1. Welcome to Unit 5 AC122 Payroll Accounting – Income Tax Withholding

2. CHAPTER 4 INCOME TAX WITHHOLDING Developed by Lisa Swallow, CPA CMA MS Payroll Accounting 2011 Bernard J. Bieg and Judith A. Toland

3.  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

4. Fringe Benefits  Noncash fringe benefits treated as compensation  ER must withhold FIT unless specifically excluded

5. How to Withhold FIT on Fringe 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

6. FIT Withholding 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 tips  Tip allocation can be done one of three methods – hours worked, gross receipts or good faith agreement

7. FIT 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

8. 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  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

9. 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

10. What is Exempt from FIT  Contribution to cafeteria plans  Contribution to Flexible-Spending Accounts  Health Savings Accounts (HSA)  Archer Medical Savings Accounts

11. What is Exempt from FIT (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

12. How Does an 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  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

13. 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

14. Other Situations on W-4  If 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-4  ER can establish electronic W-4 system but must provide paper option if employee requests

15. Validity of W-4  Employers are not required to verify authenticity  If form is altered, employer cannot accept invalid form  Can then ask for new W-4 to be submitted  Or, if a new hire, withhold at single and zero withholding rates

16. FIT Withholding on Other Income Sources  Pensions (W-4P) in excess of $24,960 per year  Withhold 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

17. 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, semiannually or daily  Need to know  Single/married, how often paid, gross pay and # of allowances

18. Example #1 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

19. Example #2 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 method  To 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

20. Example #3 Calculating FIT Withholding FACTS: Monthly salary is $3,000 - paid biweekly – Single 2 - what is 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 = $123

21. Example #4 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

22. Example #5 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

23. Example – Calculating FIT #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

24. Supplemental Wages Withholding  Examples include  Vacation pay (treated differently than other supplemental wages)  Severance pay, bonuses and commissions  Exercised nonqualified stock options  How to withhold  With regular pay (treat as one paycheck and withhold accordingly) or  Paid 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)

25. 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!

26. Wages and Tax Statement (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 http://fire.irs.gov  W-3 is transmittal form and 941s must tie to W-3  Various penalties for filing incorrect or late W-2s  Must 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

27. Returns – Quarterly & Informational  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 transmittal  See Figure 4-14 (page 4-31)  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 TIN not supplied orally, in writing or on W-9, then must withhold federal income tax = 28% of payments made

28. 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 reciprocity

29. Any Questions?