Arizona’s New Withholding

Arizona has done it again.  Currently, anyone who is being paid in Arizona must select from several percentages on the A-4.  Arizona withholding is based on a percentage of federal withholding.  The percentage you pick will be multiplied times the federal withholding number on your paycheck to arrive at Arizona withholding.  If you selected 24.5%, and your federal withholding was $112, then your Arizona withholding would be .245×112 or $27.44.

This created a problem with all the federal withholding changes that have happened over the last 10 years.  Each time there was a withholding decrease, Arizona’s revenue decreased as well.  The Making Work Pay Credit last year decreased checks for everyone and was the last straw in the problem.  Arizona’s legislature had to increase the percentages on this form each time the federal government decreased withholding  just to keep withholding even. Finally, last year, the legislature directed the AZ Department of Revenue to develop a new withholding system to be put into place by July 1, 2010.

There are other glaring problems with this method.  Arizona’s tax rates are based on a formula.  By requiring employees to pick a flat percentage, they are forced to determine a marginal (or average) tax rate for their tax situation.  This can change based on events in a person’s life like marriage, divorce, new children, home purchase, a second job or a spouse begins working that didn’t before.  Any of these events change the marginal rate.  Most people never adjust their A-4.  This obviously causes frequent confusion.

Another problem is that many people simply have no federal tax liability.  With no federal withholding, there was no way to have any Arizona withholding and inevitably, these individuals would end up paying extra every year at tax time.

Yet another problem is those that move into the state mid-year.  As a Tax Preparing CPA, I found it very difficult to advise my clients when they move in mid- year which percentage to pick.  The problem still exists in the second year (first full year of residence) since they have no history to draw from in selecting their percentage.

So…..Arizona’s new method was recently announced and here is the form.  All employees must complete a new one of these by July 1, 2010.  Guess what? They solved none of the above mentioned problems and even made some new problems.  Now, the percentage you select is percent of gross pay.  This decouples the state from federal withholding changes but still does not give employees who are new a clue to which rate to select.  Now instead of new employees only being confused, any person working in the state gets to be confused and not just for half a year, but for next year as well.  There is still no basis in the actual tax rates with these percentages.

Instead of providing some rates that anyone can pick, there are still three lines for employees to select based on income level.  This should have been removed.  If you have very low tax liability but a higher than $15,000 income, you cannot select the lowest rate.  On the back of the new form, there is a worksheet provided.  Notice in line 10 of the worksheet that there is no provision in the instructions for selecting anything other than line 1 (front side) percentages.  What if the calculation result is lower than the percentages on the form?

Employees are not able to determine their “target” withholding without digging into last year’s tax return or contacting their tax preparer.  Again, changes in taxable life events make last year’s number irrelevant.  What are you supposed to choose? This value is difficult for those without a tax background to understand.

Supposedly, payroll “experts” were used to help develop this form.  Unfortunately, they chose to tweak the existing system enough to only make things more confusing.   I hope that the state will make some wholesale changes to this form to more closely match what other states are doing and what the Arizona tax system actually looks like.  It’s not bad to use withholding allowances and marital status.  We are forced to use that on the tax form.   Let’s get this right next time.

Yikes, A Big Tax Bill!!!

Q. My husband works for a large company, and I receive disability and do not work.  We just had our taxes done this week and got quite a shock!  We had a federal income tax refund of over $4000, but owed state tax of $1000 and local taxes of $600.  We are in PA.  How can we adjust our withholding so that this does not happen again next year?

A.  When payroll people hear the Pennsylvania, they run screaming from the room.  The local tax debacle there is the stuff legends are made of.  In most states, when someone has too little withholding, an employee can simply get a copy of the state’s W-4 equivalent, and reduce the number of allowances claimed.  This has the effect of increasing the amount of income subject to tax and thus increasing the tax withheld.  Unfortunately, in PA, there is no W-4 equivalent.  PA is calculated as a flat percentage of taxable income, 3.07% to be exact.  I’m not sure where to point you on this one.  Did you have non-wage income like dividends or capital gains that were not taxed?  Do you have a small business on the side where there were no estimated payments made?  Perhaps the payroll system at your husband’s employer has a way to allow for additional withholding beyond the standard percentage.

For the local tax, there is again no W-4 equivalent in most cases.  However, there is very likely an obvious cause for this under withholding.  In PA, employers are required to withhold where the employee works.  If he works in a different jurisdiction than the one he lives in, then the withholding rate will be lower.  He will have the non-resident rate applied to his wages.  In most cases for PA, the resident rate is 1% (could be higher) and the non-resident rate is half of that.  Therefore, he could have only half as much tax taken from his check as was required.  If an employer opts to withhold at the higher resident rate, it is called courtesy withholding.  Not all employers wish to do this because of the extra record keeping requirements.  Check with your employer to see what is possible with regards to increasing the local tax withholding as well.

A Huge Tax Bill!!!

Q. I utilize the withholding calculator on the IRS website to ensure my W-4 amounts are correct. This has gotten me very close to the amounts figured on my 1040 for the past 5-6 years since I’d begun utilizing the calculator.  I do a final check with the calculator after the last pay date in the year (in this case, on 12/28) to get a rough idea of what to expect come tax time. On my final 12/28 check, as on the bi-monthly checks, it showed that I would be getting a refund of just under $2K. Since the withholding calculator accounts for mortgage interest but not real estate taxes, I assumed the refund would be even greater. However, when I fired up my 2009 copy of HR Block’s tax software, I was shocked and horrified to see that it calculated an amount owed of almost $6000! Sure that it must be incorrect, I downloaded Intuit’s Turbo Tax, and that showed I owed even more. I went back to my printout from the 12/28 visit to the IRS withholding calculator utility, and the values entered were within $200 of the actuals. What factors could the withholding calculator not be accounting for that could cause such a vast difference in liabilities? I ran my expected 2010 numbers through so I could fill out my 2010 W-4 correctly, and was presented with an equally low liability and high number of withholding allowances, which I am now concerned are incorrect. My situation is pretty vanilla: Married filing jointly, only one income, one child dependent. Claiming mortgage interest credit, and the associated taxes paid to taxing authorities and nothing else.

