Chapter 10
Payroll Taxes
Learning Objectives
LO 1. Explain the tax issues associated with payroll and Form 1040.
LO 2. Calculate federal income tax withholding, Social Security, and Medicare taxes on wages and tips.
LO 3. Describe the rules for reporting and paying payroll taxes including deposit penalties and Form 941.
LO 4. Calculate self-employment taxes, unemployment taxes, Form 940, taxes for household employees, and Schedule H.
LO 5. Determine employer payroll reporting requirements including Forms W-2 and
W-3.
LO 6. Explain supplemental payments, backup withholding, Form W-9, estimated tax payments, and Form 1040-ES.
Topics of Primary Importance
· Understanding the relationship between payroll and Form 1040.
· Understanding the calculations for federal tax withholding purposes.
· Understanding the employer’s payroll tax reporting requirements.
· Understanding some of the special issues relating to payroll.
Student Confusion Areas
· Calculating federal income tax withholding and FICA taxes on employee gross compensation and other employer related taxes.
· Determining the amounts employers must use to accurately complete various governmental forms, schedules, and reports.
· Understanding the relationship between employer payroll responsibilities and the employee’s Form 1040 return.
Notes Outline
I. LO 1 – Explain the Tax Issues Associated with Payroll and Form 1040
A. Employees pay into the system as they earn their wages on a “pay-as-you-go” basis to help fund programs and keep the government operational.
B. At the end of the year, the employer summarizes all the wages earned and the tax withheld from an employee and prepares a form W-2. Form W-2 is the starting point for completing Form 1040.
II. LO 2 – Calculate Federal Income Tax Withholding, Social Security, and Medicare Taxes on Wages and Tips.
A. Income tax withholding from wages (Publication 15 – Circular E provides detailed information on federal withholding taxes)
1. The employer is required to withhold taxes from each employee according to the filing status and withholding allowances claimed on Form W-4.
2. The IRS no longer requires employers to provide information on employees who claim more than 10 allowances but does require the employer to provide this information if requested.
B. Two withholding methods (See Appendix A for withholding tables)
1. Percentage method – uses the allowances filed with Form W-4
a. Multiply the number of allowance claimed by the employee on Form W-4 by the allowance amount found in the table.
· 2006, annual allowance = $3,300. Divide this amount by the number of pay periods. Example for a weekly payroll: $3,300 / 52 weeks = $63.46 per allowance.
b. Subtract the allowance amount from the employee’s gross wages for the period.
c. Determine the amount of withholding using the tables provided by the IRS in Circular E.
2. Wage bracket method
a. Do not deduct withholding allowances before using the table.
b. Find the table amount for the appropriate pay period and filing status.
c. On the left side of the tables are the wage ranges and on the top across the table is the number of withholding allowances.
d. The amount of tax to withhold is the intersection of wage and allowances.
In-class Example – Taxpayer is married with five withholding allowances earning $1,000 per week for annual gross earnings of $52,000.
Method 1:
· $63.46 x 5 = $317.30
· $1,000 - $317.30 = $682.70
· $682.70 - $440.00 = $242.70 x 15% = $36.41 + $28.60= $65.01
o Using Table 1 from the Percentage Withholding Table for married persons
Method 2:
· Find the chart for Weekly payroll and Married persons
· Find $1,000 on the left side and match with 5 withholding allowances across the top of the table. The intersection is at $66.
Regardless of whether method 1 or 2 is used, the results should be approximately the same.
To check this out, use Table 7 in the percentage withholding chart for the annual wages.
· $52,000 - $16,500 = $35,500
· $35,500 - $22,900 = $12,600 x 15% = $1,490 + $1,890 = $3,380
Compare with the weekly withholding amount: $65.01 x 52 weeks = $3,380.52
C. FICA Taxes - social security and Medicare tax withholding
1. Social security – Old age, survivors, and disability insurance (OASDI) is 6.2% on the first $94,200 of wages in 2006.
2. Medicare – 1.45% on all wages in 2006.
3. Employer must match the amounts withheld from employees for FICA.
In-class Example – Using the same data from the above example, the calculations for FICA are as follows:
· Social security = $52,000 x 6.2% = $3,224.00
· Medicare = $52,000 x 1.45% = $754.00
· Employer share is $3,224.00 + $754.00 = $3,978.
