Extra pay day? Here’s a refresher

Bakers dozen graphicA number of our clients with weekly and biweekly payroll periods have been raising questions about an additional payroll period occurring within their businesses this year. These queries alert us that many employers are dealing with an anomaly in 2014 that comes around every several years thanks to our calendar-year system. For businesses that are now or soon will be dealing with this payday “baker’s dozen,” here are answers to the questions frequently raised.

Income tax withholding

In the year in which there is an additional payroll period, weekly and biweekly payers must be certain to adjust the computer formulas used to compute federal income tax withholding (FITW). (Similar adjustments to the state and local income tax withholding formulas may also be necessary.)

The computer formula used by most automated payroll systems to compute federal income tax withholding is generally based on 26/52 payroll periods and is rarely automatically adjusted when there are 27/53 payroll periods. According to the IRS Office of Chief Counsel, employers using an annual withholding method must base the FITW computation on the actual number of pay periods in the year.

In other words, in the year of an additional payroll period, pay period wages are multiplied by 27/53 rather than 26/52, and the annual tax is divided by 27/53 rather than 26/52. Failure to make this modification in the FITW computation can result in the underwithholding of federal income tax (see the example below). Such errors can result in adverse consequences (e.g., tax liability, interest and penalty).

Example: Employee Angela earns $1,260 each biweekly pay period in 2014. She claims single with no allowances. She will receive 27 paychecks in the year. If her employer uses 26 payroll periods to compute her federal income tax withholding, the FITW for the year will be $189 less than it should be ($4,311.75 – $4,122.75), as shown in the calculations below.

  1. Annual withholding based on a normal 26-pay-period year:

$1,260 × 26 = $32,760

2014 FITW on $32,760 = $4,122.75

[($32,760 −$11,325) × 15% + $907.50]

  1. Annual withholding based on a 27-pay-period year:

$1,260 × 27 = $34,020

2014 FITW on $34,020 = $4,311.75

[($34,020 − $11,325) × 15% + $907.50]

Don’t forget to readjust calculations in the subsequent year. Employers must be sure to count the number of pay periods in each tax year to determine if an adjustment in the FITW computation (as previously described) is necessary. If there was an additional pay period in one tax year, and the computer formula was modified to take into account the additional pay period, be sure to change the computation back to a pay period wage multiplication of 26/52 and a division of the annual tax by 26/52 for the subsequent tax year.

Budgetary considerations

The additional payroll period will generally always result in higher-than-normal annual wages for nonexempt employees; however, whether the same is true of exempt-salaried employees depends on how their payroll period wages are determined.

There are three approaches for computing the weekly/biweekly pay of exempt-salaried employees, each having a different budgetary result.

1.  Recompute the annual salary in the year of an additional payroll period. The agreed-upon annual regular salary of exempt employees is divided by the actual number of payroll periods in the year. Hence, the biweekly pay of a salaried employee is 26 or 27 in the year having an additional payroll period. (See Example 1.)

Example 1. John’s employer agrees to pay him $50,000 per year. John is paid biweekly. In those years in which there are 26 payroll periods, John’s biweekly pay is $1,923.08 ($50,000/26). In the year in which there are 27 payroll periods, John’s biweekly pay is $1,851.85 ($50,000/27).

Budgetary result. In all years, including the year of the additional payroll period, John’s annual compensation is close to the agreed-upon regular salary of $50,000.

2.  Do not recompute the annual salary in the year of an additional payroll period. The agreed-upon annual regular salary of exempt employees is divided by 26 or 52 payroll periods and is not adjusted in those years with an additional payroll period. The result is a windfall in pay in the year of an additional payroll period. (See Example 2.)

Example 2. Mark’s employer agrees to pay him $50,000 per year. Mark is paid biweekly. His biweekly pay is computed as $1,923.08 ($50,000/26). In those years with 26 payroll periods, Mark is paid $50,000.08. In the year in which there are 27 payroll periods, Mark is paid $51,923.16 ($1,923.08 x 27).

Budgetary result. In the year of the additional payroll period, Mark receives excess compensation of $1,923.16 ($51,923.16 – $50,000). In all other years, Mark’s annual salary is close to the agreed-upon amount of $50,000.

3. Use the exact calendar-year divisor of 26.0893 or 52.1786. The agreed-upon annual regular salary is divided by 26.0893 for those paid biweekly and 52.1786 for those paid weekly. (See Example 3.)

Example 3. Ruth’s employer agrees to pay her $50,000 per year. Ruth is paid biweekly. Her biweekly pay is computed as $1,916.49 ($50,000/26.0893).

Budgetary result. In those years with 26 pay periods, Ruth is paid $49,828.74, which is $171.26 less than her agreed-upon annual regular salary of $50,000. In the year in which there are 27 payroll periods, Ruth is paid $51,745.23, an excess of $1,745.23 over the agreed-upon regular salary of $50,000.

