One of the most difficult challenges a company faces on a day-to-day basis is the proper processing of payroll taxes. If your company has at least one employee, then as the employer, you are responsible for employment taxes, which can include federal, state and local income tax withholding, Federal Insurance Contribution Act (FICA) tax (both Social Security and Medicare), federal unemployment tax (FUTA) and state unemployment tax (SUTA).
Throughout the day-to-day operations of a payroll department, there are employment tax mistakes that routinely occur and can lead to substantial penalties and interest being levied against the company. This could range from the misclassifying of an individual, not using an accountable plan for employee reimbursements, the incorrect setup of earnings and deduction codes, the exclusion of fringe benefits to employees or failing to have proper checks and balances in place.
Independent contractors versus employees
One of the most problematic issues in the U.S. marketplace is the misclassification of individuals working for a company. There are clearly benefits to treating an individual as an independent contractor and not an employee since the payroll taxes and benefit costs can be very high to the employer when the individual is classified as an employee. The IRS has conducted studies into the classification of an independent contractor and estimates that millions of individuals across the nation have been misclassified. It is important for employers to understand that the definition of misclassification is a function of a complex set of rules put in place by federal and state agencies, which include behavioral control, financial control and relationship of the parties. The careful analysis of the facts for each individual and the weighing of all the factors will help determine the proper classification of an individual.
When individuals are misclassified the implications to them include the loss of workplace protections (including the right to join a union), an increased tax burden, no overtime pay and, often, ineligibility for unemployment insurance and disability compensation. Misclassification also causes federal, state and local governments to suffer revenue losses as employers circumvent their tax obligations. Most federal and state agencies have taken an aggressive approach to the review of independent contractors, and employers should understand the role these individuals support for their company and whether their classification is in line with federal and state guidelines.
If your employees are incurring expenses for travel and entertainment and your organization does not have an accountable plan in place, employment tax dollars can be wasted. For an employer to formalize the arrangement, specific conditions must be met:
- The reimbursable expense must be business-related.
- The employee must substantiate the expense by providing the employer with evidence of the amount, time, place and business purpose of the expense within a reasonable period of time (generally 60 days, but this can be less).
- The employee must return excess reimbursements to the employer.
If the plan fails to meet any of the above-mentioned criteria, then the expenses reimbursed would be under a non-accountable plan and therefore subject to federal income tax withholding, state income tax withholding, and Social Security, Medicare and FUTA tax. It is important to note that an accountable plan does not automatically become a non-accountable plan if an employee fails to substantiate expenses.
Earnings and deduction codes
When an employee receives his or her paycheck, there is a basic understanding that it will be taxed correctly on a federal, state and local level and that all pre- and post-tax deductions will be correctly administered. Based on the complexities across the agencies and the potential changes to the payroll tax laws on a yearly basis, employers should review the setup of their earnings and deduction codes to ensure their employees are receiving the correct net payment. Depending on the type of earnings code, some payments could be subject to the supplemental tax rate and not the Form W-4 elections, while other payments might not be subject to specific types of tax on a federal, state or local level. In addition, the proper classification of deduction codes to ensure that the proper taxable wages are used in the calculation of each tax element is crucial to ensure your employee’s paycheck is correct.
Fringe benefits are defined as a form of pay for the performance of services. However, there are many complex layers associated with each fringe benefit that is provided. The IRS often scrutinizes fringe benefits during an employment tax audit since the agency will assume all fringe benefits should be included as income to the employee unless there is a specific rule that makes it nontaxable. If a fringe benefit is taxable to the employee, then it is subject to all employment taxes and includible on an employee’s Form W-2. There are benefits that are provided to employees that are classified as de minimis in nature since they are so small, and accounting for these benefits would be unreasonable or impractical to administer. Examples of de minimis benefits are personal use of an employer-provided cell phone, occasional use of a company copy machine, occasional parties for your employees, and holiday and birthday gifts with a low fair market value, if not cash. Throughout the year, it will be important for employers to review the types of fringe benefits that are being provided and whether they should be considered taxable or not and ultimately reportable as taxable in an employee’s paycheck.
Checks and balances
Many companies use outside payroll providers to handle the reporting of payroll information on a paycheck-to-paycheck basis. As an employer, even if you use an outside payroll company, the responsibility of payroll taxes and the reporting of all payroll information is on the you as the employer. All employers should ensure that there are proper checks and balances in place so regular reviews are made of the payroll information that needs to be reported. Employers should not wait until year-end to reconcile their payroll data as it is quite difficult to adjust errors then. In addition, without the proper review of your payroll information, employees can be negatively impacted and have a tax burden that was not anticipated.
It is important for all companies to be aware that payroll is a complex area. Without the proper knowledge, experience and controls in place, errors can be made that lead to severe penalties to the company and can often negatively impact your employees. Employers should be proactive, not reactive. Implementing the proper processes and procedures will help any organization ensure optimal payroll tax compliance and mitigate the negative consequences to employees. Since compliance and content employees should be a primary goal of sound payroll practices, a deep understanding of your company’s payroll procedures and the steps that can be taken to reduce risk and exposure will help ensure this result.
Director - Employment Tax,
Human Capital Services
+1 732 516 7600
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