Filing Status? What is that?

Q. My payroll person told me that the filing status on the W-4 doesn’t necessarily mean the same thing as my marital status.  Is that true?  What is filing status?

A. Filing status on the W-4 and filing status on your tax return are not necessarily the same thing.  The W-4 drives withholding only.  The withholding formulas issued by the IRS come in only two flavors, married and single.  Any other situation is handled by the number of allowances claimed.  Other situations include head of household, children and multiple jobs.  In certain situations, if married folks claim married on their W-4s, they will not have enough withholding.  By switching over to the single withholding formula, additional withholding takes place.  Some companies use the W-4 to determine the marital status of their employees.  This is not a good policy. In fact, if an employer receives a lock-in letter for a specific employee, he/she may be directed to withhold at Single with zero allowances regardless of the marital status of the employee.

On your tax return, the rules are different.  You are only allowed to claim married if you are in fact married.  If you are married, you cannot claim single.  There is a special status called married filing separately for those who wish to use it.  Certain situations may warrant this for better tax treatment.  The key here is that your marital status on the last day of the tax year determines your status for the tax return for that year.

I hope this helps.

Publication 15 is Out!!

Hooray!!  The annual update to the document every employer is anticipating finally occurred. Okay, maybe not all employers were as excited to see this as I was.  Publication 15 should be every employer’s best friend.  This document contains instructions on everything from obtaining an Employer Identification Number (EIN) to withholding, to employer taxes.

How does a business determine if it has employees or contractors? Read page 8 section 2.

What if I want to hire a family member for an employee?  Read page 9 section 3.

How does the IRS define wages?  What is included?  Read page 10 section 5.

How much do I withhold from my employees’ wages?  Read page 39 and 40 if you want to use a formula.  Reference pages 41-60 if you wish to use the charts.  You could also use PaycheckCity.com for this since all the values have already been programmed into all the calculators for the last 10 years.

Have you considered employer costs like FUTA (unemployment)?  Read page 30 section 14.

Do you get the hint yet that this is a very important document?  Some of the most frequent questions I get from employers through the American Payroll Associations member hotline are related to supplemental pay.  This could be bonuses, commissions, overtime pay etc.  There are specific instructions in Publication 15 for the right way to withhold from these types of payments.

Each state that has required withholding will have a similar document.  Employers should also find and download a version of the state document to make sure they understand specific requirements for their state that may be different than the federal information.

Relief For Small Employers

An IRS news release today reminds small employers of an alternate form available to reduce the burden of quarterly payroll tax filing.  It is called Form 944. If you have less than $1000 of annual employment tax liability, you can file this form.  For the rest of employers, Form 941 is required.  This is a newly updated and extended form that must be filed quarterly for companies that are too big for Form 944.  The record keeping requirements are much more onerous.

The problem has been a lack of education on the part of the IRS regarding who can actually file Form 944.  Even more confusion surrounds anyone who wishes instead to stick with the 941.  To have less than $1000 of annual liability, you would need to have taxable payroll of less than $6535.94.  This is an extremely small business who is likely not going to be keeping up with the latest IRS rules.  The IRS must notify the employer that they are eligible for the annual form.  Unless notification occurs, they again are stuck with the 941 anyway.  Why confuse the issue?

I propose completely doing away with the 944 and keeping everyone on the same reporting form.  It is really no easier to complete the 944. It is simply completed once per year instead of 4 times per year.  If there are questions from small businesses relating to payroll procedures, they need to seek out assistance to stay in compliance with employment tax rules.  By adding another form and relying on the IRS to notify employers in a timely manner that they qualify for the annual form, the government is nearly keeping anyone from using it anyway.

Form 944 is yet another reason why employers should be utilizing the services of a professional company for processing of payroll.  Whether this be a small local/regional provider, or the employer’s CPA, it is much too difficult to keep track of regulation changes and obscure tax nuances.  After all, unless you are in the payroll business, it is much more important to stay current with issues and customer needs surrounding your own business.

Where Do I Pay the Unemployment?

Q. I have been asked to find regulations similar to the state withholding reciprocity rules for unemployment.  I have a payroll person at one of our business units, who every time an employee is on a temporary assignment in another state she changes their SUI state to that state.  This is causing big issues not only for the employee but for those of us who process the SUI returns.  Any help you may be able to provide will be greatly appreciated.

A. The answer to your question can actually be found in the unemployment statutes of the states involved in your scenarios. Generally, all states but Minnesota follow guidelines that establish a reciprocity-like arrangement for employers where unemployment tax is paid to the state where the employee works. If the employee works in multiple states, then UI tax is paid to only one state. The general order for choosing the UI state is (check with the states involved for specifics):

1. Where does the employee perform most of his/her work?
2. Where is the employee based?
3. From which state is the employee’s work controlled?
4. If none of the above apply, use employee’s residence state.