Ernst & Young LLP insights

To eliminate complications in paying the correct annual salary to exempt employees, it is not uncommon that businesses pay their salaried exempt employees on a semimonthly basis (where allowed by state law) while paying hourly and salaried non-exempt employees on a weekly/biweekly basis. Always consult with a competent labor law advisor before making a change in the amount or frequency at which you pay salaried employees.

State tax rules for same-gender partner benefits can be complex

wedding ringsIn May 2014, in two states — Oregon and Pennsylvania — a US District Court judge ruled that same-gender couples must be allowed to marry. From the perspective of the tax treatment of same-gender partner benefits, both states highlight how a state’s civil marriage laws may not necessarily synchronize with its income tax and unemployment insurance coverage rules.

Oregon

On 19 May 2014, US District Court Judge Michael McShane overturned Oregon’s 2004 ban on same-gender marriage, ruling it unconstitutional. With no plan to appeal the ruling by either the Oregon Attorney General or its governor, Oregon is now among the 19 states and the District of Columbia that allow same-gender couples to marry.

Since 1 February 2008, Oregon has recognized in-state registered domestic partnerships, giving such same-gender couples virtually all of the rights as married couples.

In October 2013, the state began recognizing same-gender couples married outside of the state. Accordingly, for the 2013 tax year, the Oregon Department of Revenue instructed that in-state registered domestic partners and same-gender couples lawfully married in another state file their Oregon state income tax returns as joint or married filing separately.

Guidance issued in 2013 by the Oregon Department of Revenue concerning the tax status of in-state registered domestic partnerships could be revised in accordance with this most recent development.

Pennsylvania

On 20 May 2014, a US District Court judge overturned Pennsylvania’s 1996 ban on same-gender marriage, ruling it unconstitutional. (Deb Whitewood, et al, vs. Michael Wolf, 1:13-cv-1861.) Governor Tom Corbett chose not appeal the ruling, making it among the 19 states plus the District of Columbia that now allow the issuance of marriage licenses to same-gender couples.

While Pennsylvania has never recognized civil unions or registered domestic partnerships as having marital status, the state has excluded the value of health benefits provided to domestic partners from income subject to personal income tax.

The Office of Chief Counsel at the Pennsylvania Department of Revenue has confirmed that its position on this matter is not altered by the 20 May ruling. (Telephone conversation, Pennsylvania Department of Revenue, May 27, 2014.)

Pennsylvania domestic partner benefit health exclusion

In a 2008 personal income tax ruling (PIT-08-002), the Department explains that in determining the income tax treatment of employee welfare benefits, taxable income does not include the value of such benefits provided to the employee’s “beneficiary.” Whether the beneficiary is the employee’s spouse or dependent is not a determining factor.

To meet the beneficiary exclusion, the employee must have a legal or moral duty to support the beneficiary, and the employer’s plan must be nondiscriminatory pursuant to Department regulations.

Ernst & Young LLP insights

Oregon and Pennsylvania aren’t the only states where the civil marriage law is inconsistent with the tax treatment of same-gender partner benefits. It is important to keep in mind that civil marriage laws are not necessarily determinative of the tax treatment of fringe benefits.

For assistance in understanding the state rules that apply to same-gender partner benefits, ask us.

It’s time to settle FICA claims in the Windsor decision

Image of court stepsIn an email on 15 May 2014, the IRS explained that employers filing a protective FICA refund claim before 15 March 2014 pursuant to the ruling in Windsor, and that have not yet been contacted by the Service, should now submit their perfected claims along with proof that the originally filed protective claim was timely submitted.

Background

Revenue Ruling 2013-17 set forth the tax treatment of same-gender spousal benefits subsequent to the Supreme Court’s decision in Windsor. Specifically, the revenue ruling provides that its holdings will be applied prospectively as of 16 September 2013.

Subsequently, the IRS issued Notice 2013-61 to provide guidance for employers and employees making claims for refund or adjustments of FICA taxes and income tax withholding resulting from Windsor and the holdings of the revenue ruling. That guidance includes a special administrative procedure allowing employers to file one Form 941-X for each tax year (rather than one Form 941-X for each quarter, which is the normal rule).

When the Windsor decision was first appealed to the US Supreme Court, the statute of limitations was open for tax year 2009. Accordingly, some businesses filed a protective FICA refund claim for 2010 or earlier years so that they would be eligible for a FICA refund in the event of a favorable outcome in the Windsor decision.

Next steps   

Employers that filed protective FICA refund claims for 2010 and earlier years more than 60 days ago and that have not yet been contacted by the IRS pursuant to those claims should now proceed to prepare Forms 941-X according to the instructions in Notice 2013-61. Be sure to include with the Forms 941-X a copy of the protective FICA refund claim(s) originally filed with the IRS as well as proof that the protective claim(s) was submitted to the IRS before the statute of limitations lapsed (e.g., by 15 April 2013, for tax year 2009).

