5 make-or-break areas for payroll tax

Compensation Benefits: 5 make-or-break areas for payroll tax An employer’s largest tax burden is often payroll taxes. In fact, employment taxes like income tax withholding, Federal Insurance Contributions Act taxes and the Federal Unemployment Tax Act taxes account for more than 70% of federal tax revenues. Payroll tax issues — from the treatment of independent contractors to the complex interpretation of various forms of compensation — can greatly affect a company’s operations and risk.

You can reduce the tax risk by understanding these five common areas of payroll tax oversight.
  1. Worker misclassification — Worker misclassification has become a hot-button issue, with the IRS and other taxing authorities scrutinizing how businesses classify independent contractors. Companies that misclassify workers, even unintentionally, may face penalties, and penalties and fines become more severe when fraud or intentional disregard is involved. The IRS uses a multifactor analysis to determine whether workers are employees or independent contractors. Many states have their own worker classification rules, which can differ from the IRS rules. In fact, a worker can qualify as an independent contractor to the IRS yet be considered an employee by the state (and vice versa). You should have a process for analyzing the behavioral, financial and relationship characteristics of each worker during the onboarding phase.
  2. Taxation of gifts and awards — Gifts and awards to employees are generally compensation, with the value treated as wages subject to employment taxes. However, some gifts and awards may be excludable from employee wages and not subject to employment taxes, such as gifts of de minimis value and certain achievement awards. Examples of de minimis awards include flowers, plaques, coffee mugs for special occasions, and other items of such small value and occurring so infrequently that accounting for them is unreasonable or administratively impractical. Cash and cash-equivalent awards, such as gift cards, are never considered de minimis in nature and are always taxable, no matter what the value. Employee achievement awards of tangible personal property awarded for length of service or safety may be nontaxable. Employers should consider the tax treatment of each prospective gift to help ensure proper withholding and reporting.   
  3. Third-party sick pay — One of the most puzzling payroll issues for employers is the tax treatment and reporting of sick pay — an amount paid to an employee for any period when he or she is temporarily absent from work because of injury, sickness or disability. Accurately taxing and reporting sick pay depends on factors like whether the employer or the employee (or a combination of both) paid the premiums on any insurance involved, who bears the insurance risk and who makes the payments and/or files the various tax returns. Employers should review their sick pay plan(s) annually to determine specific responsibilities related to withholding and depositing income and employment taxes, and accurately reporting taxable sick pay.
  4. Reconciliation of year-end Forms 941 and W-2 — Did you know the IRS and the Social Security Administration (SSA) compare your company’s wage and income tax totals reported on Forms 941 and W-2 each year? Receiving a tax notice from the IRS Combined Annual Wage Reporting (CAWR) Unit noting that Form 941 and W-2 totals are out of balance can be the beginning of a nightmare for employers. To help avoid it, employers should reconcile the wage and tax totals submitted throughout the year on their Forms 941 (and 941-X) to the wage and tax totals to be reported on their annual Forms W-2. A leading practice is to perform the reconciliation at year-end before submitting Forms W-2 to the Social Security Administration; however, performing the reconciliation quarterly will help avoid any unwanted surprises at year-end. Because there are few acceptable reasons why an employer’s quarterly Forms 941 (and 941-X) and its W-2 totals wouldn’t reconcile for a calendar year, an imbalance is a red flag suggesting further analysis.
  5. State unemployment tax opportunities — The 2016 state unemployment insurance (SUI) tax rate season is under way, and your company has probably begun receiving 2016 calendar-year SUI tax rate notices. Don’t overlook two potential SUI tax savings opportunities: voluntary contributions (VCs) and joint accounts. VCs allow an employer to make a one-time, voluntary payment into a state’s unemployment insurance trust fund with the goal of improving its benefit ratio and lowering its tax rate for the current year. Joint accounts allow two or more legal entities paying wages to employees in the same state to combine their historical experience rating factors to achieve one blended-experience rating that will apply to each participating entity. VCs and joint accounts are available only in certain states, and employers must analyze whether a VC and/or a joint account is advantageous for their company. Employers must also act quickly because of the firm deadlines associated with submitting a VC (typically 30 days from the date of the SUI rate notice).

The end of the year marks the busy season for HR and payroll professionals. Now is the time to align your company’s strategies with leading practices. Position your team for success by understanding payroll tax issues and capitalizing on opportunities.

Please contact Tom LeClair or Emma Sadikovich for more information.

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