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CHAPTER 4

CHAPTER 4 . INCOME TAX WITHHOLDING. Coverage Under Federal Income Tax (FIT) Withholding Laws. EE-ER relationship must exist See Chapter 3 for how to determine status Statutory nonemployees (direct sellers and qualified real estate agents) have no federal taxes withheld

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CHAPTER 4

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  1. CHAPTER 4 INCOME TAX WITHHOLDING

  2. CoverageUnder Federal Income Tax (FIT) Withholding Laws • EE-ER relationship must exist • 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 wages • Bonuses • Taxable fringe • Tips • Cash awards

  3. FringeBenefits • Noncash fringe benefits treated as compensation • 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) • Complete list found in Figure 4-1 (page 4-3) • Specifically excluded fringe benefits include • De minimis and working condition fringe • Reduced tuition, qualified transportation fringes, meals & lodging if for ER benefit • Complete list found on page 4-6

  4. Howto Withhold FIT on Noncash Fringe Benefits • Value and withhold like supplemental wages (flat 25%) • ER must figure value of fringe benefits no later than 1/31 • Also a special period rule that uses 10/31 as cutoff date • Value 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 example

  5. FITWithholding 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 allocatedtips (see chapter 3) - onlyreportedtips • Tip allocation can be done one of three methods

  6. FIT Withholding on Tips (continued) • 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 • EE gets no paycheck and pays quarterly estimated tax payments or • Can pay balance of tax with 1040 tax return

  7. Traveling Expenses • Travel reimbursements but only if made under an “accountable plan” • 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

  8. 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 • Qualified moving expense reimbursements See page 4-6 for comprehensive list of exemptions

  9. What is Exempt from FIT(Pretax salary reductions) • Contribution to flex plans or cafeteria plans (known as Section 125 plans) • These are salary reductions whereby EE 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 • Health Savings Accounts (HSA) • If EE has high-deductible health insurance, can contribute annually to an HSA pretax to meet out of pocket medical bills • Archer Medical Savings Accounts apply to small employers (50 or fewer employees)

  10. 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 • Additional ‘make up amounts’ allowed to be contributed if over 50 years old • Individual Retirement Accounts [IRAs] • For certain taxpayers, the lesser of $5000 or 100% of earned income may be contributed pretax to a retirement account • Conditions must be met for deductibility • Roth IRAs accommodate nondeductible contributions

  11. How Does an Employer Know Amount to Withhold • Best for EE if FIT withholding = tax liability (goal isno refund and no tax due) • Employee completes W-4 S • See Figure 4-3 • Employee’s Withholding Allowance Certificate • 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

  12. Completing Form W-4 • Choose “Single” or “Married” or “Married, but withhold at higher single rate” box • Why would an EE choose the option listed above? (line 3) • 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 $900 (including more than $300 unearned income) • Some individuals are automatically exempt *Note: Never advise employee as to how many allowances to claim

  13. Other Situations on W-4 • If EE doesn’t provide a completed W-4, ER withholds as if single and 0 (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

  14. Validity of W-4 • Employers are not required to verify authenticity • If form is altered, ER cannot accept invalid form • Can then ask for new W-4 to be submitted • Or, if a new hire, withhold at “single and 0” rates

  15. FIT Withholding on Other Income Sources • Pensions (W-4P) in excess of $19,000 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 (W-4V) – this request is voluntary

  16. Employer Calculates FIT Withholding • Use either wage-bracket method (easiest) or • Percentage method (only use if one of the following apply) • Highly compensated or • 10+ allowances or • Compensated annually, semiannually or daily • Need to know • Single/married • How often paid • Gross pay • Number of allowances • Or can use quarterly averaging, annualizing wages or part-year employment method (rarely used)

  17. Example #1 Calculating FIT Withholding FACTS: Annual salary is $40,144 - paid weekly – Married 4 - what is FIT withholding? • Weekly gross $40,144/52 = $772.00 • Can use wage bracket tables to look up married, weekly and 4 allowances • FIT withholding = $38