Keep in mind that when filing Forms 941-X, Forms W-2c also must be issued to employees and filed with the Social Security Administration and that FICA refunds should be paid to employees. Employees receiving FICA refunds from employers should be required to sign a consent letter in accordance with page 5 of the Form 941-X instructions.

 
Ernst & Young LLP insights

Employees who filed their own protective refund claims are likely also trying to perfect their claims. Accordingly, these affected employees may now be seeking Forms W-2c or other information to assist them in identifying the correct wage adjustments for prior tax years.

Employers that have not yet adjusted their processes for identifying the retroactive and prospective tax treatment of same-gender spousal and partner benefits should consider completing these tasks as soon as possible. For assistance with the federal and state tax treatment and reporting of same-gender spousal and partner benefits, click here.

 

Summer employment shines light on unemployment insurance considerations

FerriswheelThe summer months bring an increased demand for recreational activities and a plentiful supply of students and other temporary workers to meet the peak demands of the season. The flood of available resources during the school break also gives firms an opportunity to fill job vacancies with college interns to assist in jobs requiring a professional or technical discipline.

The temporary nature of summertime employment also raises questions concerning when federal and state unemployment insurance applies.

Here we will focus on two such issues, whether summer employment wages are covered for unemployment insurance tax purposes and if seasonal workers are eligible for unemployment insurance benefits.

Length of employment is not relevant for unemployment insurance tax purposes

Employers frequently believe that the wages of summer workers are exempt from federal (FUTA) and state unemployment insurance (SUI), particularly when these workers participate in summer intern programs. The fact is, there is little distinction between students working in the summer and other part-time and seasonal employees when it comes to an employer’s unemployment tax obligations. The wages paid to students generally are subject to FUTA and SUI and are reported on the Form 940 and SUI returns.

For FUTA tax purposes, there are a few exceptions as follows (IRS Publication 15, Employer’s Tax Guide; IRC §3306; IRC §3309):

  • A son or daughter (including stepchildren and adopted children) under age 21, when paid by a parent whose business is a sole proprietorship (or a partnership consisting only of parents)
  • A spouse, when paid by his or her spouse
  • Newspaper carriers under age 18 who deliver newspapers to customers
  • Students working for a private school, college or university, if enrolled and regularly attending classes at the school at which they are employed, and spouses of students if they are advised at the time of hire that (a) the employment is provided under a program to provide financial assistance to the student by the school and (b) the individual is not covered by any unemployment program and is not entitled to unemployment insurance benefits in the event of separation
  • Students enrolled in a full-time program at a nonprofit or public educational institution that combines academic instruction with work experience, giving the student credit for services performed unless the program was established for or on behalf of an employer or group of employers
  • Student nurses for services performed in the employ of a hospital or nurses training school by an individual who is enrolled and is regularly attending classes in a nurses training school chartered or approved pursuant to state law
  • Full-time students for services performed in the employ of an organized camp, if the camp did not operate more than seven months in the calendar year and did not operate for more than seven months in the preceding calendar year
  • Students, scholars, trainees, teachers and similar who qualify as non-immigrant aliens holding F, J, M or Q visas and are working within the scope of their respective visa (IRS Reg. §301.7701(b)-3(b))
  • Aliens performing agricultural labor with H-2A visas
  • Interns and patients working in hospitals
  • Certain members of a fishing vessel

Note that this is not a complete list of those types of employment that are exempt from FUTA but rather a summary of the types of job positions exempt from FUTA that are typically held by students or other temporary or seasonal employees.

While SUI laws typically mirror the federal unemployment insurance law as it pertains to student employment, there are exceptions. For example, only a few states exempt services performed by foreign students from the definition of employment for SUI purposes. Also, several states restrict the SUI exemption for work-study students to those under the age of 22. Some states do not provide any SUI exemption for services performed by work-study students. Employers should consult the law of the state in which the students are performing services to determine whether their wages are subject to SUI.

Unemployment insurance benefits and seasonal employment

Several states make special provisions that prevent seasonal employees from receiving unemployment benefits. Since an employer’s SUI rate is based partly on the benefits paid to its separated workers, understanding when these exclusions apply is important for industries that operate only during certain months of the year. While the exclusion is commonly associated with agricultural workers, some states also make it available to other industries with seasonal employment (e.g., parks and recreation). See the state heat map below.

State law generally defines “seasonal” in terms of:

  • The industry, employer or occupation involved
  • The wages earned during the operating period of the employer or industry
  • The individual

In the applicable states, employers generally qualify or obtain approval for the seasonal employment exemption through a formal procedure of the state UI agency. When granted, the exclusion applies for a specified period during the year in accordance with the nature of the seasonal operation.

Read more about summer employment payroll considerations.

Seasonal employment heat map