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Payroll Taxes

Employers must deduct these payroll taxes from employees' pay.

The most common types of payroll deductions are Social Security taxes, federal, state and city withholding taxes, and miscellaneous items, such as insurance premiums, employee savings, and union dues.

Social Security Taxes

All corporate employers covered are required to collect the employee's share of Social Security tax by deducting it from the employee's gross pay and to remit it to the government along with the employer's share. Both the employer and the employee are taxed at the same rate, currently 6.2 percent (1996) based on the employee's gross pay up to a $62,700 annual limit.

Medicare is a two-part program designed to alleviate the high cost of medical care for those over age 65. The Basic Plan, which provides hospital and other institutional services, is financed by a separate Hospital Insurance tax (also called the Medicare tax) paid by both the employee and the employer at the rate of 1.45 percent on the employee's total compensation. The Voluntary Plan takes care of the major part of doctors' bills and other medical and health services and is financed by monthly payments from all who enroll plus matching funds from the federal government.

The combination of the O.A.S.D.I. tax, often called Federal Insurance Contribution Act (F.I.C.A.) tax, and the federal Hospital Insurance Tax make up the Social Security tax. The combined rate for these taxes, 7.65 percent on an employee's wages to $62,700 and 1.45 percent in excess of $62,700, is changed annually by acts of Congress. The corporate employer is required to remit to the government its share of F.I.C.A. tax along with the amount of F.I.C.A. tax deducted from each employee's gross compensation.

Income Tax Withholding

Federal and some state income tax laws require employers to withhold from the pay of each employee the applicable income tax due on those wages. The amount of income tax withheld is computed by the employer according to a government-prescribed formula or withholding tax table. The amount to be withheld for the pay period depends on each employee's taxable wages, marital status, and claimed dependents.

If the income tax withheld plus the employee and the employer social security taxes exceeds specified amounts per month, the employer is required to make remittances to the government at given intervals during the month. Monthly deposits are not required if the employer's liability for the calendar quarter is less than $500. Instead, the tax liability is remitted with the employer's quarterly payroll tax return.

EXAMPLE Assume a weekly payroll of $10,000, entirely subject to F.I.C.A. and Medicare (7.65 percent), income tax withholding of $1,500, and a deduction of $100 in union dues.

The entry to record the wages and salaries paid and the employee payroll deductions would be:

Wages and Salaries $10,000

Less:

F.I.C.A. Taxes Payable 765

Withholding Taxes Payable $1,500

Union Dues 00100 2,365

Net Payroll Payable $ 7,635

Unemployment Taxes

Another payroll tax levied by the federal government in cooperation with state governments provides a system of unemployment insurance. All employers who (1) paid wages of $1,500 or more during any calendar quarter in the year or preceding year or (2) employed at least one individual on at least one day in each of twenty weeks during the current or preceding calendar year are subject to the Federal Unemployment Tax Act (F.U.T.A.). This tax is levied only on the employer at a rate of 6.2 percent (1996) on the first $7,000 of compensation paid to each employee during the calendar year. However, a credit is granted for up to 5.4 percent of wages paid to the state government so that the amount paid to the federal government may be as low as 0.8 percent.

State unemployment compensation laws differ from the federal law and differ among various states. Therefore, employers must be familiar with the unemployment tax laws in each state in which they pay wages and salaries. Although the normal state tax may range from 3 percent to 7 percent or higher, all states provide for some form of merit rating under which a reduction in the state contribution rate is allowed.

In order not to penalize an employer who has earned a reduction in the state contribution rate, the federal law allows a credit of 5.4 percent even though the effective state contribution rate is less than 5.4 percent.

EXAMPLE The Cable Telephone Corporation, which has a taxable payroll of $100,000, is subject to a federal rate of 6.2 percent and a state contribution rate of 5.7 percent. But because of stable employment experience, the company's state rate is 1 percent. The computation of the federal and state unemployment taxes for Cable Telephone is as follows:

State unemployment tax payment (1%)($100,000) $1,000

Federal unemployment tax (6.2% - 5.4%)($100,000) $800

Total federal and state unemployment tax $1,800

The federal unemployment tax is paid annually on or before January 31 of the following taxable calendar year. State contributions generally are required to be paid quarterly.

Beginning in 1994, the IRS has established an electronic funds transfer (EFT) system for federal tax deposits by which employer withheld taxes may be transferred to a financial institution authorized to collect such funds on behalf of the government.

Miscellaneous Fringe Benefits

While employee compensation is taxable, the tax law encourages certain types of fringe benefits by allowing the corporation to deduct the cost of the benefit while permitting the employee to exclude the value of the benefits from her income. Some of the suggested benefits are as follows:

Pension and Profit-Sharing Plans

A newly formed corporation can set up pension, profit-sharing, and stock bonus plans, which give rise to immediate tax deductions for the corporation while enabling the corporation to attract and keep qualified individuals. Earnings in these plans are not taxable to the employees until the payments are actually received at a later date. A pension plan can be either contributory or noncontributory. Under a noncontributory pension plan, contributions are made solely by the corporation. Under a contributory pension plan, the employee makes additional contributions to supplement those made by the corporation.

