Lesson 6 - Managing payroll to withhold the correct amount of taxes
Small Business Tax Workshop

    Overview

    Welcome everyone to Managing Payroll to Withhold the Correct Amount of Taxes.

    In this workshop we'll discuss your responsibilities as an employer to identify wages that are subject to employment taxes.

    We'll explain the difference between an accountable plan and a non-accountable plan.

    And we'll show you how to calculate your payroll taxes using the appropriate method.

    We will also discuss federal unemployment taxes.

    In the first part of this workshop, we'll discuss the employment tax rules for wages and other types of compensation.

    We’ll answer questions like “what exactly are wages,” and “does all compensation or payments to employees count as wages?”

    Wages and Calculating Payroll

    These payments may be in cash or in other forms. Salaries, vacation pay, bonuses, commissions, and certain fringe benefits, are some examples of amounts that you include in wages for employment tax purposes.

    Calculating Payroll

    There are very specific rules for various types of employees.

    That is for tipped employees, employees who work for nonprofits, and for farm workers.

    Because you only need that information if you have one of those types of employees, we want to give you the opportunity to skip a section that may not apply to you.

    So please choose one of the following as it pertains to your business: choose one if your employees receive tips; select two if your business is a non-profit; and choose three if you employ farmworkers.

    Calculating Payroll: Tips

    Many employees received tips.

    Tips are taxable income and the tips employees receive from customers or other employees are generally subject to withholding. By the 10th of each month, your employees must report to you the tips they received in the prior month. For example, if employees receive tips in April, they would report them to you by May 10.

    This includes cash tips, as well as tips charged on credit or debit cards, or two accounts. If your employees receive tips, Form 4070, Employee's Report of Tips to Employer, is a great tool to give them to assist in their reporting requirements.

    Form 4070 can be found in IRS Publication 1244, Employee's Daily Record of Tips and Report to Employer.

    In addition to the Form 4070, there is also a daily log employees can complete as well as helpful instructions for recording and reporting tip income. Additionally, with the enforcement of Revenue Ruling 2012-18, employees are instructed not to write in their tip diary the amount of any service charge that the employer adds to a customer's bill and then pays to the employee. Service charges — auto gratuities — are wages, not a tip.

    For more information see IRS Publication 531, Reporting Tip Income.

    Allocated Tips

    Employers of large food and beverage establishments use the Form 8027 to annually report receipts and tips to determine allocated tips for tipped employees.

    Some employees may receive allocated tips.

    Generally the amount allocated is the difference between the total tips reported by employees and 8 percent of the gross receipts.

    These are tips you assign to an employee in addition to the tips the employee reported to you for the year.

    No income, Social Security, Medicare, additional Medicare, or railroad retirement taxes, are withheld on allocated tips.

    Show the allocated tips separately in box 8 on Form W-2.

    Do not include allocated tips in box 1 with wages and reported tips. IRS Publication 531, Reporting Tip Income, as well as the instructions for the Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips, can give you more guidance on allocated tips.

    Calculating allocated tips can be a difficult process but the IRS can help make it easier.

    Tip Rate and Education Program

    If your employees receive tips, you can participate in the tip rate determination and education program.

    The IRS has several voluntary tip agreements to help employers and employees understand and meet their tip reporting responsibilities.

    The two most common agreements are the tip rate determination agreement — or TRDA — and the gaming industry tip compliance agreement — or GITCA. Again see IRS Publication 531, for more information.

    Calculating Payroll: Non-Profits

    Although nonprofit organizations are usually exempt from income tax, their employees are not.

    You must withhold income tax from the pay of your employees.

    However there are special rules for Social Security taxes, Medicare taxes, and federal unemployment taxes for employees of nonprofit organizations.

    For more information see the employees of exempt organizations section of IRS Publication 15 A, Employer's Supplemental Tax Guide.

    Calculating Payroll: Farm workers

    To report income tax withheld as well as employer and employee Social Security and Medicare taxes on farm workers, use Form 943, Employer's Annual Federal Tax Return for Agricultural Employees. See IRS Publication 51, Agricultural Employer's Tax Guide, and IRS Publication 225, Farmer’s Tax Guide, for more information.

