Chapter 9


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  • Section 9.1 Withholding Methods Employers are required to withhold taxes from the amounts paid to employees as wages. Each employee should complete a Form W-4 to establish their filing status and number of exemptions. Employees may have additional amounts withheld from their wages, which can be authorized on a Form W-4. Single employees with only one job may claim one special withholding allowance. Married employees may also claim the special withholding allowance if the employee has only one job and the spouse does not work or wages earned from a second job, or the spouse’s job, are $1,000 or less. Federal withholding is computed based on gross wages before deduction for Social Security taxes, pension payments, union dues, insurance and other deductions. Most accounting software has the withholding tables in the payroll programs. The withholding tables are included in IRS Publication 15, Circular E, Employer’s Tax Guide. Withholding taxes are required on pension and other deferred income payments. For periodic payments, rates are based on the taxpayer’s withholding certificate as if the payments were additional wages. For nonperiodic payments, the withholding is a flat 10 percent, except for certain distributions that have a required 20 percent withholding. Tips are also subject to taxation. Employers are not required to withhold income, Social Security, or Medicare taxes on allocated tips, but are required to collect those taxes on tips reported by employees. Individuals may be subject to backup withholding on payments such as interest and dividends. The payor must withhold 28 percent for payments made to the taxpayers.
  • Section 9.2 Estimated Payments Self-employed taxpayers must make quarterly estimated tax payments since they are not subject to withholding. Payments are made on April 15, June 15, and September 15 of the tax year and January 15 of the following tax year based on the estimated tax liability for the tax year. Any taxpayer who has estimated tax liability of $1,000 or more (less withholdings) must make quarterly estimated payments. The requirements for the minimum annual payment are as follows: Ninety percent of the tax shown on the current year’s return, or One hundred percent of the tax shown on the preceding year’s return, or Ninety percent of the tax determined by placing taxable income, alternative minimum taxable income, and adjusted self-employment income on an annualized basis. Individuals with adjusted gross income in excess of $150,000 for the previous year must pay 110 percent of 2008 tax for year 2009 to qualify for the safe harbor. The IRS assesses penalties on the underpayment of estimated tax.
  • Section 9.3 The FICA Tax The Federal Insurance Contributions Act (FICA) imposed Social Security taxes. FICA taxes have two parts, Social Security (old age, survivors, and disability insurance) and Medicare (hospital insurance). Both employees and employers pay FICA tax. For 2008, the Social Security (OASDI) tax rate is 6.2 percent on the first $102,000 of wages. The Medicare tax rate for 2008 is 1.45 percent on all wages. The original FICA tax in 1935 was 1 percent on the first $3,000 in earnings. Taxpayers who work for more than one employer could pay more than the maximum amount of FICA taxes. If an overpayment exists, the taxpayer receives a credit on their personal tax return.
  • Section 9.4 Federal Tax Deposit System Employers must make deposits for the withholding taxes. The frequency of deposits, typically monthly or semiweekly, is based on the amounts withheld. The deposit status is determined by using a lookback period, consisting of the four quarters beginning July 1 of the second preceding year and ending June 30 of the prior year. If the attributable FICA and withholdings are $50,000 or less, employers are considered monthly depositors. If the attributable FICA and withholdings are greater than $50,000, employers are semiweekly depositors. A Form 8109 must accompany the deposit. Each quarter, employers must file a Form 941 to report federal income taxes and total taxes for the quarter. The deposits are made to any commercial bank that acts as a federal depository, may be made as electronic funds transfer (EFT) or mailed by the second day before the due date.
  • Section 9.5 Employer Reporting Requirements Form W-2 is used to report wages, tips and other compensation paid to employees. These forms must be furnished to employees by January 31 of the following calendar year. Form W-3 must be filed with the Social Security Administration by February 28 of the year following the calendar year of payment. Also, gambling winnings are reported on a Form W-2G. Form W-3G is sent to the IRS by February 28 of the year following payment. Form 1099 is used to report the earnings of nonemployees. A Form 1096 must be transmitted to the appropriate IRS Service Center by February 28 of the year following the calendar year of payment.