Under a profit-sharing plan, the employer allocates a share of corporate profits according to some predetermined formula. Incidental benefits such as disability, death, or medical insurance can also be provided as part of a profit-sharing arrangement. A profit-sharing plan can be established in addition to or in lieu of a pension plan.

A stock bonus plan is a special type of arrangement whereby the employer's stock is contributed to a trust. The stock is then allocated to each participant in the trust for eventual distribution to them.

Qualified pension, profit-sharing and stock plans must meet complex rules in order to achieve their favorable tax treatment of immediate deductibility.

Cash or Deferred Arrangement Plans

Corporate executives can sign agreements calling for compensation to be paid at future dates. Such agreements result in a tax savings because the income will be spread over several future periods, thereby resulting in the income being taxed at lower rates.

EXAMPLE Wade Flag, a retired baseball player, is hired by Syndicated Restaurant Chains Inc. to represent them at all public events sponsored by the chain. Syndicated initially proposed a salary agreement calling for annual payments of $300,000 per year for three years or a total of $900,000. Instead, Flag demanded and eventually received a contract calling for specified payments of $90,000 per year to be paid over ten years thereby allowing the income to be taxed at a lower personal rate.

Life Insurance Arrangements

The corporation can make the following programs available to its employees.

1. Group-term. Under this arrangement, the corporation provides group insurance coverage for its employees. The corporation gets a deduction for the premium payment, and the premiums attributable to the first $50,000 of coverage are excluded from the employee's gross income.

2. Split-dollar. Split-dollar insurance is an arrangement in which the corporation purchases life insurance on certain key employees. The corporation pays that part of the premium equal to the annual increase in the cash value of the policy, and the employee pays the balance of the premium.

3. Key-employee. Key-employee insurance is a form designed almost exclusively to compensate the corporation for the loss of a vital employee whose services are important to the success of the enterprise. The insurance proceeds received by the corporation in the event of the employee's death are nontaxable. The premiums, however, are nondeductible by the corporation.

Health Insurance Arrangements

These plans may include the following:

1. Accident and health insurance. A corporation may provide accident and health insurance coverage for its employees. Under the Internal Revenue Code, the employer's premium payments are deductible by the corporation and are not included in the employee's income. Moreover, the actual payment of the insurance benefit is not included in the employee's income.

2. Medical reimbursement plans. This type of plan allows employees to exclude from income amounts received as reimbursement for medical expenses they incur for their medical care and those of their spouses and dependents.

Death Benefits

The corporation may establish a death benefit program whereby payments are made to a family or friends of the employee who dies. The Internal Revenue Code permits a $5,000 exclusion for each deceased employee. If there is more than one beneficiary, the $5,000 exclusion is allocated among all of the beneficiaries.

EXAMPLE Randolph Brand, an employee of the Whitecomb Chair Corp., died in 19XX. According to his death benefit policy, his $10,000 death benefit was to be shared equally by his mother and his companion. Thus, each beneficiary will receive a $5,000 death benefit of which $2,500 will be excluded from taxes ($5,000/2), and each will be taxed on the remaining $2,500.

Cafeteria Plans

These are plans that offer employees the option of choosing cash or certain nontaxable fringe benefits, such as group term life insurance, accident and health benefits, or child care. If the employee chooses cash, the cash is taxable. However, if the employee instead chooses a nontaxable fringe benefit, the value of the benefit is excluded from gross income. The fact that the employee could have chosen cash will not cause the fringe benefit to be taxed. The plan cannot discriminate in favor of highly compensated employees or their dependents or spouses. Employer plans may specify what benefits are offered and may limit the amount of benefits that individual employees may receive.

Dependent Care Assistance Programs

An employer can set up a dependent care assistance program that provides for care of an employee's children or other dependents. The purpose of the program is to allow the employee to work. Payments up to $5,000 annually is excluded from the employee's gross income.

"Flextime" programs

In order to allow employees to spend more time with their families, some corporations offer "flextime" where employees can arrange their work schedules in different ways, such as four ten-hour days with three days off, work from home part of the day, etc.

The Family and Medical Leave Act of 1993

Under the Family and Medical Leave Act (FMLA), covered employers must provide access to up to twelve weeks' leave per calendar or fiscal year for the employee's own illness, the illness of a close family member, or the birth or adoption of a child. This act applies to employers with fifty or more employees in each day of twenty or more workweeks in a year in which an employee seeks to take leave.

Other Miscellaneous Benefits

Corporations may also provide such nontaxable fringe benefits as qualified employee discounts, de minimis (meaning minimal cost) fringe benefits, such as free coffee, free parking subject to a monthly statutory limit, and the use of athletic facilities, such as employer owned tennis courts.

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