Payroll tax issues or what I like to refer to as opportunities.
There will always be opportunities to encounter errors when dealing with payroll and/or payroll taxes. As the word implies, opportunities give you a chance to identify issues before they occur. With that in mind, I will discuss ten (10) pitfalls that can be avoided by just being aware of known problem areas.
In this ever-changing landscape where remote workers are now in almost every business, new payroll tax challenges having been identified. Nexus is no longer a new word for payroll processors. First, the definition of Nexus is defined as, “The term "nexus" is used in tax law to describe a situation in which a business has a tax presence in a particular state. A nexus is a connection between the taxing authority and an entity that must collect or pay the tax”. What does this mean for employers? It means that the lone salesperson you hired in Illinois when your business is located in Oklahoma makes you responsible for filing Illinois state withholding and unemployment returns as well as issuing IL state information on the W2’s. This adds both deposits and tax filings to your pay periodic schedule. Depending on the tax amount, the deposit may be due more frequently than just quarterly. In this particular example, you also need to consider your General Ledger needs in that you will now be required to accrue the unemployment amounts as they are paid quarterly. Multi-State tax reporting is a complex subject that I made sound simple. There is a reason the American Payroll Association offers an entire class on just this one subject.
If you are using Scissortail, much of the pain in multi-state taxation is already handled for you. The employee data needs to be updated any time there is a change in either the employee's home address or work location. Once those have been updated, then Scissortail will automatically know the behind-the-scenes taxation needed. For example, LA and MN do not recognize wage base limits that have been applied to another state, but Scissortail has the rules built-in and will tax correctly. A lot of payroll systems handle multi-state taxation, but, in my opinion, Scissortail handles it exceptionally well. We can really get in the weeds here talking about how locals are calculated and how the term reciprocity between tax authorities is used. But this is just a general overview to get you thinking about how your system handles various tax situations.
New Tax Authority Registrations
To make timely tax deposits and return filings, you must register your business with each new tax authority. Many companies are now outsourcing their payroll taxes to a third party. It is also important to keep your tax partner in the loop so third-party access can be assigned. Without this third-party access, your provider’s hands are tied on filing all your returns. In most cases, the withholding deposits can be made with no problem, but unemployment returns and associated payments can be a major issue. Local tax registrations are often overlooked, so be sure to include those as well.
Timely Tax Deposits and/or Returns
It is imperative that timely tax deposits are made for each taxing authority in your organization to avoid a penalty situation. Some of these penalties can run into the hundreds of thousands of dollars. A deposit/return calendar is handy to keep updated. As your company grows, an authority can change the payment schedule to a more frequent schedule. Or conversely, if you have a downturn in your business, the schedule can be reduced to a less frequent one. When you are setting up for the new year, be sure and review that your schedule has not changed.
One particular concern is anticipating when your payroll will incur greater than $100,000 of federal tax liability as those are due the next day regardless of your regular schedule.
Each year the IRS publishes Circular E The Employer’s Tax Guide and can be found here https://www.irs.gov/pub/irs-pdf/p15.pdf for tax year 201:
Publication 15 states, “For amounts not properly or timely deposited, the penalty rates are as follows.
- 2% for deposits made 1 to 5 days late.
- 5% for deposits made 6 to 15 days late.
- 10% for deposits made 16 or more days late, but before 10 days from the date of the first notice, the IRS sent asking for the tax due. 10% is calculated on the amount that should have been deposited but instead were paid directly to the IRS or paid with your tax return. But see Payment with return, earlier in this section, for exceptions.
- 15% for amounts still unpaid more than 10 days after the date of the first notice the IRS sent asking for the tax due or the day on which you received notice and demand for immediate payment, whichever is earlier.”
Tax notices need to be responded to as soon as they are received. Depending on the type of tax notice, hundreds if not thousands of dollars in penalties and interest can be incurred. It is best to respond in writing to notices, so you have the written documentation for support should the same issue come up again, say in an audit. Good record keeping is a must when dealing with payroll and/or payroll taxes. State Withholding and Unemployment returns each have their own set of rules for late or missed deposits and/or returns. Some state penalties are more severe than others, but if you have everything listed on your tax calendar, there is no reason for you to receive tax notices of penalties.
Rates and Limits
Every year the annual rates and limits for OASDI/Medicare/Unemployment are published usually by late December. A few states will not update until closer to the end of the 1st quarter. Since businesses have access to the internet, most states no longer mail the annual rate notices. When planning the new tax year, it is important to review the rates and/or limits and update your payroll system accordingly. I think all supported payroll software automatically includes the new wage limits, so you only need to check the rates. There is nothing worse than receiving a huge tax bill at the end of the quarter because you did not anticipate the rate changes were much higher than expected. I have read that in 2022, most states will feel the pain of how the Covid pandemic has impacted the unemployment usage and, in turn, will pass that pain on to you, the employer. If your rates are not updated, you could be penalized to the tune of thousands of dollars. I cannot stress enough the importance of limits and rate reviews. Another important thing to consider is you can protest rate changes. Just be prepared to have a solid documented argument before you go down that path.