A. The answer to your question is truly impossible to solve using a forum like this because I can’t possibly know everything about your financial and tax situation.  What I can tell you is the the IRS withholding calculator and the official IRS W-4 form are designed to recommend withholding settings that will slightly overpay your liability if completed properly.  Judging by your statement that it has always been relatively close until this year, there must be something affecting either your tax prep software, or your values from the withholding calculator.

There are two possible causes for your dilemma.

1- The Making Work Pay Credit gave an $800 credit to those who utilize the married withholding tables.  The problem is that if both spouses work, they would both get the credit on their withholding.  Certain individuals are actually not eligible for the credit and the withholding tables don’t account for this either.  This could cause huge under withholding problems such as you described.

2- Which leads to the second solution. The Making Work Pay Credit problem was a hot topic of discussion all year in tax preparation and CPA circles.  It created a serious problem for two-income families.  Had you been utilizing the services of a tax professional over the years, you would have been notified of this potential problem and been able to appropriately adjust withholding for one or both spouses.  Turbo Tax and the Block product are designed to simplify the tax preparation process.  They cannot use the judgment that a tax preparer can.   While they are both great products, everyone has to admit that we have very complex tax laws in this country.  There simply is no substitute for the advice and assistance of a professional tax preparer or CPA.

I would recommend making an appointment as soon as possible.  $6000 is worth the extra effort to get this right.

What Are These Taxes?

Q. I just started as a temp through an agency.  I work full-time and just received my first paycheck.  I want to ask about the OASDI and the NY 2010-NYCNY withholdings.  I was taxed heavily for the OASDI.  What is the NYCNY withholding? Most importantly, I wanted to ask you is there any way to check whether I had overpaid for taxes in a paycheck?

A. The items that came out of your check look completely appropriate.  The most common questions from employees to payroll departments about paychecks come from the cryptic descriptions of deductions shown on the paystub.  In your case, OASDI is the abbreviation for “Old age, survivors, and disability insurance.”  This is the official name for Social Security.  It is calculated as 6.2% of taxable wages up to a maximum of $106,800.  This means, you can pay up to $6,621.60 this year towards this tax.  Your employer(s) will also match 6.2% of your taxable wages.  For lower income individuals, this tax can be the highest amount taken from the paycheck.  There is another tax that is closely associated with this called Medicare.  It is 1.45% of all taxable wages.

NYCNY looks like New York City Tax.  All residents of New York City get to pay an extra tax.  Rates on this tax range from 1.9 to 4% depending on your level of income.

As for your last question, there are only three ways to determine the correct amount of withholding.  First, you download withholding formulas from each jurisdiction in which you owe tax and run hand calculations to see what is correct.  Since that is time consuming and too difficult for most of us, I recommend the second method.  PaycheckCity.com has a free Salary Calculator that calculates all your taxes for you using the formulas from each jurisdiction.  You simply need to know what settings are on the W-4 Form you gave to the payroll department.

Most importantly, if you have specific questions about your paycheck, your payroll department should be able to assist you as long as you are not asking for tax advice.

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.

2009 Year-End Tips

As the end of 2009 quickly approaches, it’s important for all tax payers to begin preparing for the filing of their 2009 tax returns.

- Have you maxed out your HSA or IRA contributions?  People with these kinds of accounts can actually make contributions for 2009 through April 15.  Maximizing your contribution helps reduce your taxable income by the amount of the contribution.  For certain tax payers, contributions to specific retirement accounts provide a special credit.  This credit is based on income level.

- Have you tallied up all those miles?  If you drive a personal vehicle for company business, or have your own business, adding up the miles and summarizing them will make your tax preparer much happier.  Miles driven for charitable or medical purposes also can be useful. If you can do this in a spreadsheet program and provide it digitally, you may be able to save some money.  Check now to make sure you can find all of your logs.  It’s much easier to begin assembling your records now than the night before your appointment with the preparer.

- Make a list now of the documents your tax preparer might need.  You should be receiving an organizer from the preparer that can guide you as you dig for your documentation.

- Take a look at tax changes for 2010.  The website paycheckcity.com has free calculators available that can help you evaluate your paycheck based on 2010 tax tables.  Do you need to make some changes?  Did you have more or less withholding this year than you were expecting?  Now is the time to change it before the new year starts and you forget.

- Did you move in 2009?  If so, to get your W-2s from past or current employers in a timely fashion, you will need to notify them to update their records.  Also make sure you tell your tax preparer if you moved.  This can affect the types and amounts of taxes you pay.

- Did you claim exempt on your W-4 for 2009?  If you plan on remaining in that status, you must submit a new W-4 to your employer verifying that status by February 15.  Keep in mind that Form W-4 is used to notify your employer of address changes as well.

- Are there any last minute charitable contributions you can make?  Keep in mind the requirements for documentation for non-cash contributions.   Independent appraisals are often required if the value of the non-cash donation exceeds $5,000.

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.

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.

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.