Bernard J. Bieg and Judith A. Toland PAYROLL ACCOUNTING 2014 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or
Income Tax Withholding Chapter 4
Learning Objectives 1. Explain coverage under the Federal Income Tax (FIT) Withholding Law 2. Explain types of withholding allowances that may be claimed and purpose/use of Form W-4 3. Compute amount of FIT withheld using various methods 4. Explain completion of critical quarterly and year-end information returns and impact of state/local income taxes on payroll accounting process
Coverage Under FIT Withholding Laws Employee-employer relationship must exist for FIT withholding laws to apply See Chapter 3 for guidance on determining status Statutory nonemployees (direct sellers and qualified real estate agents) have no federal taxes withheld LO-1
Coverage Under FIT Withholding Laws (cont.) Taxable wages for FIT withholding purposes gross amount of following items are taxable Wages/Salaries Vacation pay Supplemental payments Bonuses/Commissions Taxable fringe benefits (see next slide) LO-1
Coverage Under FIT Withholding Laws (cont.) Tips Cash awards See Figure 4-1 (page 4-3) for other types of taxable payments LO-1
Figure 4-1 LO-1
Figure 4-1(cont.) LO-1
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 tips Tip allocation can be done one of three methods hours worked, gross receipts or good faith agreement LO-1
Pretax Salary Reductions are Exempt from FIT Contribution to cafeteria plans Employee can choose between cash (pay) or qualified (nontaxable) benefits (list of potential benefits found 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 LO-1
Cafeteria Plans, Potential Benefits LO-1
Pretax Salary Reductions are Exempt from FIT (cont.) 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 are monies set aside from current paychecks that will be paid out to employee upon retirement 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) LO-1
Tax Deferred Retirement Accounts LO-1
Tax-Deferred Retirement Contributions Exempt from FIT (cont.) Individual Retirement Accounts (IRA) In 2014, depending upon certain conditions, an employee can contribute lesser of $5,500 or 100% of earned income pretax to a retirement account If made through payroll deductions, generally employer does not need to comply with ERISA as long as certain guidelines are met Roth IRAs are used for nondeductible contributions LO-1
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 of Form W-4) LO-2
Completing Form W-4 (cont.) Line 3 LO-2
Completing Form W-4 (cont.) Exempt status Can claim if taxpayer had no income tax liability last year and none expected this year (line 7 of Form W-4) LO-2
Completing Form W-4 (cont.) Line 7 LO-2
Completing Form W-4 (cont.) 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 $1,000 (including more than $330 unearned income) Some individuals are automatically exempt Note: Never advise employee as to how many allowances to claim LO-2
Gross-Up Supplemental Wages If want to give an employee the intended amount of supplemental check, must gross up this amount For example, an employer wants Dov, an employee, to receive a $700 net bonus check LO-3
Gross-Up Supplemental Wages (cont.) To do: Must divide desired net check by [1.00 tax rates] FIT tax rate = 0.25 OASDI tax rate = 0.062 HI tax rate = 0.0145 $700/[1.00 (0.25 + 0.062 + 0.0145)] = $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
Returns Quarterly & Informational Quarterly reports of taxable wages required (see Figure 4-11 and 4-12, pages 4-27 and 4-28 for major required returns) Payroll income tax withholdings reported on Form 941 Employers must file information returns for compensation paid to independent contractors (IC) Form 945 LO-4
Figure 4-11 Major Returns Filed by Employers LO-4
Figure 4-12 Major Information Returns LO-4
Returns Quarterly & Informational (cont.) 1099-MISC with 1096 as transmittal - See Figure 4-13 (page 4-29) Must issue to IC if paid at least $600 and aren t incorporated IC must submit taxpayer identification number (TIN) on W-9 to hiring agent If this is not done, then hiring agent must withhold federal income tax = 28% of payments made Nonpayroll items (like withholding on independent contractors, pensions, IRAs, etc. ) reported on Form 945 LO-4
Figure 4-13 Form 1099-MISC LO-4
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 withheld LO-4
Withholding State & Local Income Taxes (cont.) Issue information returns to report payments to individuals not subject to withholding Three different methods of withholding SIT full taxation, leftover taxation and reciprocity Most states require employers to withhold tax from both nonresidents and residents, unless a reciprocal agreement is in place LO-4