    Calculating Withholding

    To ensure that you are withholding the correct amount, you'll first need to know the total amount of compensation, benefits, and any supplemental wages included in each employee's wages for the pay period.

    Supplemental wages are wage payments to an employee that aren't regular wages, including but not limited to: bonuses, commissions, overtime pay, payments for accumulated sick leave, severance pay, awards, prizes, backpay retroactive pay increases, payments for non deductible moving expenses, taxable fringe benefits, and expenses paid under a non-accountable plan.

    How you would withhold on the supplemental wages depends on whether the supplemental payment is identified as a separate payment from the regular wages.

    For additional information on withholding on supplemental wages.

    See the supplemental wages section of IRS Publication 15 A, Employer's Supplemental Tax Guide. Next, you'll need to calculate the amount of income tax to withhold from each employee.

    The two most common methods are the wage bracket method and the percentage method.

    Calculating Withholding: Wage Bracket Method

    Under the wage bracket method, you simply locate an IRS Publication 15-T the proper table for your payroll period and the employee's marital status as shown on the employee's Form W-4.

    Then look at the employee's Form W-4 for the number of withholding allowances claimed.

    Using the number of allowances claimed on the Form W-4, and the amount of taxable wages paid, follow the column and row to find the amount of tax to withhold.

    For withholding computations for employees claiming more than 10 withholding allowances, you will need to refer to the special wage bracket instructions in IRS Publication 15-T.

    Calculating Withholding: Percentage Method

    If the employee's wages are greater than the amount in the last wage bracket of the wage tables, or if you do not want to use the wage bracket tables, you can use the percentage method.

    This method works for any number of withholding allowances the employee claims on any amount of wages.

    To calculate withholding by the percentage method, you will again use IRS Publication 15-T. Using the percentage method table, multiply 1 withholding allowance for your payroll period by the number of allowances the employee claims on the Form W-4.

    Then subtract that amount from the employee's wages.

    Next find the amount to withhold from the tables for the percentage method of withholding.

    Understanding wages for employment tax purposes is not easy.

    Remember to start with IRS Publication 15, to answer most of your questions related to compensation.

    Other Withholding - Social Security, Medicare, and Additional Medicare Taxes

    You are also responsible for withholding the employee share of Social Security and Medicare taxes, as well as additional Medicare as required by law.

    The Form W-4 information does not affect Social Security and Medicare taxes. To calculate Social Security and Medicare taxes, simply multiply the total wage by the applicable employee Social Security and Medicare tax percentages.

    You can find the current employee rate for Social Security in Publication 15 and on their web site at www.ssa.gov.

    As an employer, you also pay a matching amount.

    In addition each year the amount of wages subject to Social Security withholding changes.

    You do not have to withhold or match any more Social Security taxes once the employees wages you have paid reached that limit.

    This is known as the wage base limit and this limit is published annually in IRS Publication 15.

    The employee tax rate for Medicare tax can be found in IRS Publication 15 and on the SSA website at www.ssa.gov.

    There is no wage limit for Medicare taxes so all wages are subject to withholding and just like Social Security taxes, you as the employer must pay a matching amount.

    Generally you compute all payroll deductions on the gross pay of each employee.

    However as your business grows there may be portions of an employee's pay such as certain contributions to retirement plans that are not subject to some or all of these taxes.

    Additional Medicare Tax Withholding

    The employee tax rate for additional Medicare tax is an employee only tax that begins when wages paid to an employee exceed a certain amount.

    Both the tax rate and the wage threshold are detailed in IRS Publication 15.

    As an employer you are responsible for withholding additional Medicare tax when an employee meets this threshold, but you do not have an employer matching share to pay.

    Taxes on Employee Tips

    Taxes will also have to be collected on tip income too.

    As an employer you must collect income tax, employee Social Security tax, employee Medicare tax, and additional Medicare tax if applicable on tip income.

    You can collect these taxes from wages or from other funds your employee makes available.

