One State, Two State, Three State Withholding

Q. I have a question regarding payroll tax withholding, and personal income tax reporting. When an employee is a resident of state X, but works in state A, B anc C, as a travelling consultant. And where B has reciprocity agreement with state X. What are the employees income tax reporting responsibility. Does the employee have to file income tax in all 4 states, assuming the income threshold is satisfied? Can the employee,claim tax credits for taxes witheld from other states?What are the employer’s state payroll tax responsibility, does the company have to withold payroll taxes based on where the employee is working (A, B, and C)?

A.  This is a great question.  At my day job at Symmetry Software, we try to come up with scenarios like you described that are as difficult as possible to test the accuracy of our withholding calculations.  We have no idea if they really exist outside the theoretical realm.  If this situation is true, we’ll have to add this to the list that we test with for new versions.

To answer your question, yes, no and maybe for both scenarios.  Let’s tackle these situations one at a time.  If an employee is working in a state that has a reciprocal agreement with the state of the employee’s residence, the employer does not withhold, and the employee has no filing obligation in that state.  A good example of this is Indiana and Ohio.  The requirement is that the employee file a certificate of Non-Residence with the employer in the state where they do not live.  Withholding in this situation would only be in the resident state of the employee.  Certain situations cloud this answer but those go beyond the scope of this blog.  You can find copies of these non-resident withholding certificates on StateW4.

As for the other states without reciprocity with your home state, your employer should withhold in the state where you perform the work.  If you have taxes withheld for work performed in a state, you need to file a tax return in that state for those wages.  Depending on the amount of earnings, you may get a refund for all of that withholding.  Your home state obviously requires a tax return and may give you credit for taxes paid to the other states on those wages.  Much depends on the states involved.  Tax returns with the level of complexity you described are very involved and may require that you work with a professional tax preparer to make sure you aren’t paying too much in taxes.

Payroll and Filing Status

Q. The Indiana State Form WH-4 doesn’t have a place for the employee to indicate Married or Single.  However, our payroll system (ADP Enterprise) requires us to complete this with entering state tax information. The employee has indicated Married on the Federal W4 form so should we also use Married for the state?

A. State W-4 forms are so much fun.  Some of them follow the format of the federal form W-4.  Others have a completely unique format.  The main thing to keep in mind when dealing with State W-4 forms is that they are asking only for information that is necessary to calculate payroll withholding correctly for that state.  For the state of Indiana, the WH-4 form does not ask for marital status because there is only one withholding formula in that state.  Marital status is irrelevant to the calculation for state purposes.  While I am not an ADP expert by any means, it is very likely that you could pick either filing status in the program and get the same withholding result.  Is there some way you can run a sample calculation for that employee without actually running payroll to see the difference?

On a broader note, some employers use the filing status found on W-4 forms to keep track of the marital status of their employees.  While this has potentially questionable legality, the employee is under no obligation to actually select their filing status on this withholding form.  If your married employee has a lot of non-wage income, he/she may need to have a large amount of additional withholding.  Choosing the single filing status will cause his withholding calculation to come from the “Single” status withholding formula.  This method and the use of the “Additional Withholding” line on federal and State W-4 are ways for your employees to plan their tax payments throughout the year.

Finally, with another successful tax season behind me, I get a little bit of free time back.  Thanks to those readers who have submitted questions over the last couple of months.  You’ll see discussions of those questions start appearing over the next few weeks.

W-2 questions

Q1. If I was paid a cash bonus in 2010 and 2011, can my employer report both years of bonus on my 2011 w-2?

A. The answer to your question is really quite simple.  When did you receive the money?  Payroll taxes are calculated like cash accounting.  When funds are “constructively received,” they become taxable.  If your employer gave you a check in 2011 and you didn’t deposit it until 2012, those funds are still taxable in 2011.  If your employer pays you a bonus in 2010, it is to be reported and taxed in 2010.  The only way a 2010 bonus could be added into a 2011 W-2 would be if the bonus was announced, but not actually paid until the following year.

Q2. What if I never get my W-2 from my employer for last year’s work?

A2. You need a W-2 to get your tax return right.  No tax preparer should be trying to make a return based on a pay stub.  The IRS has issued Tax Tip 2012-20 to address this issue.

1. Contact your employer to see if the W-2 was even mailed yet.  Employers are required to have these in the mail before February 1st.  Perhaps they have an old address for you?  Once you contact the employer, give them some time to get the W-2 into the mail system.
2. Contact the IRS.  If you do not receive your W-2 by Feb. 14, contact the IRS for assistance at 800-829-1040. When you call, you will be asked for your name, address, Social Security number, phone number.  You will be verbally creating a new W-2.  The IRS will ask for the employer’s name, address and phone number, dates of employment and an estimate of wages and withholding.  You may be required to get this from your final pay stub if you still have it.  This will probably initiate some inquiries from the IRS to your employer as to the reason they are ignoring their requirements.
3. File your return using Form 4852, which is the substitute W-2.  This may delay any refunds you are entitled to because of the verification process.
4. If your W-2 unexpectedly shows up after filing your return, examine it to see if it matches the substitute values you reported.  If they are different, you will need to file an amended tax return.

W-2s are a serious business with the IRS, make sure, as an employer, you take care to get them right.  Employees count on them to process a correct tax return and determine their actual legal tax liability.

Making Estimated Tax Payments

Q. I am a 1 person (no employees) sole proprietor.  What would be the best way for me to calculate taxes and make quarterly tax payments (both Fed. and State)?

A. This is one of the most common questions I get from self-employed individuals who are just starting out.  Basically, estimated payments in a self-employed environment is the equivalent to withholding from an employee.  The object is to not pay too much and of course, not pay too little.  Let’s look at a few scenarios to answer your question completely:

1. new business with no history
2. business with history
3. going out of business

You must make estimated payments if you think your tax liability will be more than $1,000 in a calendar year.  The tricky part however is guessing how much income, and therefore tax liability, you will have.  In scenario 3, if your business is losing money and you anticipate having no profit, you may not actually need to make payments.    In scenario 1, if you previously had W-2 wages, you may wish to make payments equivalent to the previous year’s liability.  This number is found on your tax return.  In scenario 2, you need to pay at least 90% of the estimated liability due for the current year, or 100% of the tax liability from the previous year as estimated payments.

There are penalties for underpaying your liability as well.  The best way to get this right is to meet with a CPA or well-qualified tax preparer and go over your estimates for the current year.  CPAs can also help with other parts of your business plan as well to set you up for the best chance of success.

Also keep in mind that the IRS no longer accepts paper coupons for estimated payments.  You need to remit through the Electronic Federal Tax Payment System (EFTPS).

The rules for making estimated payments to your state depends on the state.  Check with the Department of Revenue in your states. Your CPA/tax preparer can help with this as well.

Medicare Tax Twice From Payroll?

Q. Because of the economic situation, I now have to work two jobs because  my main job cut my hours.  I have Medicare and Social Security tax coming out of both checks.  Isn’t there a way to stop this tax deduction from one of them?

A.  Unfortunately…no.  Medicare withholding is required on all your wages.  It is calculated at 1.45% of taxable gross.  Your employer matches this amount as well.  There is no limit on Medicare withholding tax.  Therefore, it should be withheld from wages at all jobs, even if you are retired.  Those who are self-employed must make estimated tax payments  to cover this obligation as well.  Self-employed individuals should get with a tax preparer or adviser to ensure they are making enough estimated tax payments and to determine what that liability might look like in their situation.

Social Security on the other hand has some different rules.  Like Medicare, Social Security withholding is required to be withheld from every job even if you are retired.  However, there are two quirks to this tax.  For 2011, the most income that can be taxed for Social Security purposes is $106,800.  This number changes almost every year.  In 2011, as the result of a tax cut, employees pay only 4.2% of their taxable wages towards the Social Security liability.  Employers must pay 6.2%.  That means in 2011, 10.4% of all taxable wages go towards Social Security.  Employees, however, pay at most $4485.60 per year.

But wait!  There is a catch.  If you have multiple jobs during the year, and your withholding is more than $4485.60 for Social Security purposes, you can get a refund of the extra Social Security tax you paid during 2011 on your tax return when you file in 2012.  When would this happen?  As mentioned, you could have multiple jobs that push you over the limit. You could also change jobs after meeting the limit.  The employer at your second job would also start withholding as if there was none taken during the year.

The seemingly unfair part about the Social Security tax is the employee gets a refund for overwithheld Social Security tax.  The employer does not.  The employer must pay 6.2% of all wages up to the limit on each employee regardless if they met the withholding limit somewhere else.

Remember, if you want to see how changes in your W-4 status or benefits affect your paycheck, PaycheckCity offers free Paycheck Calculators that are simple to use.  They provide quick, accurate answers to payroll questions.  Check them out.

Did You Tell Your Payroll Department?

This week’s post was inspired by my attendance at the American Payroll Association‘s 29th Annual Congress.  This is the biggest gathering of payroll professionals and vendors anywhere in the world.  The common theme I observed during workshops and networking opportunities was that employees just don’t communicate changes to their payroll system well enough.  Many presenters and attendees experienced the problem of  a significant payroll event that was never given to them for processing.  The demand was that the payroll department “just fix it.”

This post is to motivate anyone who is an employee to stay on top of changes to their payroll situation.  The following examples can provide a taste of items that you can help with.

1. Getting married. This requires a change to the filing status on the federal and maybe state W-4 forms.  Those with the married filing status often see significantly lower withholding.  If you don’t make this change, you may receive a much larger than is necessary tax refund.
2. Changing state.  Generally, withholding is required in the state where you work.  If you change states, you need to make sure and complete a new federal and state W-4 to notify your payroll department of the change.  Without this change, you may end up with no withholding where payments were required.  This would force you to file a return in the state with incorrect withholding in order to get a refund of this money so you can forward it to the correct location.  This is such a hassle!
3. Garnishments/Levies/Child Support. If you have paid off the amount that was being withheld from your check and you do not follow up with that entity quickly enough, your payroll department will have no idea they are supposed to discontinue withholding.  This means you will end up paying money for something that you don’t owe.  It’s often really difficult to get this money back in a timely fashion.
4. Terminations. This one really is the job of the manager or supervisor of employees.  If you do not complete the necessary paperwork with the payroll department, you could allow an employee to continue to be paid for no work.  That means you as a boss are directly hurting the profitability of your company.  Unless in the case of a mass layoff or headcount reduction policy, employees are normally terminated for cause.  Why pay them extra?  They may already be receiving termination payments at the same time.  It is very difficult for a company to recover these funds.  It’s so much easier just to communicate the event to payroll

These events are more common that most people realize.  By staying on top of these issues before they create a problem you are helping improve company profitability, reduce stress of employees, and reduce confusion with employees.

What is the Earned Income Credit?

Q. What is the Earned Income Credit?

A. A common question from my tax preparation clients each year is “Why is my refund so big?”  Many of my clients can’t understand that they are getting a refund bigger than the total of the tax they had withheld from their check during the year.  One major reason for lower income clients is the Earned Income Credit.

What is It?

The Earned Income credit is a refundable credit that low or moderate income taxpayers are eligible for.  It acts like the child tax credit because those who are eligible receive a credit against their tax owed because of this credit.  According to the IRS website, it was originally designed to offset the amount of Social Security and Medicare taxes paid by people in this category.

How is it Calculated?

For 2011, the IRS offered the following chart to calculate the amount of EIC you may be eligible for:

Earned Income and adjusted gross income (AGI) must each be less than:

• $43,998 ($49,078 married filing jointly) with three or more qualifying children
• $40,964 ($46,044 married filing jointly) with two qualifying children
• $36,052 ($41,132 married filing jointly) with one qualifying child
• $13,660 ($18,740 married filing jointly) with no qualifying children

Tax Year 2011 maximum credit:

• $5,751 with three or more qualifying children
• $5,112 with two qualifying children
• $3,094 with one qualifying child
• $464 with no qualifying children

Investment income must be $3,150 or less for the year.

I thought this came in my paychecks throughout the year

This was called the Advanced Earned Income Credit or AEIC.  In the old days, taxpayers eligible for the EIC could get the money early throughout the year by submitting Form W-5 to their employer.  Effective January 1, 2011, because of the Education Jobs and Medicaid Assistance Act of 2010, this no longer happens.  The program was full of fraudulent payments and difficult to administer.  If a taxpayer was eligible in the beginning of the year and for some reason went above the threshold limit during the year and did not stop the payments, they could actually end up owing extra tax at the end of the year. I’m glad it’s gone.  Fortunately, this means taxpayers get a bigger refund if they fall into one of the categories listed above.

Tax software generally checks to make sure you are actually getting credits like this that you may be eligible for.  If you forget to include some of your income when preparing your own return and claim this credit by mistake, there could be some very serious penalties and interest in store for you.  For that reason, I always recommend a professional preparer no matter what level of income you receive.  The tax laws these days are just too complex to navigate alone. Visit my Tax Services page to learn more about how my firm can help with your tax preparation needs.

Health Care and Overtime—Do the Twain Meet in 2014?

This month’s post from guest blogger, Vicki Lambert:

The passage of the Affordable Care Act has certainly generated questions in the payroll
community. Will the taxation of health care change? No it is still nontaxable. Will it need to be
reported on the Form W-2 anyway? Yes, but not mandatory until 2012. But one question is still
outstanding and is in fact not being raised quite as strongly as the other two and that is… Will
health insurance being paid for by employers have to be included in calculating regular rate of
pay under the Fair Labor Standards Act?

The law states that employers must offer their employees’ health care coverage or face a penalty
beginning in 2014. The law does not give a mandate that employers must offer health care, only
that they will be penalized if they don’t. And there is an exception for under a certain number of
employees so small employers will not be penalized at all. This is as close to a mandate on fringe
benefits as we have ever come on the national level.

