CHAPTER 4

1. Payroll Accounting 2013 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 critical quarterly and year-end information returns and impact of state/local income taxes on payroll accounting process

3. 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 • 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) • Tips • Cash awards • See Figure 4-1 (page 4-3) for other types of taxable payments LO-1

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

5. 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 • 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

6. 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) • Individual Retirement Accounts (IRA) • In 2013, depending upon certain conditions, an employee can contribute lesser of $5,000 or 100% of earned income pretax to a retirement account • If made through payroll deductions, generally employer does not need to comply with ERISA • Roth IRAs are used for nondeductible contributions LO-1

7. 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 LO-2

8. 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 • To do: Must divide desired net check by [1.00 – tax rates] • FIT tax rate = .25 • OASDI tax rate = .042 • HI tax rate = .0145 • $700/[1.00 – (.25 + .042 + .0145)] = $1,009.37 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

9. Returns – Quarterly & Informational • Quarterly reports of taxable wages required (see Figure 4-11 (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) • 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 • Nonpayrollitems (like withholding on independent contractors, pensions, IRAs, etc. ) reported on Form 945 LO-4

10. 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 • 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