  18. Example#2 Calculating FIT Withholding FACTS: Annual salary is $84,400 – paid semimonthly – Married 1 - what is FIT withholding? • Semimonthly gross is $84,400/24 = $3,516.67 • Must use percentage method • To Do: • Subtract (# of allowances x amount for each allowance) from gross: • $3,516.67 - (1 x $145.83) = $3,370.84 • FIT equals $368.55 + (.25)($3,370.84 – 3,006.00) = $459.76

  19. Example #3 Calculating FIT Withholding 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, semimonthly and 2 allowances • FIT withholding = $150

  20. 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 (# of allowances x amount for each allowance) from gross: • $28,000 - (2 x 291.67) = $27,416.66 • FIT equals $3735.45 + (.33)(27,416.66 -17,308.00) = $7,071.31

  21. 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 (# of allowances x amount for each allowance) from gross: • 20,208.33 - (4 x 145.83) = $19,625.01 • FIT equals $4,032.32 + (.35)(19,625.01 – 15,213.00) = $5,576.52

  22. SupplementalWages Withholding • Examples include: • Vacation Pay (treated differently than other supplemental wages) • Severance pay, bonuses and commissions • Exercised nonqualified stock options • Retroactive increases • How to withhold • With regular pay (treat as one paycheck and withhold accordingly) • Paid Separately • Method A – Add supplemental and regular wages from recent payroll. Calculate FIT and then subtract tax withheld from regular wages. • Method B - 25% flat supplemental withholding (35% for amounts in excess of $1,000,000)

  23. Gross-Up Supplementals • If want to give $700 bonus check (net), employer must ‘gross up’ this amount • Divide net check by total of [1.00 – tax rates] • FIT = .25 • OASDI = .062 • HI = .0145 • $700/[1.0 – (.25 + .062 + .0145)] = $1039.35 grossed up bonus less taxes = $700 net bonus Note: in many states there is a required withholding rate for state income tax!

  24. Advanced EIC • Earned income credit [EIC] is intended to offset living expenses for eligible employees • To get advanced EIC on each paycheck, file Form W-5 • Can only get advanced earned income credit if have at least one qualifying child • Can get up to $4,824/year with 2 qualifying children • Advanced EIC does not change amount employers must withhold from wages • Sometimes EIC payments exceeds withheld taxes – employer can handle one of two ways • Reduce each advance EIC payment proportionately or • Fully pay and treat as advance payment of company’s employment payroll taxes

  25. Advanced EIC [continued] • EE may only have one certificate on file at a time • If married, both spouses can have certificate • Have to file a new certificate each year • Have to revoke in 10 days if ineligible • On Form 941 advanced EIC shows up as a reduction from total taxes to calculate net taxes due for quarter • Advanced EIC is treated as having been paid to the IRS

  26. Wages and Tax Statement [W-2] • Form W-2 • Hard copy to EE by 1/31 or • Can post on secure web site so EE can access individual W-2) • Send to SSA by 2/28 • If issuing 250+ W-2s must use magnetic media and have until 3/31 to electronically file • Can request extension of time via FIRE at http://fire.irs.gov • W-3 is transmittal form • 941s must tie to W-3 • Various penalties for filing incorrect or late W-2s • W-2c and W-3c (if correcting)

  27. Information Returns • Employers must file information returns for compensation paid to independent contractors (IC) • 1099-MISC with 1096 as transmittal • See Figure 4-16 (page 4-33) • Must issue to IC paid over $600 that aren’t incorporated • Backup withholding • IC must submit taxpayer identification number (TIN) on W-9 • If W-9 not on file, hiring agent must withhold federal income tax = 28% of payments made

  28. Withholding State and Local Income Taxes • In states with state income tax and localities with local income tax, generally the payroll department must • File periodic withholding returns - report wages and withholding • Prepare reconciliation returns – compare deposits to withholdings • File annual statements – annual wages paid and state tax withheld • Issue information returns – used to report payments to individuals not subject to withholding • Three different methods of withholding *Note: all but nine states have a state income tax

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