What happens with the employee makes more than $94,200? Assume taxpayer earns $100,000 for 2006.
· Social security = $94,200 x 6.2% = $5,840.40
· Medicare = $100,000 x 1.45% = $1,450.00
· Employer share is $7,290.40
D. Tips - Employees are required to report cash tips to their employer by the 10th of the month after the month in which the employee receives the tips. Employees use Form 4070 to report tips. If tips are less than $20 in one month from any one job, no reporting is required.
E. Large food and beverage establishments may be required to “allocate” tips to employees. Defined as an establishment with more than 10 employees on a typical business day during the preceding year where tipping is customary.
1. If tipped employees do not report tips in an amount at least 8% of gross receipts, the employer must allocate the difference to the employees on Form 8027.
· Employers are not required to withhold income, Social Security, or Medicare taxes on allocated tips. They will be recorded on Form W-2
III. LO 3 – Describe the Rules for Reporting and Paying Payroll Taxes
A. Payment of Payroll Taxes – Federal tax deposits are made either using a federal depository financial institution or through the Electronic Federal Tax Payment System (EFTPS).
B. Deposits are made on a monthly or semiweekly basis based on a “lookback” period. For 2006, the lookback period runs from the quarters starting July 1, 2004 through June 30, 2005.
1. If total payroll taxes were $50,000 or less during this time, the employer is a monthly depositor; otherwise it is a semiweekly depositor.
C. Semiweekly depositors remit taxes according to this schedule:
1. Payrolls paid on a Wednesday, Thursday, or Friday must be deposited by the following Wednesday.
2. Payrolls paid on a Saturday, Sunday, Monday, or Tuesday must be deposited by the following Friday.
D. If an employer accumulates $100,000 or more in taxes on any day during a deposit period, they must deposit the tax by the next banking day.
1. Once an employer accumulates $100,000 in any one day, they become a semimonthly depositor for the remainder of the year and the next year.
In-class Example – A company has the following lookback amounts:
7/1/04 – 9/30/04 $ 6,300
10/1/04 – 12/31/04 $10,700
1/1/05 – 3/31/05 $15,100
4/1/05 – 6/30/05 $16,900
Total liability: $49,000
The company is considered to be a monthly depositor for 2006.
What if, on Wednesday, August 16, 2006, there was $101,000 of accumulated payroll tax liability.
· When is the tax deposit due? The next banking day-8/17/06
· Is the company still a monthly depositor? No, the company is now a semi-weekly depositor for the remainder of 2006 and all of 2007.
E. Deposit Penalties - A progressive penalty is assessed on taxes which have not been timely or completely deposited. The penalties range from 2% to 15%.
1. Penalties are strictly enforced because employers have a fiduciary responsibility to remit employee taxes in a timely fashion.
F. Reporting Payroll Taxes and Form 941
1. Form 941 is completed by the employer every quarter and is a summarization of FICA and federal withholding taxes.
2. At year end, Form 941 is used to reconcile annual payroll amounts.
IV. LO 4 – Calculate Self-employment taxes, unemployment taxes, Form 940, taxes for household employees, and Schedule H.
A. Self-employment tax - Based on net earnings generated by a business where the sole proprietor pays both the employee and employer share. The taxable base is 92.35% of the net earnings subject to tax.
1. Self-employed taxpayers are allowed a 50% deduction for self-employment tax in determining adjusted gross income.
2. Special situation where the self-employed taxpayer also has a regular job where he/she has W-2 income.
In-class Example – A taxpayer works as an accountant for a company and earns $86,000. She is also a sole proprietor in a small tax practice where she earned $15,000 in 2006.
