Payroll Taxes & Liabilities
Federal payroll tax regulations are enacted by the United States Congress and enforced by the Internal Revenue Service (IRS). Since federal law supersedes state law and many states have patterned their laws and regulations after Federal tax code, compliance and an understanding of Federal payroll tax requirements are essential to the operation of your business. For more information on payroll tax filing and depositing requirements, consult the IRS Publication 15 (Circular E). This Reference Center includes information on:
Earned Income Credit: Employees who work and support one or more children may claim a credit on their individual tax returns known as the earned income credit (EIC). Lower income workers without children may also be eligible for the earned income credit. Congress has granted this credit to eligible working taxpayers to help them with the costs associated with maintaining a home either for themselves or for qualifying children.
If an individual’s tax liability for the year is zero, the individual will still receive the EIC. The EIC then becomes a fully refundable credit. Earned income credit is by definition a credit and therefore not considered income. EIC is not subject to income, Social Security, or Medicare tax withholding.
The EIC can be advanced to the employee by the employer on the employee’s paycheck. The employer may deduct the EIC amount(s) paid to employees on Form 941.
The Form W-5 is required for advanced earned income credit. The Form W-5 expires every December 31. An eligible employee must file a new form with the employer for each calendar year that the employee is eligible to receive the advance credit.
Employers should understand these requirements and maintain a current W-5 on file for each employee who claims the earned income credit. The employer computes the amount of the earned income credit and adds it to the employee’s net pay each pay period. The additional amount is not subject to withholding and does not alter the employee’s Medicare, or FICA amounts.
Electronic Federal Tax Payment System (EFTPS)
Like many organizations, the Internal Revenue Service (IRS) is seeking additional efficiency and convenience through the use of web technologies such as the Internet. One benefit to employers is that they can now make federal payments electronically through EFTPS. EFTPS currently serves over 2.5 million business taxpayers and new enrollments equal 16,500 businesses each month.
EFTPS allows businesses to:
Make federal tax payments directly by phone, personal computer or through a financial institution.
“Warehouse” payments for up to 30 days and have them deposited automatically on a pre-determined date.
Eliminate the cost of writing and mailing paper checks.
No special equipment is required. For those who wish to use a personal computer, free Windows®-based software is available from the IRS.
While there are many advantages for any business to deposit electronically using EFTPS, certain businesses are required to make electronic deposits of all federal tax liabilities (employment, excise and corporate).
EFTPS is mandated if the business was required to deposit such taxes by electronic funds transfer in 2000, or
the business deposited more than $200,000 in total federal employment, excise and corporate taxes in 1999.
There is a 10% penalty for businesses that are required to make electronic deposits and fail to do so.
Tax Returns – Forms and Filings
The preparation of payroll tax reports is an integral part of the payroll accounting process. These reports are filed on various forms as prescribed by federal, state and local laws.
Forms and instructions are available online from the IRS.
The Form 941 is a tax return prepared and filed by the majority of U.S. employers who withhold Social Security and federal income taxes from their employees. It is filed quarterly, and asks the employer to report the following information:
- All wages, tips, and other compensation.
- The amount of federal income tax withheld from wages, tips, sick pay, or other compensation.
- Total wages and tips subject to Social Security and Medicare taxes.
- Total deposits for the quarter, including balance due or any overpayment.
- The due date for Form 941 is the last business day of the month following the end of the quarter. If tax deposits have previously been on time and for the full amount due, employers can take a 10-day filing extension. This form is used for all tax depositors; however, Schedule B, Form 941 is used for semiweekly and one-day depositors.
The IRS released a new Form 944, which is an annual employment tax filing for certain small employers. The IRS designed this form to allow smaller employers to be able to file and pay these taxes only once a year, rather than filing Form 941 four times a year. Smaller employers are those whose combined annual liability for social security, Medicare, and federal income tax withholdings is $1,000 or less. A semiweekly or next-day depositor who is required to file Form 944 must also submit Form 945A.
Form 945A shows the Employer’s Record of Federal Tax Liability. This form is a listing of the combined federal, social security, and Medicare tax liability by day. Completion of the form depends on the amount of federal tax liability. A semiweekly or next-day depositor who is required to file Form 944 must also submit Form 945A. The amounts reported are the actual total liabilities by date incurred, not the amounts of the deposits. The total tax liability for the year should equal the deposits, plus or minus any adjustments.
Form 941 Schedule B
Schedule B is used with Form 941 and shows the Employer’s Record of Federal Tax Liability. This form is a listing of the liability for withheld income and FICA taxes by day. Completion of the form depends on the amount of federal tax liability. A semiweekly or one-day depositor must use Schedule B of Form 941. The amounts reported are the actual total liabilities by date incurred, not the amounts of the deposits. The total tax liability for the quarter should equal the deposits, plus or minus any adjustments.
Form 945, Annual Return of Withholding Federal Income Tax
This form reports all non-payroll withholdings to the IRS. The non-payroll items include backup withholding and withholding from pensions, annuities, IRA’s, military retirement, and gambling winnings. The due date for the return for any year will be January 31 of the following year.
Form 943, Form 943A
Those who employ agricultural workers, and report Social Security and Medicare taxes and federal income tax withheld on Form 943, Employer’s Annual Tax Return for Agricultural Employees. This form is an annual return. If the tax liability is deposited semi-weekly, the 943 filer is required to list the liability amounts on Form 943A.
The Form 941C, Supporting Statement to Correct Information, is used to correct previously reported wages and taxes to the IRS.