The state you select doesn’t change unless the employee is making a permanent move in which case there are predecessor state rules involved.  This is a very common question for employers who operate in multiple states.

Social Security Tax Keeps Going and Going…

Q. I work for a large company that maintains a few different business units under the parent company.  The company uses different tax ID’s for each business unit.  This year I changed jobs internally, moving from one business unit to another.  In July I noticed that my year-to-date FICA contributions had reset as a result of the change.  The result for me is that my net income will be significantly lower in the last 4 months of this year (typically I’d have reached my FICA cap by the end of August, and I’d see my net income rise in the remaining months of the year), and I won’t see that income returned to me until April 2010 when I complete my 2009 tax return. Is there any mechanism that might be available to our payroll department to account for the contributions already made under the previous Tax ID?  I’m lead to believe there’s nothing that can be done in this scenario, despite the fact that the company only has a single payroll department.

A. This is a very good question that shows you are very observant about things changing on your paystub.  I fear most employees would not notice the FICA reset. The bad news is, there is no mechanism for directly stopping FICA contributions due to this change. If the employees are really only moving between divisions with separate EIN’s, perhaps your company could set up a “common paymaster” arrangement where the employees really only work for one employer.  Without an arrangement like this, not only do your FICA taxes continue, but your employer matches of Social Security continue as well.  Your employer does not have the opportunity to recover the double tax as you do on your tax return.  Employees moving between divisions become very expensive under the scenario you described because of the extra tax.

The good news is (you mentioned it in your question) that you do get to claim the extra SS tax as a refund on your tax return.  That being said, if you get most of the double Social Security tax back, you may be able to adjust your allowances to reduce federal withholding for the remainder of the year to compensate.  You want to check with your CPA or tax adviser to make sure that when you change your W-4, you have the correct tax withholding amount.  You don’t want to be under withheld when the tax return is filed and cause penalties and interest.  You can use the Paycheck Calculator at PaycheckCity.com to determine what filing status and allowance value will get you the correct amount of withholding from each check so you can complete your W-4 accurately.

What Tax Bracket Am I In?

Q. How do I know what tax bracket I’m in?  Where does that number come from?

A. This question probably ranks right up at the top of the list of most frequent questions.  First of all, you probably meant to ask what is your marginal tax rate.  Let me explain.  Federal income tax is calculated on a graduated scale. If you look at the image to the left of this post, you will see several numbers under the heading “Tax Rate.”  These are the percentages used in calculating your tax liability for a given amount of income.  You can see that your income is taxed at different rates as the amount of taxable income increases.  To say you are in the 25% bracket, only means that you make at least $67,900 of taxable income (for married people) and that a portion of your income is taxed at that rate.  Truly, your marginal or average rate is lower than your bracket in most cases until income gets significantly over $372,950.

To determine your marginal rate, you need to look at last year’s tax return.  Take your total tax liability number from line 61 of the 1040 and divide that by the number found in line 38 of the IRS Form 1040. This tells you the percentage of your income that is subject to federal tax.  For a total marginal tax rate, simply add up all the taxes you pay and divide by the value in line 38 of the 1040.

I think you will be surprised to see how high that number actually is.  Keep in mind that to get this exact, you should include property, sales, income and payroll taxes.  Higher income individuals in New York and California for instance, could see their marginal rate rise above 50%  Ouch!

Learn About Payroll

Q.  I just started a new job and my employer wants me to do the payroll too. How do I learn some more about it so I don’t mess it up?

A. Thank you for looking for more education.  So many people think that payroll is nothing more than taking out taxes.  The payroll process has grown so complex in the last 15 to 20 years that it takes some serious education and study to keep up with everything.  There are several places you can look for payroll education.

1. I don’t know what state you are in, but there is likely a local chapter of the American Payroll Association close to you.  You can find the one closest to you using this chart.  Local chapter meetings allow you to network with your payroll peers and gives you a chance to ask questions as you learn.
2. The American Payroll Association itself has courses and books available that can guide you through issues you may be having.  They also offer an email list-serve and member hotline that can be useful resources as well.
3. PayrollTalk.com is a good resource.  It is a free online forum for discussion payroll topics.  Everything from tax calculation, to international payroll, to handling complaints is discussed.  You can read and search other posts or add your own after registering.  There are already several thousands members of this community who actively discuss payroll issues each day.
4. PaycheckCity.com can help you learn about the effect of different pay frequencies and W-4 values on your paycheck.  It can even be used for training your employees how to read their paycheck and the impact on take home pay of making changes to their W4.
5. Your local community college likely offers a class or two about payroll.  If not, payroll is often included as part of the accounting curriculum.
6. Publication 15 is the document published by the IRS that spells out fairly clearly your responsibilities as an employer for paying withholding taxes from employees.

Where Do I Put The Money?