  • Section 9.6 Self-Employment Tax Self-employed taxpayers pay self-employment tax instead of FICA taxes. The individual pays the entire tax. Like the FICA taxes, self-employment taxes consist of a Social Security (OASDI) and a Medicare part. The base rate of $102,000 for Social Security taxes is used for self-employed taxpayers. Individuals with net earnings from self-employment of $400 or more are subject to self-employment tax
  • Section 9.7 The FUTA Tax Employers are required to pay unemployment tax equal to 6.2 percent of an employee’s wages up to $7,000, but a credit is allowed for state unemployment taxes up to 5.4 percent. Therefore, the effective federal tax rate is only .8 percent if the maximum amount of state tax is paid. Employers file a Form 940 or Form 940-EZ and remit payment the same as with withholding taxes.
  • Section 9.8 The Nanny Tax Household employers are not required to pay FICA taxes on cash payments of less than $1,600 paid to any household employee in a calendar year. If the payments exceed $1,700, then the wages are subject to FICA and Medicare taxes. The employer must also pay FUTA tax if more than $1,000 in cash wages are paid to household employees during any calendar quarter. Examples of household employees are babysitters, caretakers, cooks, drivers, gardeners, housekeepers and maids. Under the nanny tax provisions, household employers only have to report FICA and Medicare, federal income tax withholding and FUTA tax once a year. The taxpayer remits the withholdings with their Form 1040. See IRS Publication 926 for more details on the nanny tax.
  • Chapter 9

    1. 1. Income Tax Fundamentals 2010 Gerald E. Whittenburg Martha Altus-Buller 2010 Cengage Learning
    2. 2. <ul><li>Employer calculates income tax withholding from employees’ paychecks based on their Form W-4 </li></ul><ul><ul><li>Pay includes salaries, bonuses, commissions </li></ul></ul><ul><ul><li>W-4 completed by employee, tells employer: </li></ul></ul><ul><ul><ul><li>Number of allowances claimed by employee </li></ul></ul></ul><ul><ul><ul><li>Single, married, or married but withhold tax at higher single rate </li></ul></ul></ul><ul><ul><ul><li>Exempt status – employee can only claim exempt if he/she had no income tax liability last year and expects none this year </li></ul></ul></ul><ul><ul><li>If no W-4 filed, employer must withhold at highest rate </li></ul></ul>2010 Cengage Learning
    3. 3. <ul><li>To compute amount to withhold from pay using percentage method </li></ul><ul><ul><li>Multiply number of allowances found on W-4 by allowance amounts </li></ul></ul><ul><ul><li>Subtract that amount from employee’s gross wages </li></ul></ul><ul><ul><li>Then, use IRS tables to calculate federal income tax based on wages after allowance amounts </li></ul></ul><ul><ul><ul><li>Found in textbook in Appendix C </li></ul></ul></ul><ul><ul><ul><li>IRS also publishes Circular E – “Employer’s Tax Guide” </li></ul></ul></ul>2010 Cengage Learning
    4. 4. <ul><li>Withholding is mandatory on pension and other deferred income payments </li></ul><ul><li>Rates used depend on nature of payment </li></ul><ul><ul><li>Rates on periodic payments based on taxpayer’s W-4 </li></ul></ul><ul><ul><li>FIT withholding at either flat 10% (or 20% for certain distributions) </li></ul></ul>2010 Cengage Learning
    5. 5. <ul><li>If employee reports less than 8% of gross food/beverage sales in tips, then employer must allocate tips </li></ul><ul><ul><li>However, employer is not required to withhold taxes based on allocated tips </li></ul></ul><ul><li>Employer must report employees’ tips to IRS and may allocate using one of four methods </li></ul><ul><ul><li>Gross receipts per employee </li></ul></ul><ul><ul><li>Hours worked by each employee </li></ul></ul><ul><ul><li>Good faith agreement on Employer’s Annual Information Return of Tip Income & Allocated Tips (Form 8027) </li></ul></ul><ul><ul><li>Attributed Tip Income Program – any reasonable method for allocating tips is allowed </li></ul></ul><ul><ul><ul><li>Elected by ‘checking a box’ on Form 8027 </li></ul></ul></ul>2010 Cengage Learning
