Chapter 4 Payroll Acct.

Bernard J. Bieg and Judith A.
Toland
PAYROLL
ACCOUNTING 2016
2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom
Income Tax Withholding

Chapter 4
2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Learning Objectives
1.
2.
Explain coverage under the Federal

Income Tax (FIT) Withholding Law by
determining: (a) the employeremployee relationship, (b) the kinds of
payments defined as wages, and (c)
the kinds of pretax salary reductions.
Explain: (a) the types of withholding
allowances that may be claimed by
employees for income tax withholding
and (b) the purpose and use of Form
W-4
Learning Objectives
(cont.)
3.
4.
Compute the amount of federal income tax to

be withheld using: (a) the percentage method;
(b) the wage-bracket method; (c) alternative
methods such as quarterly averaging,
annualizing of wages, and part-year
employment; and (d) withholding of federal
income taxes on supplementary wage
payments.
Explain: (a) Form W-2, (b) the completion of
Form 941, Employers Quarterly Federal
Tax Return, (c) major types of information
returns, and (d) the impact of state and local
income taxes on the payroll accounting process.
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
LO-1
Coverage Under FIT

Withholding Laws (cont.)
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)
LO-1
Coverage Under FIT

Withholding Laws (cont.)
Tips
Cash
awards
See Figure 4.1for other types of
taxable payments
LO-1
Figure 4.1
Taxable Payments to
Employees
LO-1
Figure 4.1(cont.)
LO-1
Fringe Benefits
Noncash
fringe benefits treated

as compensation
Employer must withhold FIT unless
specifically excluded
Examples of noncash fringe include
Tickets to athletic events

Athletic club membership
Personal use of corporate car
Frequent flier miles
Stock options (when option exercised)
LO-1
Fringe Benefits (cont.)

Specifically excluded fringe benefits
include
Qualified employee discounts
Reduced tuition, meals & lodging if for employer
benefit
De minimis fringe benefits (like personal use of
corporate cell phone)
Complete list found on page 4-4 or consult
Publication 15 (Circular E), Employers Tax Guide
http://www.irs.gov/pub/irs-pdf/p15.pdf
LO-1
How to Withhold FIT on

Fringe Benefits
Value
and withhold like supplemental

wages (flat 25%)
Employer must figure value of fringe
benefits no later than 1/31 (except if use
special period rule)
Value
and add to regular pay - treat as

one paycheck and withhold accordingly
Flexible reporting option of treating
benefits as being paid on one or more dates
in the same calendar year, even if benefit
received at one time
LO-1
How to Withhold FIT on

Fringe Benefits (cont.)
For example, can add entire $2,000
value of country club membership or
add $500 on each of 4 paychecks
then calculate withholding
accordingly
Note: Employer can choose not to
withhold FIT on employees personal
use of corporate car
LO-1
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 allocated tips - only
reported tips
Tip allocation can be done one of
LO-1
three methods hours worked, gross
FIT Withholding on Tips

(cont.)
What
if taxes withheld > hourly

wages to be paid?
For example blackjack dealer in South
Lake Tahoe reports tips = $2,000 for one
week; her FIT/FICA withholding will
exceed her gross paycheck
In that situation, she gets no paycheck
and pays quarterly estimated tax
payments or
Can pay balance of tax when she
files1040 tax return
LO-1
Traveling Expenses
Travel
reimbursements made to an
employee, paid under an accountable
plan, are not subject to FIT withholding
An accountable plan is an IRS-approved plan;
must meet three rules
Business connected
Adequate accounting within reasonable time period
Employee returns advanced cash in excess of
substantiated expenses
If there is not a plan in place, travel

reimbursements are made under a nonaccountable plan and considered wages
Therefore employer must withhold FIT
LO-1
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 (also applies
to down-sized employees)
Qualified moving expense reimbursements

Transportation in a commuter highway
vehicle/transit pass up to $130/month value
See Figure 4.2, pg. 4-6 for comprehensive list of
exempt payments
LO-1
Figure 4.2
Exempt Payments
Figure 4.2 (continued)
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
LO-1
Cafeteria Plans, Potential

Benefits
LO-1
Pretax Salary Reductions

are Exempt from FIT
(cont.)
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 highLO-1

deductible insurance plans
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 4-8 for
annual contribution amounts)
LO-1
Tax Deferred Retirement

Accounts
LO-1
Tax-Deferred Retirement
Contributions Exempt from FIT (cont.)
Individual
Retirement Accounts
(IRA)
In 2015, depending upon certain
conditions, an employee can
contribute lesser of $5,500 or 100%
of earned income pretax to a
retirement account
If made through payroll deductions,
generally employer does not need to
comply with ERISA as long as certain
guidelines are met
LO-1
Roth IRAs are used for nondeductible
How Much to Withhold for