Form 1096, Annual Summary and Transmittal
An employer must file Form 1096 transmittal with each type of Form 1099-MISC. This form summarizes all information included on Form 1099-MISC by category. The deadline for filing this form is the last day of February in the year following the payments.
Known as the Employer’s Annual Federal Unemployment Tax Return, this form is a simplified version of the Form 940. This form can and should be used when the employer meets the following conditions:
- The employer pays state unemployment taxes to only one state.
- The employer has made timely payments to that state, and all taxes due to that state have been paid by the filing date of the Form 940EZ.
- All wages that are taxable for federal unemployment purposes are also taxable for state unemployment (SUTA) purposes.
The Form 940, is a two-page form that requires more information from the employer than the 940EZ does. This form is more complex because the employer must list specific information about state unemployment tax payments and experience or merit rating. This version of the Form 940 must be prepared if the company employs workers in more than one state.
Form 1099-MISC, Miscellaneous Income
Companies using the services of independent contractors must notify the IRS and the independent contractor of the amounts paid for their services. An employer must file a Form 1099-MISC, Miscellaneous Income for each person, other than a corporation, who:
- Was paid at least $600 in rents, royalties, services, or prizes and awards; or
- Had federal income tax withheld under the backup withholding rules, regardless of the amount of payment.
- Employers engaged in a for-profit trade or business are subject to these requirements, as are certain non-profit organizations. Employers must transmit FORM 1099-MISC to the recipient by January 31 and to the IRS by the end of February. The recipient will include a copy when filing his/her tax return.
Tax Returns – Forms W2 and W3
Wage and Tax Statement, Form W-2: Form W-2, Wage and Tax Statement, shows wages received during the calendar year (including tips and other compensation) and the amount of taxes withheld from those wages. At the end of each calendar year, all employers must furnish a Form W-2 to each employee who has worked for them during the calendar year. Even if the employee has no federal income tax withheld, the employer must still provide a Form W-2 if the wages were subject to Social Security and Medicare taxes. Employee W-2s must be postmarked by January 31. The W-2 Wage Statement must be reported to the Social Security Administration by the last day in February. Employers filing electronically to Social Security are given an extra thirty days.
Transmittal of Wage and Tax Statements, Form W-3: Employers must use Form W-3, Transmittal of Wage and Tax Statements, when filing paper W-2s with the Social Security Administration. Form W-3 summarizes the total wages, Social Security wages, federal income tax withheld, and FICA tax withheld from employees during the year and lists the number of W-2s being transmitted.
Corrections: Form W-2C, W-3C, Statement of Corrected Income and Tax Amounts are used if an error in reporting occurred.
Forms and instructions are available from the IRS Web site.
Each state also has its own set of laws and taxes affecting payroll. In addition to complying with all federal laws, employers are responsible for complying with the laws of the state in which they do business. Usually, state laws cover areas such as child and spousal support enforcement, new hire and termination reporting, pay frequency reporting, etc.
Electronic Fund Transfer (EFT)
Many states are following the lead of the federal government and offering employers the option of filing payroll taxes electronically. The majority of businesses are required to deposit payroll taxes electronically, however smaller employers and new businesses can continue to use paper coupons. While most states have phased-in electronic filing requirements, many also allow for voluntary participation.
Contact the state in which your employees work to find out the specific requirements for electronic filing. As with other employment-related issues, understanding your state’s requirements can save both time and money.
New Hire Reporting
All employers are required to report newly hired and rehired employees to state agencies. Depending on the state, this information may be used to facilitate the collection of child support and/or to uncover fraud or misuse of the state’s unemployment compensation, workers’ compensation, or public assistance (welfare) benefit programs. Generally, the information an employer must provide includes the employee’s name, address, Social Security number, as well as the employer’s name, address, and Federal employer identification number. States using the information to track parents who are delinquent in paying child support may require additional information.
Generally, the information an employer must provide includes the employee’s name, address, Social Security number, and date of birth, as well as the employer’s name, address, and identification number assigned by the agency involved. States using the information to track parents who are delinquent in paying child support may require wage, salary, and benefit information.
Most states allow the required information to be provided on a copy of federal Form W-4, the Employee’s Withholding Allowance Certificate. Some states require state-issued forms, magnetic or electronic media, or print-outs of employer’s new hire lists. The requirements cover all full-time and most part-time employees (including student workers), although most states exempt employees working less than a month or who work sporadically. Employers are given a specific amount of time to report the required information and most states penalize employers for failing to do so. Employers should check with their state for specific new hire reporting requirements.
Pay Frequency Requirements
How often should employees be paid? Do Fair Labor Standards Act (FLSA) non-exempt employees need to be paid at a different frequency than FLSA exempt employees? What should be included in an employee’s final paycheck?
The answers to these questions can be found by contacting the state in which your employees work. Requirements for pay frequencies, the timing of payments to employees, and the payment of wages to employees upon termination of employment are regulated by each state.
Most states have established pay frequencies for employers to follow. These requirements range from weekly to monthly, with the majority of states requiring semi-monthly payment. Guidelines are also available for the number of days in which an employee must be paid following a pay period. The number of days range from six to 31 days. Refer to the table below for the requirements of your state(s).
Payment on Termination
Each state also has their own rules governing payment of employees upon termination, whether through discharge, layoff, or resignation. These requirements are designed to guarantee that employees receive all wages they have earned on or soon after their last day of employment. There are also guidelines for what must be included in an employee’s final paycheck (e.g., fringe benefits owed, commissions, severance). Please contact your state for the most current guidelines.