    6. 6. <ul><li>In some situations, individuals may be subject to flat 28% back-up withholding on interest and dividends (to assure that tax is paid on this income) </li></ul><ul><li>This backup withholding, applied to dividends and interest, is required when: </li></ul><ul><ul><li>Taxpayer does not provide an identification number (SSN) or provides incorrect number </li></ul></ul><ul><ul><li>Taxpayer fails to certify that he/she is not subject to withholding </li></ul></ul><ul><ul><li>IRS informs payor that taxpayer gave incorrect identification number </li></ul></ul><ul><ul><li>IRS informs payor that withholding is mandatory because taxpayer hasn’t complied in the past </li></ul></ul>2010 Cengage Learning
    7. 7. <ul><li>Self-employed taxpayers must make quarterly estimated tax payments if </li></ul><ul><ul><li>Annual payment due for the year is ≥ $1000 (after withholding) </li></ul></ul><ul><ul><li>Quarterly payments due April 15, June 15, September 15, and January 15 of next year </li></ul></ul><ul><li>Total annual estimated payments is lesser of </li></ul><ul><ul><li>90% of current year tax </li></ul></ul><ul><ul><li>or </li></ul></ul><ul><ul><li>100% of prior year tax </li></ul></ul><ul><ul><li>or </li></ul></ul><ul><ul><li>90% of current year TI, AMTI & annualized self employment (SE) income </li></ul></ul><ul><ul><ul><li>Exception: if AGI > $150,000 for prior year, then annual required payment = 110% of prior year tax </li></ul></ul></ul><ul><ul><ul><li>For 2009 only, qualified small business owners get a break on amount required to be paid in for estimated tax payments </li></ul></ul></ul>2010 Cengage Learning
    8. 8. <ul><li>Federal Insurance Contributions Act (FICA) was legislation intended to provide retirement and disability benefits for American workers and their families </li></ul><ul><li>FICA comprised of two taxes </li></ul><ul><ul><li>Social Security - 6.2% of first $106,800 of gross wages </li></ul></ul><ul><ul><li>Medicare - 1.45% of total gross earnings, with no cap </li></ul></ul>2010 Cengage Learning
    9. 9. <ul><li>Example </li></ul><ul><li>Shannon is employed at California SolarTech LLC where her annual salary = $115,000; what is her FICA tax for the current year? How much does her employer match? </li></ul>2010 Cengage Learning
    10. 10. <ul><li>Example </li></ul><ul><li>Shannon is employed at California SolarTech LLC where her annual salary = $115,000; what is her FICA tax for the current year? How much does her employer match? </li></ul><ul><li>Solution </li></ul><ul><li>$106,800 x 6.2% = Social Security tax $6,621.60 </li></ul><ul><li>$115,000 x 1.45% = Medicare tax 1,667.50 </li></ul><ul><li>Total FICA $8,289.10 </li></ul><ul><li>Employer match is the same amount </li></ul>2010 Cengage Learning
    11. 11. <ul><li>If taxpayer has more than one source of income, possible to overpay Social Security taxes </li></ul><ul><ul><li>For example: Renaldo works two jobs and receives wages = $49,000 and $65,000; how much FICA has he overpaid? </li></ul></ul><ul><ul><li>Solution: ($114,000 – 106,800) x 6.2% = $446 overpaid. Taxpayer should then claim the excess against his/her tax liability. </li></ul></ul>2010 Cengage Learning
    12. 12. <ul><li>Employer withholds both income tax and FICA from paychecks </li></ul><ul><li>Must deposit these taxes either monthly or semiweekly (IRS determines by analyzing deposits in lookback period) </li></ul><ul><ul><li>Monthly depositors make deposit by 15th of following month </li></ul></ul><ul><ul><ul><li>All new employers are automatically monthly </li></ul></ul></ul><ul><ul><li>Semiweekly depositors make deposit either Wednesday and/or Friday (depending upon when payroll is run) </li></ul></ul><ul><li>Very small employers with federal payroll tax liabilities of $1,000 or less can file/pay annually by using a Form 944 </li></ul>2010 Cengage Learning