FIT
Best for employee if FIT withholding =
tax liability (Goal is no refund and no
tax due)
Employee completes W-4
See W-4 (Employees Withholding
Allowance Certificate) in Figure 4.3 (page
4-11)
The W-4 identifies number of withholding
allowances; employee can take:
One allowance for self (if not claimed

by other person) and one allowance
LO-2
for each dependent
How Much to Withhold for

FIT
Special allowances such as itemized
deductions, other compensation, tax
credits, etc. - use worksheet on
back of W-4 to calculate
Employer must retain W-4 as long as
its in effect and for four years
thereafter
LO-2
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 of Form W-4)
A: couples with both spouses employed or

a married employee with more than one
employer may elect to have her/his federal
withholding computed at the single rate to
increase the amount of income tax
withheld.
NOTE: IRS doesnt pay interest on over withheld
LO-2
Completing Form W-4

(cont.)
Line 3
LO-2
Completing Form W-4

(cont.)
Exempt
status
Can claim if taxpayer had no income

tax liability last year and none
expected this year (line 7 of Form W4)
LO-2
Completing Form W-4

(cont.)
Line 7
LO-2
Completing Form W-4

(cont.)
Valid for one year and must be
reclaimed each year
Cant claim exempt if:
Dependent on someone elses tax return
and
Income exceeds $1,050 (including more
than $350 unearned income)
Or if unearned income < $350, but total
income >$6,300
Some individuals are automatically

exempt
LO-2
Note: Never advise employee as to
Other Situations on W-4

If employee doesnt provide a
completed W-4, employer must
withhold as if single and zero
allowances (highest rate)
Employee can change W-4
When employer receives amended W-4,
has 30 days to change
Employee must change within 10 days
for decrease in # of allowances
If theres an increase in # of allowances,
can change or leave in effect
LO-2
Other Situations on W-4

(cont.)
Additional/voluntary withholding
agreements
Can effect additional FIT withholding by
either reducing number of withholding
allowances or request specific additional
amount be withheld on line 6
Employer can establish electronic W4 system, but must provide paper

option if employee requests
Unauthorized changes/additions
invalidate W-4
Employers should submit W-4s to IRS LO-2
FIT Withholding on Other

Income Sources
Pensions
(W-4P) in excess of
$20,640 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 benefits, by
LO-2
completing a W-4V
Employer Calculates FIT

Withholding
Textbook used 2015 tax tables for
FIT rates
Use either wage-bracket method
(easiest) or
Percentage method (only use if one
of the following situations apply)
Highly compensated individual
Compensated annually or semiannually
Need to know
Single/married, how often paid, gross pay
LO-3
and # of allowances
Note: also other methods, rarely used,
Example #1
Calculating FIT
Withholding
FACTS: Nonis annual salary is

$40,144 she is paid biweekly and
her W-4 shows Married with 4.
What is her FIT withholding?
Biweekly gross $40,144/26 =
$1,544.00
Can use wage bracket tables to
look up married, biweekly and 4
allowances
LO-3
FIT withholding = $60
Example #2
Calculating FIT
Withholding
FACTS: John earns an annual salary of
$84,400 and is paid biweekly. His W-4 shows
Married with 1. What is his FIT withholding?
Biweekly gross is $84,400/26 = $3,246.15
Must use percentage method
Steps to percentage method:
Subtract allowance amount * (biweekly allowance
for1) from gross
$3,246.15 - $153.80* = $3,092.35
FIT equals $70.90 + (.15)($3,092.35 - $1,040.00 =

$378.75
*From Table of Allowances found in Appendix
LO-3
Example #3
Calculating FIT
Withholding
FACTS: Maggie earns an annual salary of
$336,000 and is paid monthly. Her W-4
shows Married with 2 . What is FIT
withholding?
Monthly gross is $336,000/12 = $28,000
Steps:
Subtract allowance amount (monthly allowance
for 2) from gross
$28,000 (2 x $333.30) = $27,333.40
FIT equals $4,298.17 + (.33)($27,333.40 $19,921 = $6,744.26
LO-3
Example #4
Calculating FIT
Withholding
FACTS: Belinda earns a monthly

salary of $3,000 and is paid
biweekly. Her W-4 says Single
with 2. What is her FIT
withholding?
Annualize salary $3,000 x 12 =
$36,000
Biweekly gross $36,000/26 =
$1,384.62
LO-3
Can use wage bracket tables to
Example #5
Calculating FIT
Withholding
FACTS: Ferharts annual salary is $485,000
he is paid semimonthly. His W-4 says Married
with 4. What is his FIT withholding?
Semimonthly gross is $485,000/24 =
$20,208.33
Steps:
Subtract allowance amounts (semimonthly
allowance for 4) from gross
$20,208.33 (4 x $166.70) = $19,541.53
FIT equals $4,638.53 + (.35)($19,541.53 $17,504) = $5,351.67

