The In's and Out's of Payroll Withholding Taxes

By Mark D. Zinn

As an employer, you must withhold from an employee's pay money to cover the employee's federal income tax liability, Social Security and Medicare taxes.

The combination of the employee's withheld federal income, Social Security and Medicare taxes are called "trust taxes." The reason for this designation is that the money belongs to the employee, since it is withheld directly from his or her pay. The employer is legally responsible to accurately withhold, account for and pay the required amounts to the IRS on the employee's behalf.

Both the employee's share and the employer's share of employment taxes are reported on Form 941, Employer's Quarterly Federal Tax Return. Form 941 is required to be filed no later than one month after the close of the calendar quarter.

Each employee must complete a Form W-4, "Employees Withholding Allowance Certificate." Use the employee's gross wages and the information on the W-4 to figure the amount to withhold. If an employee doesn't give you a signed W-4, withhold tax at the single rate with no withholding allowances.

If an employee claims to be exempt from withholding, the exemption only applies to income tax, not to Social Security or Medicare-the FICA taxes. And, employees claiming exemption from withholding must submit a new W-4 each year by Feb. 15, to re-establish their exempt status.

Wages that are subject to federal employment taxes include all payments you give an employee for services performed. The pay may be in cash or in other forms (i.e., salaries, vacation pay, bonuses, commissions and certain fringe benefits). However, not all employee compensation is considered wages.

For example, if you pay the cost of an accident or health insurance plan for your employees, these payments are not wages and are not subject to tax. Also, if you reimburse an employee for business expenses under an "accountable plan," those amounts are not wages and are not subject to tax. However, payments to employees for necessary business expenses under a "non-accountable plan" are deemed supplemental wages subject to employment taxes.

An accountable plan is a reimbursement or allowance arrangement between you and your employee that meets all three of the following rules: 1) Your employee must pay for deductible expenses while performing services as your employee, 2) the employee must account for those expenses, and 3) return to you any advanced amounts that are more than the actual expenses within a reasonable period.

If an employee is not required to, or does not account for expenses in a timely manner, you have a non-accountable plan. It is also a non-accountable plan if you advance an amount to the employee for business expenses and that employee is not required to return, or does not return, any amounts not used for business expenses.

To figure payroll, you must first determine the total amount of compensation and benefits included in each employee's wages for the pay period. The next step is to figure the amount of income tax to withhold from each employee. The two most common methods are the "wage bracket method" and the "percentage method."

For Social Security and Medicare taxes, simply multiply the total wage by the applicable employee Social Security and Medicare tax percentages. As the employer, you also pay a matching amount.

The amount of wages subject to Social Security withholding changes each year. You do not have to withhold any more Social Security taxes once the employee's wages have reached that limit. This "wage base limit" is published annually in Publication 15.

There is no wage limit for Medicare taxes, so all wages are subject to withholding and, just like Social Security taxes, the employer must pay a matching amount.

You pay your payroll taxes to the IRS by depositing them directly with the U.S. Treasury. You can do this through your bank or through the Electronic Federal Tax Payment System. How often you pay these taxes depends on the type of tax and the amount.

The best time to make a tax deposit is the same day you pay your employees. You can deposit anytime up through the deposit due date, but if you deposit late, penalties kick in.

So, what are the due dates? If the payroll tax is less than $2,500 for the quarter, you can pay it with your Form 941, "Employer's Quarterly Federal Tax Return." If the payroll tax is $2,500 or more for the quarter, your deposit is based either on a monthly or semi-weekly schedule.

Mark D. Zinn, J.D., L.L.M., is an attorney with the Zinn Law Firm, P.A. You can reach him at (913) 262-4829, or, on the web at, www.zinnlawfirm.com