    If the employee receives regular wages and reports tips, calculate income tax as if the tips were supplemental wages or part of regular wages.

    If you have not withheld income tax from the regular wages because the wages were too low, add the tips to the regular wages and withhold income tax based on the total.

    But if you withhold income tax from the regular wages, then you have two options available.

    You can withhold a flat 22 percent for tax year after 2017, or you can add the tips and the regular wages for the most recent payroll period and calculate the income tax withholding as if the total were a single payment.

    Then subtract the tax already withheld from the regular wages and withhold the remaining tax from the tips.

    As the employer you’re responsible for the employer's Social Security tax on wages and tips until the wages — including tips — reach the limit.

    You are responsible for the employer Medicare tax for the whole year on all wages and tips.

    If the employee's income is below the 22 percent income tax bracket, calculating their tax using the 22 percent flat rate may mean that you're withholding a lot more tax than is necessary.

    This could cause a hardship for the employee.

    So try to consider this before using the flat 22 percent withholding method.

    Tax on Employee Tips - Withholding

    There may be times when an employee's regular wages may not be enough for you to withhold all the tax owed on the regular pay, plus reported tips.

    If there is not enough money to cover all the taxes, withhold taxes in this order: all taxes on regular pay, then Social Security, Medicare, and additional Medicare taxes on reported tips, and finally income taxes on reported tips.

    Withhold any remaining unpaid federal income taxes from the employee's next paycheck up to the close of the calendar year.

    However if you can't collect all of the employee's Social Security and Medicare taxes on tips by the 10th day of the month following the month in which your employee reported the tips you don't have to collect the taxes.

    Be sure to show the uncollected amount as an adjustment on your employment tax return and include the uncollected Social Security and Medicare taxes in the appropriate box on the employee's Form W-2, Wage and Tax Statement.

    But don't show any uncollected additional Medicare tax on Form W-2.

    You may want to inform your tipped employees that if all the federal income taxes and additional Medicare tax on their wages and tips won't be collected by the end of the year, they may need to make estimated tax payments.

    If an employee doesn't pay enough tax throughout the year either through withholding or by making estimated tax payments, the employees may be subject to a penalty for underpayment of estimated taxes.

    Note that when it comes to withholding taxes there is no difference between full or part-time employees and it does not matter if the worker has another job.

    You are only responsible for knowing when the employee meets the wage base for the wages you have paid them regardless of their wages earned at another job.

    There are exceptions however when you take over an existing business.

    If you acquire an existing business you may include the wages paid by the previous employer to your employee's wages when you calculate their annual wage limit for Social Security tax purposes.

    IRS Publication 15 has more information on this topic in the section Successor Employers.

    Federal Unemployment Tax Act (FUTA)

    Let's talk about the Federal Unemployment Tax Act or FUTA.

    FUTA directs the states and the federal government to make and to run the unemployment tax program which provides unemployment payments to workers who have lost their jobs.

    The various states create the actual employment insurance systems and the federal government approves the state laws and pays the administrative cost of the state programs.

    Because this is a joint program between the state and federal governments, you are first subject to the state tax.

    Then this tax becomes a credit against the federal tax.

    In your state you may even be exempt from the tax but you still have to pay the federal tax.

    Conversely, you may not owe FUTA tax but you still need to pay the state.

    Unlike other payroll taxes this tax is the sole responsibility of the employer.

    It is not deducted from the employee's paycheck.

    You are an employer for FUTA tax purposes and must file and pay the tax if, in the current year or last year, you paid wages of $1,500 or more in any calendar quarter to employees or had one or more employees at any time in each of the 20 or more weeks.

    The 20 weeks do not have to be full or consecutive weeks.

    Count all regular temporary and  part-time employees, including employees on vacation or sick leave.

    Not all employee wages are subject to FUTA tax.

    There are exceptions for certain employers as well as certain types of employees.

    For more information refer to the table: Special Rules for Various Types of Services and Payments, in IRS Publication 15.

    FUTA Tax – Household Workers

    For household workers you are subject to FUTA tax only if you paid total cash wages of a $1,000 or more for all household employees in any calendar quarter in the current or prior year.

    A household worker is an employee who performs household work in a private home, local college club, or local fraternity, or sorority chapter.

    Calculating FUTA Tax

    Here is how the FUTA tax is calculated.

    Currently the FUTA tax rate is 6 percent.

    FUTA tax is figured on the first $7,000 in wages paid to each employee during the year.

    Be sure to always check IRS.gov for the current tax rates.

    The tax is imposed on you as the employer. Do not collect it or deduct from your employee's wages.

    You can take a tax credit of up to 5.4 percent against FUTA tax for the amounts you paid into state unemployment funds resulting in a net tax rate of .6%.

    But you can only take this credit in full if the taxes are paid to the state on time.

    There is also something called a credit reduction state.

    In some states the credit of 5.4% is reduced.

    See the instructions for Form 940 for current year credit reduction states.

    Also see IRS publications 15 and 15-A, for more information on the FUTA tax as well as the current rate.

    Remember this tax is the sole responsibility of the employer.

    It is not deducted from the employee's paycheck.

    FUTA Tax Example

    Here is an example: let's say late last year you hired Frank and you paid him $3,500 in wages before the year ended.

    All of the $3,500 was subject to the FUTA tax at a rate of 6 percent.

    Assuming you were eligible for the maximum FUTA state tax credit and all the required state contributions were paid on time, your tax on Frank’s wages would have been $21.

    Then let's say a few months into the beginning of this year Frank's total wages for the year reached $7,000.

    None of the wages you pay him after that are subject to the FUTA tax for the rest of the year.

    Let's say though that Frank quits his job and Nancy replaces him.

    The first $7,000 you pay Nancy this year is also subject to the FUTA tax. Remember, with the first $7,000 you pay each employee each year subject to the FUTA tax, the FUTA tax you would pay is $42 for Frank’s wages and $42 for Nancy's wages.

    Your total FUTA tax this year is $84.

    Small business employers file Form 940, Employer's Annual Federal Unemployment Tax Return to report FUTA tax.

    The due date to deposit FUTA tax for the first quarter is April 30th.

    Due date for the second quarter is July 31st.

    The third quarter is October 31st and the due date for the fourth quarter is January 31st.

    If your liability for the fourth quarter, plus any amount not deposited from an earlier quarter is over $500, deposit the entire amount by the due date of Form 940: January 31st.

    If it is $500 or less you can either make a deposit or pay the tax with your Form 940 by January 31st.

    Summary

    But before we end let's look at what we've covered.

    We identified wages that are subject to employment taxes, learned about accountable and non — accountable plans, and discussed how to calculate your payroll.

    We've also defined wages subject to FUTA tax, figured the FUTA tax due, and described the deposit requirements for this tax.

    Thank you for joining us for this lesson and best wishes on your business.

    Employer’s Federal Unemployment Tax Return

    Some states may require that you file unemployment taxes at various times throughout the year.

    But the federal unemployment tax return is filed annually.

    The due date for the Form 940 is January 31.

    If you have deposited all of your FUTA tax on time however, you are given until February 10th to file.

    As with all due dates, if the date falls on a Saturday, Sunday, or a federal holiday, you can file on the next business day.

    As you've learned with employment taxes, FUTA tax also has rules on when you must deposit taxes.

    If at the end of any calendar quarter you owe, but have not yet deposited, more than  $500 in FUTA tax, you must deposit the FUTA tax by the last day of the first month after the quarter ends.

    If the accumulated tax at the end of any of the first three quarters is $500 or less, you do not have to deposit the amount. Instead, you may carry it forward and add it to the liability calculated in the next quarter to see if you must make a deposit.

    Remember all of this information is in IRS Publication 15.

    FUTA Tax- Farm Workers

    For farm workers you are subject to FUTA tax on the wages you pay to farm workers, if you paid cash wages of $20,000 or more during any calendar quarter in the current or prior year, or if you employ ten or more farm workers at least some or part of a day — whether or not at the same time — during any 20 or more different weeks in the current or prior year.

    Which best describes your employees and business?