CHAPTER 4 INCOME TAX WITHHOLDING Developed by Lisa Swallow, CPA CMA MS Payroll Accounting 2005 Bernard J. Bieg

Taxable Wages for FIT Withholding Purposes yWages/Salaries  Cash  Bonuses  Profit sharing ySupplemental Wages  Severance pay  Retroactive increases  Vacation pay  How to withhold:  with regular pay (treat as one paycheck and withhold accordingly)  alone - 25% flat supplemental withholding

Fringe Benefits yNoncash fringe benefits  ER must withhold FIT unless specifically excluded  Examples include:  tickets to athletic events  athletic club membership  personal use of corporate car  frequent flier miles  stock options(when option exercised)  Specifically excluded fringe benefits include:  de minimis and working condition fringe  reduced tuition, qualified transportation fringes, meals & lodging if for ER benefit

How to Withhold FIT on Noncash Fringe Benefits yValue and withhold like supplemental wages (flat 25%) yValue and add to regular pay - treat as one paycheck and withhold accordingly  Flexible reporting - can add $500 on 4 paychecks or entire $2,000 with one paycheck and withhold  For FICA/FIT, ER must withhold on fair market value of benefit > amount employee paid towards benefit  ER must figure value of fringe benefits no later than 12/31 unless using the “special period rule”

FIT Withholding on Tips yER receives Form 4070 from EE by 10th of each month yER must withhold based on Form 4070 (reported tips) yEmployer is not required to withhold on allocated tips (see chapter 3) - only reported tips

FIT Withholding on Tips (continued) yWhat 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  EE gets no paycheck and pays quarterly estimated tax payments or can pay balance of tax with 1040 tax return

Who is Exempt from FIT yMinisters yNewspaper carriers (under 18 years old) yEducational assistance  if maintains/improves job status  $5,250 per year of employer provided assistance for undergraduate or graduate is tax-free yTravel Reimbursements but only if made under an “accountable plan”  An accountable plan is an IRS-approved plan yIf there is not a plan in place, travel reimbursements are made under a non-accountable plan and considered wages  Therefore ER must withhold FIT *see page 4-8 for comprehensive list*

Wages Exempt from FIT yContributions to deferred compensation plan are exempt from FIT y401(k) or SIMPLE contributions  These are retirement plan contributions that are made pretax for FIT purposes;  However, ER must still withhold and match FICA  Make up amounts allowed if over 50 years old yIRA  Make up amounts allowed if over 50 years old  Phase outs apply

Wages Exempt from FIT yContribution to flex plans or cafeteria plans  Known as “Section 125”  These are salary reductions whereby EE puts pretax dollars into a trust account to be used for health care and dependent care  These dollars do not have FIT or FICA withheld on them

How does ER know how much to withhold yBest for EE if FIT withholding = tax liability (goal is no refund and no tax due) yW-4 (look at page 4-11)  How many withholding allowances  One allowance for self (if not claimed by other person)  One for each dependent  Special allowances (itemized deduction, other compensation, tax credits, etc. – use worksheet on back of W-4 to calculate)

W-4 ySingle or married or “married but tax withheld at higher single rate” box  Why would an EE choose this? (line 3)  Because possibly other sources of taxable income yExempt status (line 7)  Can claim if taxpayer had no income tax liability last year and none expected this year  Can’t claim exempt if:  dependent on someone else’s tax return and  income exceeds $800 including more than $250 unearned income  Some individuals are automatically exempt – FT students with part time work and 65+/blind * never advise employee as to how many allowances to claim*

Other Situations on W-4 yIf EE doesn’t provide a completed W-4, ER withholds at single rate, 0 allowances (highest amount withheld) yEE can change W-4  When ER receives new W-4, has 30 days  EE must change within 10 days for decrease in # of allowances  Lose child as an allowance (custody)  Become single  Don’t have to do if lose allowance due to death yUnauthorized changes/additions invalidate W-4 yFile in personnel file – only send to IRS if  EE claims 11+ withholding allowances  Claims exempt and is earning more than $200/week

