross pay = Number of units produced x Various rates per unit

Logan Company pays Abby Rogers on the basis of the following schedule:

Last week Abby produced 300 dolls. What is Abby’s gross pay?

(50 x $.50) +(100 x $.62)+(50 x $.75) + (100 x $1.25) = $249.50

Example:

STRAIGHT COMMISSION WITH DRAW

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Commission is a certain percentage of the amount a salesperson sells.

Draw is an advance on the salesperson’s commission.

Logan Company pays Jackie Okamoto a straight commission of 15% on her net sales (net sales are total sales less sales returns). In May, Jackie had net sales of $56,000. Logan gave Jackie a $600 draw in May. What is Jackie’s gross pay?

($56,000 x .15) = $8,400 -- 600

$7,800

Example:

VARIABLE COMMISSION SCALE

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Different commission rates for different levels of net sales.

Up to $35,000 4%

Excess of $35,000 to $45,000 6%

Over $45,000 8%

Last month, Jane Ring’s net sales were $160,000. What is Jane’s gross pay based on the schedule?

($35,000 x .04) + ($10,000 x .06) + ($115,000 x .08)

Example:

= $1,400 + $600 + $9,200 = $11,200

SALARY PLUS COMMISSION

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Gross pay = Salary + Commission

Logan Company pays Joe Roy a $3,000 monthly salary plus a 4% commission for sales over $20,000. Last month Joe’s net sales were $50,000. Calculate Joe’s gross pay.

$3,000 + ($30,000 x .04) = $4,200

Example:

EMPLOYEE’S W-4 FORM

• When an employee is hired, a W-4 Form is completed.

• This information is needed to calculate the federal income tax.

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PAYROLL REGISTER

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Rate Base

Social Security 6.20% $110,100

Medicare 1.45 No Base

FICA taxes fund Social Security and Medicare.

FEDERAL INCOME TAX WITHHOLDING (FIT)

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1. Percentage Method

PERCENTAGE METHOD INCOME TAX WITHHOLDING TABLES

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TABLE 7.1

TABLE 7.2 (Partial)

You can use the

percentage method

to calculate federal income

tax withholdin

g (FIT).

Step 1. In Table 7.1, locate the weekly withholding for one allowance. Multiply this number by 2.

PERCENTAGE METHOD

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Step 2. Subtract Step 1 from employee’s pay.

Step 3. In Table 7.2, locate appropriate table and compute income tax.

$73.08 x 2 = $146.16

$2,250.00 -- 146.16$2,103.84

$2,103.84 -- 1,515.00 $ 588.84Tax $187.15 + .25 ($588.81) $187.15 + 147.21 = $334.36

Example: Alice Rey earns $2,250 for week 47. She is married with two allowances.

EMPLOYERS’ RESPONSIBILITIES

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Federal Unemployment Tax Act (FUTA) —6.2% tax on the first $7,000 paid to

employees as wages during the calendar year

State Unemployment Tax Act (SUTA) *– 5.4% tax on the first $7,000 paid to

employees as wages during the calendar year

*Can be credited against the 6.2% federal rate.

Assume a company had total wages of $19,000 in a calendar year. No employee earned more than $7,000 during the calendar year. The FUTA tax is .8% (6.2%-5.4%) . How much does the company pay in FUTA tax?

.008 x $19,000 = $152 FUTA tax due to federal government

6.2% FUTA

5.4% SUTA credit

.8% FUTA tax

Example:

EMPLOYERS’ RESPONSIBILITIES

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Federal Unemployment Tax Act (FUTA) —6.2% tax on the first $7,000 paid to

employees as wages during the calendar year

State Unemployment Tax Act (SUTA) *– 5.4% tax on the first $7,000 paid to

employees as wages during the calendar year

*Can be credited against the 6.2% federal rate.

Assume a company has total wages of $19,000 and $4,000 of the wages are exempt from SUTA. What are the company’s SUTA and FUTA taxes if the company’s SUTA rate is 5.8% due to a poor employment record?

$20,000 -- $4,000 (exempt wages) = $16,000 SUTA = $16,000 x .058 = $928; FUTA = $16,000 x .008 = $128

6.2% FUTA

5.4% SUTA credit

.8% FUTA tax

Example:

CALCULATING TAXABLE INCOME AND TAX LIABILITY

• In the United States, the tax liability – what is owed to the government – is based on calculated taxable income and the IRS tax rate schedules (tax tables).

• Keep in mind a taxpayer in the 25% bracket saves 25 cents in federal income tax for each dollar spent on a deductible expense.

• Knowing what is a deductible expense can go a long way toward effective tax planning.

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CALCULATING TAXABLE INCOME

Step 1. Total all income.

Step 2. Subtract from Step 1 any adjustments to income to calculate adjusted gross income.

Step 3. Subtract from Step 2 the standard deduction (see Figure 7.2) or the total of itemized deductions --- whichever is greater.

Step 4. Subtract from Step 3 the exemption allowance, found by multiplying the total number of exemptions claimed by the exemption amount. See Figure 7.2.

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Taxable Income = Adjusted gross income

— Standard or itemized deductions

— Exemption allowance

2012 STANDARD DEDUCTION AND EXEMPTION AMOUNT –

FIGURE 7.2

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CALCULATING TAXABLE INCOME

Example: Calculate taxable income for Bree Langemo who files as head of household and claims two exemptions. She earned $95,720; sold stock with a capital gain totaling $2,500; earned a $1,750 bonus, had a capital loss of $7,000; contributed $2,000 to her IRA; had moving expenses of $15,500, mortgage interest of $12,500, and charitable contributions of $450.

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Step 1. $95,720 + $2.500 = $1.750 - $7,000 = $92,970.Step 2. $92,970 - $2,000 = $90,970.

Step 3. Choose the greater of the two: standard deduction of $8,700 (from Figure 7.2) or itemized deductions of $28,450 ($15,500+$12,500+$450). Itemized deductions are greater, so $90,970 - $28,450 = $62,520.Step 4. $62,520 – ($3,800 x 2) = $54,920 taxable income

DETERMINING INCOME TAX LIABILITY

Step 1. Locate the filing status in Figure 7.2.

Example 1: Mary Frey files head of household and has taxable income of $86,500. Calculate her tax liability.

Her filing status is Head of Household. 7-22

DETERMINING INCOME TAX LIABILITY

Step 2. Find the taxable income bracket in Table 7.3.

Example 1: Mary Frey files head of household and has taxable income of $86,500. Calculate her tax liability.

Her taxable income lies within the over $47,350 but not over $122,300.

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DETERMINING INCOME TAX LIABILITY

Step 3. Calculate the tax owed for each bracket.

Example 1: Mary Frey files head of household and has taxable income of $86,500. Calculate her tax liability.

10% on taxable income from $0 to $12,400: $12,400 x .10 = $1.240

15% on taxable income over $12,400 to $47,350: $47,350 - $12,400 = $34,950 x .15 = $5,242.50

25% on taxable income over $47,350 to $122,300: $86,500 - $47,350 = $39,150 x .25 = $9,787.50

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DETERMINING INCOME TAX LIABILITY

Step 4. Total the taxes owed for each bracket to find the tax liability.

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Example 1: Mary Frey files head of household and has taxable income of $86,500. Calculate her tax liability.

$1,240 + $5,242.50 + $9,787.50 = $16,270 tax liability