Q. I’m a new employer and have started withholding taxes from my workers checks.  Where do I put the money?

A. Definitely don’t put it under your mattress!  Publication 15 from the IRS is what I like to call the Employer’s Tax Bible. Every employer whether new or seasoned should look through that document each year.  Within its pages, you will see a schedule of how often you must remit the taxes you withhold from employee checks to the IRS.  The section that relates to your question is chapter 11 “Depositing Taxes”.  The frequency depends on the total amount of tax liability you report.  Certain employers can remit their totals with their quarterly 941.  Certain employers must make a deposit monthly.  Still others get semi-weekly treatment.  The largest employers have a next-day obligation for deposits. You can make your deposits using the EFTPS system, or take a paper coupon and check to the bank. If you are using a payroll service, they can likely handle the deposits for you.

All money withheld from employee checks must remain in trust once it comes out.  The employee is relying on you to put their tax payments into an account and pay it for them.  Then, once per year when they file their taxes, those payments will count toward their tax liability.  Many employers recently have been convicted of not paying these taxes and instead running with them or spending them on business or personal expenses.  You don’t what to join that crowd.  Here is a link of some of the cases where employers didn’t pay over the money they withheld.

New Business Starting

Q. Dear Mr. Kerch,
I have read your blog with interest. I will soon start a new business. I will sell advertising to small service-oriented businesses. I expect to recruit agents to sell this service at the local level in small communities. I do not wish to be classified as an employer and thus want to structure the business and my relationship with these local agents in a manner consistent with this goal. I have read the IRS publication employee vs. sub-contractor (19, I think) a few times. It has succeeded in convincing me that there are a myriad of ways in which to fail in my goal. How do I best find and screen the right professional to help me not only set up this enterprise but also review my internal systems of fee collection, commission payment, the provision of agent network working tools, and management of agent network so as not to trigger an IRS determination of employer status? Also, I will need a salesforce software tool (salesforce.com?) and also software for paying commissions.
Ideas?

A.  The document used in determining the type of relationship is actually form SS-8.  In my opinion, the key factor in determining whether the relationship is employee/employer or between contractors is the level of control.

• Are you going to direct the methods used by the reps?
• Will you supply sales leads?
• Will you supply materials and/or training?
• Will you dictate schedules?
• Are the agents allowed to sell other products besides yours to clients they visit?
• Do your reps bid on an area?
• Do you bill the clients and pay the reps based on collections or do they collect and remit to you?

Unfortunately, the main goal of most companies when this question arises is the avoidance of both employment taxes and workers compensation insurance.  Essentially, if you don’t have employees, you don’t pay unemployment tax.  But, if one of these agents files a claim for unemployment if the relationship does not work out, and it is determined that you were actually an employer, heavy fines will be the result.  In fact, the same result will occur if the IRS determines you were actually an employer and did not pay any employment taxes for these individuals.

There is no fee for completing form SS-8 and filing it with the IRS.  Because this is a big audit area and probably a big contributor to the tax gap (estimated unpaid taxes), the IRS is probably going to consider your agents to be employees 99% of the time.

The questions you ask regarding structure are good questions and probably best answered by finding an industry group that closely aligns with your desired business.  Some examples are the NFIB and the NASP. Certains CPAs and business consultants who specialize in your industry can help you with specifics about the type of software that is best for CRM (customer relationship management) and payments to your agents.  Good luck with the new business.  Make sure you have a competent tax adviser around to help you take advantage of all the legal ways to reduce your taxes.  You don’t want to miss any deductions that are due to you.

Enough Withholding?

Q. I followed your advice and had my payroll department withhold based on W4 stuff instead of a flat percent.  How do I know if I’m on track?

A. That’s a rather amusing question actually.  Publication 15 and the W-4 both require that you use only marital status and number of allowances on the form.  If that is not the case, then the form is invalid and you revert to the status of Single-0 which is the highest regular withholding amount available.  You are not permitted to use a flat percent when calculating your federal withholding.  Your payroll department should already know this.

To answer your question, you have two options when deciding if your withholding needs to be adjusted.  I recommend to my clients that they do the annual check up in late August or early September.  That way, if there is gross over or under withholding, there is still time to fix it before the end of the year without breaking the budget.  Your CPA or tax planner of course is the first place you should check.  He/she will know your financial situation already and can quickly compare your withholding to your expected liability.

Secondly, you could visit the IRS website and download Publication 919.  This document is not for the faint of heart.  Basically, you will be completing a tax return using your last paystub and estimated information from your tax return.

Remember, the objective of withholding for federal and state purposes (not Social Security and Medicare) is to have your payments (withholding) match your liability (from your tax return) so that your refund or extra payment with the 1040 is as small as possible.

On a side note, if you look in the right margin of this blog, you will see my most recent Twitter posts.  Feel free to follow me on Twitter for daily financial thoughts.