Group Term Life Taxability
When the company's taxability provided group term life first started 20 some odd years ago, all the payroll departments in existence were deluged with phone calls asking what did imputed GTL mean. Imputed GTL is now so common one rarely gets a question on it.
However, when setting up the taxability of group term life, I have found that through various conversations with other payroll professionals, employers are not giving the employee credit for their after-tax contribution to the plan. Employers are not trying to avoid giving credit. They just do not know this little caveat in the rules. The IRS states, “You must include in your employee's wages the cost of group-term life insurance beyond $50,000 worth of coverage, reduced by the amount the employee paid toward the insurance”.
Imputed GTL is treated as wages in boxes 1, 3, and 5 of the employee’s W2. The amount is also reported in box 12 with the code “C”. The imputed amount is subject to both social security and medicare taxes.
When calculating the Imputed income based on the age table, you use what age the employee will be on 12/31 of the year and use that cost all year, so even if you turn 50 on November 15, you would calculate the rate as .23 per thousand from January 1 of that year.
Cost Per $1,000 of Protection for 1 Month
Age Cost Under 25 ................................ $ 0.05
25 through 29 .............................. 0.06
30 through 34 ............................. 0.08
35 through 39 ............................. 0.09
40 through 44 ............................. 0.10
45 through 49 ............................. 0.15
50 through 54 ............................. 0.23
55 through 59 ............................. 0.43
60 through 64 ............................. 0.66
65 through 69 ............................. 1.27
70 and older .............................. 2.06
Coverage for Spouse and Dependents
The cost of employer-provided group-term life insurance on the life of an employee’s spouse or dependent, paid by the employer, is not taxable to the employee if the face amount of the coverage does not exceed $2,000. This coverage is excluded as a de minimis fringe benefit.
Whether a benefit provided is considered de minimis depends on all the facts and circumstances. In some cases, an amount greater than $2,000 of coverage could be considered a de minimis benefit. See Notice 89-110 for more information.
If part of the coverage for a spouse or dependents is taxable, the same Premium Table is used for the employee. The entire amount is taxable, not just the amount that exceeds $2,000.
When I first started doing payroll, gift cards given to employees were considered de minis if they were under $25. Some employers are still under the assumption this is still the case and not reporting the gift card value. According to the IRS, gift cards in any amount are to be imputed as taxable income. In my experience, most employers gross gift cards up so the employee will get the full benefit of the gift card. Since gift cards are often purchased and then reimbursed on an expense report, the payroll department needs to work closely with their accounts payable department to identify the recipient of the gift so it can be included in their income.
Third-Party Sick Reporting
It seems that third-party sick reporting is gotten more complex than it used to be in some ways yet simpler in other ways depending on the arrangement made with the insurance provider. The going trend is to let the insurer be your third-party agent and keep the mix out of payroll. In that instance, the insurer withholds the OASDI/Medicare amounts due and deposits them along with the employer share under their FEIN. The insurer also files the associated tax returns. Of course, there is a fee for using this method, but it is so much simpler for the payroll department.
If the insurer only withholds the EE portion of the OASDI and Medicare, the employer should receive these updates at least quarterly. It then becomes the responsibility of the employer to include the employer portion on their 941. Form 8922 https://www.irs.gov/pub/irs-pdf/f8922.pdf will also be required. There are many rules around third-party sickness, and this is just a highlight of some of the rules, but I would not want it to be construed as the end all be all of the requirements.
Validating Employee Data
Employers should validate their employees’ Names, Social Security Number, and Addresses at the very least annually. Even long-term employees need to confirm the data. The payroll provider could have changed and the data loaded incorrectly, or it could have been keyed into the system incorrectly. Time spent on the front end will save you time at the back end. There is nothing worse than having to do a W2C for an invalid social security number because one number is transposed or just wrong altogether. Also, tracking returned W2’s is a painful process for both the employee and the employer.
According to https://www.phishing.org, “Phishing is a cybercrime in which a target or targets are contacted by email, telephone, or text message by someone posing as a legitimate institution to lure individuals into providing sensitive data such as personally identifiable information, banking and credit card details, and passwords”.
Everyone in the payroll process needs to be aware of data protection from human resources to tax filings since both contain confidential employee data such as social security numbers. Phishing is the latest scam to access what should be protected data. At my last job, I received what looked like an email from our CEO asking me to send him a copy of the W2’s for that year. And in yet another email, it looked like a senior VP asked me to update his direct deposit. I knew both individuals and that neither would conduct business this way. However, it would be easy to fall prey to this type of scam in larger firms as you don’t always know your audience personally. Just be aware and do not be afraid to ask questions. If you receive an email requesting personal data and you are not sure of it, follow up with a call or write a new email to the person in question qualifying their request. Do not forward the original request as it just gives the sender one more opportunity to access data.
Once you have recognized these early pitfalls, you may still see something like this: