A 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.
- 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]
- 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.
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.