The question arises because the Fair Labor Standards Act requires that all remuneration for
employment unless specifically excluded be included in the regular rate of pay for overtime
calculations. These excluded items are sometimes referred to as “statutory exclusions” and
they are spelled out in the laws. For example, payments for hours not worked are excluded.
These include the fringe benefits of vacation, sick or holiday pay. But these are specifically
listed and are made in most cases voluntarily by the employer. It also lists payments made to
a bona fide plan providing old-age, life or health insurance. But these are contributions made
on behalf of the employee to the employer’s plan. Does this change if the employer is making
the contribution to avoid a penalty by the government? Does this now make the payment
remuneration?

I contacted the Department of Labor directly to find the answers to these questions. I was
referred to the Employee Benefits Security Administration (EBSA). They’re answer…they don’t
know yet. They are looking into the matter to make a determination. The new law is just not
clear enough right now. This is unchartered territory with a new concept for employers in the 21st
century hitting smack up against a law written in 1938. So we will have to wait and see if we
need to include the payment for health care in the regular rate of pay in 2014.

In the meantime maybe this should open up the debate of whether or not these older wage and
hour laws should be revisited for the 21st century. But that is the topic for another blog.

Vicki M. Lambert, CPP
www.thepayrolladvisor.com

Mortgage Insurance Premium – Tax Deductible?

Another great question from one of my readers: “My question is in regards to the Upfront Mortgage Insurance Premium that was charged on my HUD statement (line 905) on the house I closed on in February 2010. Is this amount tax deductible on my taxes in full this year? I have been told a few different stories about it and assume many others will have the same question. I know that I can deduct the premiums I paid throughout the year and they were on my 1098.”

The short answer is mostly yes.   Qualified Mortgage Insurance can be included with regular home mortgage insurance on schedule A of the 1040 tax form.  If you do not itemize, you are out of luck for meeting the qualifications to take this deduction.

There are of course some other caveats introduced into the picture.

• Your Adjusted Gross Income (AGI) must be less than $100,000.
• The house in question must have been purchased after 2006.
• If you prepaid insurance in some way, the amount you can deduct needs to be allocated over several years.
• Mortgage Insurance is often called PMI.  However, the provider of your insurance may use a different name such as “Funding Fee” or “Guarantee Fee.”

It’s important to speak with a qualified tax preparer or CPA regarding questions specific to your situation.  There may be other issues in your case that would disallow this deduction.  It’s always a better idea to get professional advice rather than risk standing empty-handed in front of an auditor some day trying to claim ignorance.

The tax filing period is now on the home stretch.  If you have not yet filed or made an appointment to have your return completed, do it soon.  The closer you get to the due date, the more likely it is that your tax preparer will simply file an extension in your case.  This means any refunds you are owed will be delayed as well.

Which 1040 Do I Use

A great question this week comes from one of my readers.  Which Form 1040 am I supposed to use?  As a professional tax preparer, I always recommend you let a professional handle the complicated task of determining your tax liability.  However, there are people who choose to go it alone with Turbo Tax or another of the myriad of self-help tax prep solutions.  But which form do you need to file?  How do you know the software is picking the correct one?  It’s obvious when you look at the 1040, 1040EZ and 1040A that two of them are much simpler to complete.  The 1040 is very complex and is meant to be flexible enough to handle all personal tax situations.  From a recent IRS Tax Tip, here is the answer you are looking for.

Here are some general rules to consider when deciding which paper tax form to file.

Use the 1040EZ if:

* Your taxable income is below $100,000
* Your filing status is Single or Married Filing Jointly
* You and your spouse – if married — are under age 65 and not blind
* You are not claiming any dependents
* Your interest income is $1,500 or less

Use the 1040A if:

* Your taxable income is below $100,000
* You have capital gain distributions
* You claim certain tax credits
* You claim adjustments to income for IRA contributions and student loan interest

If you cannot use the 1040EZ or the 1040A, you’ll probably need to file using the 1040. Among the reasons you must use the 1040 are:

* Your taxable income is $100,000 or more
* You claim itemized deductions
* You are reporting self-employment income
* You are reporting income from sale of property

This year, the IRS stopped mailing paper books to taxpayers in an effort to save some money.  It’s even more important that tax payers pay attention to which form meets their needs now that they have to make the choice themselves.

On a side note, make sure you adjust your W-4 if you are getting a large allowance. Paycheck City has a great tool for making changes to your w-4 here.  Next week, I’ll discuss the logic behind the Form W-4.  If you complete it correctly, your refund will shrink and give you access to your own money throughout the year.