Calculate the self-employment tax in this special situation.
· Calculate net earnings from self-employment.
o $15,000 x 92.35% = $13,852.50
· Figure the amount of wages to be taxed for Social Security
o $94,200 - $86,000 = $8,200
· Calculate Social Security = $8,200 x 12.4% = $1,016.80
· Calculate Medicare = $15,000 x 2.9% = $401.72
Total Schedule SE taxes= $1,418.52; deduction for AGI = $1,418.52 / 2 = $709.26 on Line 27 on Form 1040; and Net earnings from self-employment = $15,000 on Schedule C.
B. Unemployment taxes – The Social Security Act of 1935 required every state to institute an unemployment compensation program to provide payments to people during temporary periods of unemployment. The actual payments made come from the state unemployment program while the federal program is more administrative.
C. Employers are subject to FUTA if either of these criteria apply:
1. They paid wages of $1,500 or more in any calendar quarter in the current or preceding calendar year, or
2. The employer had one or more employees in any 20 different weeks in the current or preceding calendar year.
D. The rate is 6.2% of employee wages up to $7,000. The employer receives a credit of 5.4% if they pay into their state programs; bringing the federal rate to 0.8%. Form 940 is prepared at the end of the year to summarize the four quarters of FUTA liability and deposits.
1. If the employer is late in depositing funds into the state unemployment program, the credit is limited to 10% of the amount of deposit that would have been allowed as a credit.
In-class Example - $50,000 wages subject to SUTA and FUTA.
$50,000 x 6.2% = $3,100
$50,000 x 5.4% = $2,700
FUTA tax $ 400
What if, the company did not make the SUTA payments on a timely basis?
$50,000 x 6.2% = $3,100
$2,700 x 90% = $2,430
FUTA tax $ 670
E. Deposits are made on a quarterly basis and are deposited with a federal depository institution or through EFTPS payments. If the liability is less than $500, the amount can be carried to the next quarter but must be paid when filing the annual 940.
F. Household Employees
1. Individuals employing household workers are subject to payroll tax rules if any of the following are true:
a. They paid any one household employee wages of $1,400 or more in 2006.
b. Federal income taxes were withheld from employee wages.
c. Household wages of at least $1,000 were paid to all household workers combined in any calendar quarter in 2005 or 2006.
2. Household workers do not include the taxpayer’s spouse, father or mother, children under 21, or anyone under age 18 unless providing household services is his or her primary occupation.
3. Household workers may be classified as independent contractors if they work for more than one individual.
4. Schedule H is filed by the employer/taxpayer and this schedule is attached with the taxpayer’s Form 1040.
V. LO 5 – Determine employer payroll reporting requirements including Forms W-2 and W-3.
A. Employer payroll reporting to employees
1. Form W-2 is a multipart form that summarizes the individual employee’s wages and taxes for the year.
2. Copy A of the form is sent by the employer to the Social Security Administration no later than February 27, 2007. Form W-3 is the transmittal form sent with Copy A.
3. Forms W-2c and W-3c are used to correct an employee’s payroll information.
4. There are employer penalties ranging from $15 per return to $100 per return for incorrect or missing information on the W-2.
VI. LO 6 – Explain supplemental wage payments, backup withholding, Form W-9, estimated tax payments, and Form 1040-ES
A. Supplemental wage payments - Compensation paid in addition to an employee’s regular wages and include vacation pay, commissions, bonuses, accumulated sick pay, severance pay, taxable fringe benefits, and expense allowances paid under a non-accountable plan.
B. Two methods are available to figure the tax withholding on the supplemental payments. The first method is used if taxes are withheld from the employee’s wages and the second method is used when taxes are not withheld from the employee’s wages. Regardless of the method used to withhold income tax on supplemental wages, the wages are also subject to FICA and FUTA taxes.
In-class Example – A married taxpayer has a base salary of $3,000, is paid on the first of every month, claims zero withholding allowances, and has $291 of federal withholding taxes deducted.