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CHAPTER 4

Payroll Accounting 2012 Bernard J. Bieg and Judith A. Toland. CHAPTER 4. INCOME TAX WITHHOLDING. Developed by Lisa Swallow, CPA CMA MS. Learning Objectives. Explain coverage under the Federal Income Tax (FIT) Withholding Law

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CHAPTER 4

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  1. Payroll Accounting 2012 Bernard J. Bieg and Judith A. Toland CHAPTER 4 INCOME TAX WITHHOLDING Developed by Lisa Swallow, CPA CMA MS

  2. 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

  3. Coverage Under FIT Withholding Laws LO-1 • 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 Figure 4-1 on page 4-3) • Tips • Cash awards

  4. FIT Withholding on Tips LO-1 • 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 allocatedtips - onlyreportedtips • Tip allocation can be done one of three methods – hours worked, gross receipts or good faith agreement

  5. What is Exempt from FIT LO-1 • 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

  6. Pretax Salary Reductions are Exempt from FIT LO-1 • 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

  7. Tax-Deferred Retirement Contributions Exempt from FIT LO-1 • 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

  8. How Does Employer Know Amount to Withhold for FIT? LO-2 • 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 withholding

  9. Completing Form W-4 LO-2 • 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

  10. Gross-Up Supplemental Wages LO-3 • 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!

  11. Returns – Quarterly & Informational LO-4 • Quarterly reports of taxable wages required (see Figure 4-12 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 transmittal • See Figure 4-13 on 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

  12. Withholding State & Local Income Taxes LO-4 • 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

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