FIT Withholding on Other Sorts of Income yPensions (W-4P) in excess of $14,700 per year  Withhold as if M3 (married with 3 allowances) unless complete W-4P to change amount of tax withholding yThird party payer of sick pay (W-4S) yGovernment payments such as Social Security (W-4V)

ER needs to calculate FIT withholding yUse Circular E and find correct withholding  Either Wage-Bracket Method (easiest) or  Percentage Method, only use if  highly compensated or  10+ allowances or  compensated annually, semiannually or daily  Need to know  Single/married  How often paid  Gross pay  Number of allowances

Examples - Calculating FIT Withholding (#1)  FACTS: Annual salary is $40,144 - paid weekly – Married, 4 - what is FIT withholding?” weekly – Married, 4 - what is FIT withholding?”  Weekly gross $40,144/52 = $  Can use wage bracket tables to look up married with 4 allowances  FIT withholding = ( ) x.10 = $3.17 ( ) x.10 = $3.17

Examples - Calculating FIT Withholding (#2) FACTS: Annual salary is $84,400 - paid semimonthly – Married, 1 - what is FIT withholding?  Semimonthly gross is $84,400/24 = $3,517  Must use Percentage of Withholding tables  To Do:  Subtract (# of allowances x amount for each allowance) from gross:  $3,517 - (1 x $129.17) = $3,  $ (3, – 2,698)(.25) = $ FIT

Examples - Calculating FIT Withholding (#3) FACTS: Monthly salary is $3,000 - paid semimonthly – Single, 2 - what is FIT withholding?  Annualize salary $3,000 x 12 = $36,000  Semimonthly gross $36,000/24 = $1,500  Can use wage bracket tables to look up single with 2 allowances FIT withholding = $157

Examples - Calculating FIT Withholding (#4) 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 of Withholding tables  To Do:  Subtract (# of allowances x amount for each allowance) from gross:  $28,000 - (2 x ) = $27, to table  $7, (27, – 26,767) x.35 = $7, FIT

Examples - Calculating FIT Withholding (#5) FACTS: Annual salary is $485,000 - paid semimonthly - Married 4 - what is FIT withholding?  Semimonthly gross is $485,000/24 = $20,208  Must use Percentage of Withholding tables  To Do:  Subtract (# of allowances x amount for each allowance) from gross:  20,208 - (4 x ) = $19, to table  $3, (19, – 13,588.00) x.35 = $5, FIT

Withholding on Supplemental Wages yItems like vacation pay, retroactive increases and bonuses yCan add to regular wages and utilize wage bracket or % method on total gross or yCan withhold at flat 25% if supplemental wage check issued separately

Earned Income Credit (EIC) yTo get reduction in FIT for low income taxpayers  In 2004, qualify for EIC if  Employee has a qualifying child  Employee’s expected earned income and adjusted gross income must each be less than $30,338, $31,338 joint and  Expect to be able to claim the EIC for 2004  ‘ Earned income’ is tips, wages, self employment income (and no deduction for salary deferral)

Advanced EIC yTo get part of this on each paycheck, file Form W-5 (Earned Income Credit Advance Payment Certificate)  Can only get advanced earned income credit if have at least one qualifying child  Can get up to $4,300/year with 2 qualified children yAdvanced EIC does not change amount employers must withhold from wages  This amount is treated as having been paid to the IRS (on Form 941 shows up as a payment) yOnly one certificate on file at a time  If married, both spouses can have certificate  Have to refile each year and have to revoke in 10 days if ineligible

Information Returns Statements Required at Year End yW-2  Hard copy to EE by 1/31 (or can post on secure web site so EE can access individual W-2) & to SSA by 2/28  W-3is transmittal form  W-2c and W-3c (if correcting)  if issuing 250+ W-2s must use magnetic media and have until 3/31 to electronically file y941s must tie to W-3 y1099-MISC with 1096 as transmittal* y1099-DIV with 1096 as transmittal* y1099-INT with 1096 as transmittal* *See figure 4-16, p. 4-32

Withholding State and Local Income Taxes yIn states with state income tax and localities with local income tax, generally, payroll department must:  Withhold and deposit accordingly  Periodically report tax withheld  Reconcile withholding to deposits  Complete annual statements showing wages and withholding