Avoiding Potential Payroll Payment Pitfalls
Surprisingly, many of the withholding rules that every employer must comply with are contained in old statutes — at least old by tax standards. In recent years, a few of the relevant Internal Revenue Service (IRS) forms have been revised, but not much has changed at the conceptual level. Do you understand the withholding issues as they apply to your HVACR business?
Withholding Taxes On WagesAt its most basic, as an employer, every HVACR business must withhold income taxes and other amounts from the “wages” of workers each time that worker is paid. According to the tax rules, “wages” include all remuneration for services performed by an employee for an employer — including the cash value of all remuneration (including benefits) paid in any medium other than cash. Salaries, fees, bonuses, commissions on sales or on insurance premiums, taxable fringe benefits, pensions and retirement pay are, if paid as compensation for services, subject to withholding.
Naturally, the term “employee” must be distinguished from an “independent contractor” for purposes of employment tax obligations. An employer is not required to withhold taxes on payments made to independent contractors. A common law definition of “employee” focuses on the control that is or isn't exercised over what is done and how it is done. The IRS also uses a 20-factor test to assist in making the determination of whether a worker is an employee or an independent contractor.
Withholding FICAUnder the Federal Insurance Contributions Act, an employer is required to withhold social security taxes, including hospital insurance tax, from the wages paid to an employee during the year. What's more, the business must also match the amount withheld from the employee's wages. In 2002, the combined tax rate was 7.65 percent, consisting of a 6.2 percent payment compound for old-age, survivors, and disability insurance (OASDI) and a 1.45 percent component for hospital insurance (Medicare).
The OASDI rate applies only to wages paid within an OASDI wage base ($84,900 in 2002 and $87,000 in 2003). There is no cap on wages subject to the Medicare tax.
FUTA Tax RatesAnother law, the Federal Unemployment Tax Act (FUTA), imposes a tax on employers who employed one or more persons in “covered” employment. In this case, “employer” is defined as a contractor, wholesaler, distributor, or manufacturer who had workers who were employed at least one day in each of 20 weeks during the current or preceding calendar year, or who paid wages (in covered employment) of at least $1,500 in a calendar quarter in either the current or preceding calendar year.
The FUTA unemployment tax is based on the first $7,000 of wages paid during the calendar year to each employee. The full rate of the tax is 6.2 percent, but the employer is usually allowed a partial credit against this tax based on its state unemployment insurance tax liability.
Forms And FilingNot only must every HVACR business withhold income taxes, social security, and unemployment taxes from the wages and salaries paid to workers and match the social security amounts withheld, they must also report these amounts to the government — plus pay over the withheld amounts, of course.
A business/employer subject to either income tax withholding or social security taxes, or both, must file Form 941, “Employer's Quarterly Federal Tax Return.” That return combines the reporting of income and FICA taxes withheld.
Form 941 is due on or before the last day of the month following the quarter involved. However, an extension of time for filing is automatically granted to the 10th day of the second month following the close of the calendar quarter if the return is accompanied by depository receipts showing timely deposits in full payment of taxes due for the period.
Forms W-2, 1099-R, and transmittal Form W-3, must be filed with the Social Security Administration (SSA) by the last day of February following the year included in the return. The SSA transmits the income tax information on the return to the IRS.
Depositing LegitimatelyGenerally, an employer must deposit the income tax withheld and the FICA taxes with an authorized commercial bank depository. Most HVACR businesses are classified as either monthly or semiweekly depositors. An employer's status for a given calendar year is determined annually, based on the employer's employment tax reporting history during a 12-month lookback period ending on June 30 of the preceding year. The IRS will inform employers by November of each year which schedule they are to follow for the upcoming year.
Generally, an employer must deposit employment taxes on a monthly basis during 2003 if, during the lookback period from July 1, 2001 through June 30, 2002, the amount of the aggregate employment taxes reported was $50,000 or less. Monthly depositors are required to deposit each month's taxes on or before the 15th day of the following month.
An employer that reported more than $50,000 in aggregate employment taxes during the 2001-2002 lookback period will be a semiweekly depositor in 2003. Semiweekly depositors are generally required to deposit their taxes by the Wednesday after payday, if payday falls on a Wednesday, Thursday, or Friday. For all other paydays, the deposit is due by the Friday following payday.
According to the IRS, both monthly and semiweekly depositors will always have at least three banking days after the payday to make the deposit. Remember, however, only an original Form 8109 (Federal Tax Deposit Coupons) may be used to make deposits of withheld amounts. Under the IRS's AUTOGEN program, taxpayers automatically receive a new FTD coupon book as they are needed.
Electronic Fund TransfersMany businesses are required to make their deposits using the IRS’s Electronic Fund Transfer (EFT) system. Any business that exceeds threshold aggregate amounts of employment and other taxes must deposit by EFT.
Under the rules, a business is required to make deposits using EFT in 2003 if (1) the total deposits of all depository taxes (such as employment taxes, excise taxes, and corporate income tax) in 2001 was more than $200,000, or (2) the business was required to use EFT in 2002.
Once a taxpayer is required to make EFT deposits, all future deposits must be made via EFT, regardless of whether the amount is reached in each calendar year thereafter. If a taxpayer is required to use EFT and fails to do so, a 10 percent penalty may be imposed. Any contractor, wholesaler, distributor, or manufacturer not required to use EFT may, of course, voluntarily participate in the payment system.
The Downside PenaltiesNot only is the business responsible for withholding and paying over payroll taxes, any “responsible person” — typically an officer or employee of the HVACR operation — who willfully fails to withhold, account for, or pay over withholding tax to the government is subject to a penalty equal to 100 percent of such taxes. This penalty is a collection device, usually assessed only when the tax cannot be collected from the employer. It does, however, result in a personal liability not dischargeable by bankruptcy.
In general, a four-tier graduated penalty applies to failures to make timely deposits of tax — unless the failure is due to reasonable cause and not willful neglect. The penalty amount varies with the length of time within which the taxpayer corrects the failure to make the required deposit.
The penalty is assessed as follows: (1) 2 percent of the amount of the underpayment if the failure is for no more than five days; (2) 5 percent of the amount of the underpayment if the failure is for more than five days but for no more than 15 days; and (3) 10 percent of the amount of the underpayment if the failure is for more than 15 days.
A rate of 15 percent applies if a required tax deposit is not made on or before the day that is 10 days after the date of the first delinquency notice to the taxpayer — or, if earlier, on or before the day on which notice and demand for immediate payment of tax is given in cases of jeopardy.
Whether a business has one employee or a hundred, understanding and complying with the basic rules can go a long way toward avoiding — or even eliminating — unpleasant confrontations. IRS examiners are well aware of the confusion that exists — and the mistakes that are made — by many contractors, distributors, wholesalers, and manufacturers when it comes to payroll withholding.
Mark E. Battersby is a freelance writer, columnist, author, and lecturer with offices in suburban Philadelphia. He can be reached at 610-789-2480 or Mbattersby@MCImail.com.
Publication date: 07/07/2003