LO-3
Supplemental Wages
Withholding
Examples
include
Vacation pay (treated differently

than other supplemental wages)
Severance pay, bonuses and
commissions
How
to withhold
With regular pay (treat as one

paycheck and withhold accordingly)
Except if amount indicated separately
(then use flat rates see below)
LO-3
Supplemental Wages
Withholding (cont.)
or
Paid separately
Method A Add supplemental and regular
wages from recent payroll; calculate FIT as if it
were single regular payroll payment
Method B - 25% flat supplemental withholding
(39.6% for amounts in excess of $1,000,000)
LO-3
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
LO-3
Gross-Up Supplemental
Wages (cont.)
To
do: Must divide desired net

check by [1.00 tax rates]
FIT tax rate
= 0.25
OASDI tax rate
= 0.062
HI tax rate
= 0.0145
$700/[1.00 (0.25 + 0.062 + 0.0145)] =
$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!
LO-3
Wages and Tax Statement

(W-2)
Employers required to furnish Form
W-2 to employees (and also must
send copies to federal and
state/local governments
Reports wages and withholding taxes
Instructions for completing in Figure 4.8
(pages 4-23 and 4-24)
Hard copy to employee on or before 1/31
or
Can post on secure web site so employee
can access individual W-2
LO-4
Wages and Tax Statement

(W-2) (cont.)
If issuing 250+ W-2s, must use magnetic
media and have until 3/31
Can request extension of time via FIRE at
http://fire.irs.gov
W-3 is transmittal form and 941s

must tie to W-3
Various penalties for filing incorrect
or late W-2s
Must file W-2c and W-3c (if
correcting)
LO-4
Returns Quarterly &

Informational
Quarterly reports of taxable wages
required (see Figure 4.11 and 4.12,
pages 4-27 and 4-28 for major
required returns)
Payroll income tax withholdings reported
on Form 941
Employers must file information

returns to report tax liability for
nonpayroll items such as backup
withholding* and withholding on
gambling winnings, pensions, and
annuities Form 945
LO-4
Figure 4.11
Major Returns Filed by
Employers
LO-4
Figure 4.12
Major Information Returns
LO-4
Returns Quarterly &

Informational (cont.)
1099-MISC with 1096 as transmittal - See
Figure 4.13, page 4-29
Must issue to IC if paid at least $600 and
arent 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
Nonpayroll items (like withholding on
independent contractors, pensions, IRAs, etc. )
reported on Form 945
LO-4
Figure 4.13
Form 1099-MISC
LO-4
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 LO-4
taxes withheld
Withholding State & Local

Income Taxes (cont.)
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

Chapter 4 Payroll Acct.

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Chapter 4 Payroll Acct.

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Bernard J. Bieg and Judith A.

Income Tax Withholding

Explain coverage under the Federal

Compute the amount of federal income tax to

Coverage Under FIT

Coverage Under FIT

wages for FIT withholding

Coverage Under FIT

fringe benefits treated

Tickets to athletic events

Fringe Benefits (cont.)

How to Withhold FIT on

and withhold like supplemental

and add to regular pay - treat as

How to Withhold FIT on

FIT Withholding on Tips

must report tips to

FIT Withholding on Tips

if taxes withheld > hourly

If there is not a plan in place, travel

What is Exempt from FIT

excludes certain payments including

Qualified moving expense reimbursements

Figure 4.2 (continued)

Pretax Salary Reductions

Employee can choose between cash

Cafeteria Plans, Potential

Pretax Salary Reductions

These dollars do not have FIT or FICA

Savings Accounts (HSA)

If employee has high-deductible

Medical Savings Accounts

For small employers that have highLO-1

Tax Deferred Retirement

Roth IRAs are used for nondeductible

How Much to Withhold for

One allowance for self (if not claimed

How Much to Withhold for

Completing Form W-4

A: couples with both spouses employed or

Completing Form W-4

Completing Form W-4

Can claim if taxpayer had no income

Completing Form W-4

Completing Form W-4

Some individuals are automatically

Other Situations on W-4

Other Situations on W-4

Employer can establish electronic W4 system, but must provide paper

FIT Withholding on Other

party payer of sick pay (W-

Employer Calculates FIT

FACTS: Nonis annual salary is

FIT equals $70.90 + (.15)($3,092.35 - $1,040.00 =

FIT equals $4,298.17 + (.33)($27,333.40 $19,921 = $6,744.26

FACTS: Belinda earns a monthly

FIT equals $4,638.53 + (.35)($19,541.53 $17,504) = $5,351.67

Vacation pay (treated differently

With regular pay (treat as one

want to give an employee the

do: Must divide desired net

Note: in many states there is a

Wages and Tax Statement