    13. 13. <ul><li>Deposits made either at authorized depository (select banks) with a Form 8109 coupon or may be electronically deposited via Electronic Federal Tax Payment System (EFTPS) </li></ul><ul><ul><li>Some employers must deposit using EFTPS </li></ul></ul><ul><li>Form 941 (Employer’s Quarterly Federal Tax Return) must be accompanied by payroll taxes not yet deposited for quarter </li></ul>Note that if liability is less than $2,500, employer may skip monthly deposits and pay with Form 941 2010 Cengage Learning
    14. 14. <ul><li>Annually, employers must send Wage and Tax Statement (Form W-2) to each employee by 1/31 </li></ul><ul><ul><li>Also, send to Social Security Administration by 2/28 with a Form W-3 transmittal </li></ul></ul><ul><li>W-2 shows gross wages, income tax and FICA withholding and other items with tax ramifications </li></ul><ul><ul><li>Note that not all amounts on W-2 are subject to income tax withholding </li></ul></ul><ul><ul><li>Special rules pertain to employer reimbursements for travel, if there is not an accountable plan in place </li></ul></ul><ul><li>Form W-2G </li></ul><ul><ul><li>Required for gambling winnings </li></ul></ul>2010 Cengage Learning
    15. 15. <ul><li>Annually, employers must complete and send out various Form 1099s for various recipients of certain payments </li></ul><ul><ul><li>Must be mailed to recipients by 1/31 </li></ul></ul><ul><ul><li>Exception: Stockbrokers have until 2/15 to mail 1099-B statements to recipients </li></ul></ul><ul><li>Each kind of 1099 is transmitted by separate Form 1096 </li></ul>2010 Cengage Learning
    16. 16. <ul><li>Self-employment tax is the same as FICA, except self-employed taxpayer pays both shares </li></ul><ul><li>Therefore, rates are: </li></ul><ul><ul><li>Social Security (OASDI) is 12.4% of first $106,800 of net self-employment income </li></ul></ul><ul><ul><li>Medicare is 2.9% on total net self-employment income </li></ul></ul><ul><li>If taxpayer has both W-2 wages and self-employment income, the $106,800 limit applies to the combined earnings </li></ul><ul><ul><li>FICA is not required if net earnings < $400 </li></ul></ul><ul><ul><li>May take a Deduction for AGI for 1/2 of SE tax paid </li></ul></ul>2010 Cengage Learning
    17. 17. <ul><li>Federal Unemployment Tax Act (FUTA) requires employers to pay tax to administer state unemployment programs </li></ul><ul><li>Employer pays 6.2% up to first $7,000 per employee per year </li></ul><ul><ul><li>However credit of up to 5.4% for state unemployment tax is taken against the 6.2% </li></ul></ul><ul><li>Therefore, net FUTA rate = .8% (6.2% - 5.4%) </li></ul><ul><ul><li>Must deposit quarterly if over $500 </li></ul></ul><ul><ul><li>Must file annual report Form 940 </li></ul></ul>2010 Cengage Learning
    18. 18. <ul><li>Provisions in place to simplify reporting process for employers of domestic household workers (full- and part-time) </li></ul><ul><ul><li>Household worker is anyone working in taxpayer’s home, such as cook, housekeeper, etc. </li></ul></ul><ul><li>Household employer must withhold and match FICA on any household worker who earns >= $1,700 in a calendar year </li></ul><ul><ul><li>Must withhold and deposit income taxes for household employees if asked to do so by employee </li></ul></ul><ul><ul><li>Must pay FUTA if employee earns >= $1,000 </li></ul></ul>2010 Cengage Learning
    19. 19. <ul><li>To report, household employer must </li></ul><ul><ul><li>Complete Schedule H annually and attach to 1040 or </li></ul></ul><ul><ul><li>If have non-household workers, may report household employees on Forms 941 and 940 with regular employees </li></ul></ul><ul><li>Must file W-2 for each household employee who earns $1,700 or more a year </li></ul>2010 Cengage Learning
    20. 20. 2010 Cengage Learning