Common payroll issues
Employers need to be alert to avoid problems.
July 30, 2012
In today’s business environment, employers must be well-versed in tax, employment, and benefits guidelines to maintain compliance with all the various regulations. Based on Paychex, Inc.’s experience in working with hundreds of thousands of employers, this information includes the most common payroll pitfalls that companies may encounter, and should be aware of, to help avoid hefty fines.
Accuracy of Social Security numbers
To ensure accurate and timely W-2 filing, employers must ensure that they provide accurate Social Security numbers on their employee’s W-2s. A W-2 filed with the Social Security Administration with an incorrect or missing Social Security number and/or employee name will be held in suspense and the wages will not be credited to the employee. The Social Security Administration provides a tool employers can use to verify that the Social Security number matches the employee name. The Social Security Number Verification Service (SSNVS) is available for free on the SSA website.
FUTA credit reductions
2011 saw an unprecedented number of states classified as "credit reduction" states for Federal Unemployment Tax Act (FUTA) purposes. These states had to take out a loan from the Federal Unemployment Trust Fund to be able to meet their state unemployment obligations and were unable to pay the balance of the loan off within the two-year window set by the federal government. The number of states potentially impacted for 2012 is expected to be at least equal to the number in 2011. Currently the following states and territory have outstanding loan balances with the federal government: Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Georgia, Illinois, Indiana, Kentucky, Missouri, Nevada, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, South Carolina, Vermont, the Virgin Islands, and Wisconsin. These states and territory have until November to pay off their loans or they will be subject to a credit reduction on their FUTA tax. This credit reduction will result in an increase in FUTA tax that employers must pay at the end of the year. Employers who have employees in the above mentioned states and territory should be aware of this possible increase and should plan accordingly.
Health care law/Medicare changes
The health care law, known as the Patient Protection and Affordable Care Act of 2010, has several provisions that take effect in 2013. One of these provisions is an increase in the Medicare tax rate. As of Jan. 1, 2013, the Medicare tax rate for employees earning over $200,000 ($250,000 for joint filers) will increase 0.9%, making the new rate for 2013 2.35% for wages in excess of the $200,000 ($250,000 for joint filers) threshold. This change will not impact anyone earning $200,000 or under in wages. The Medicare tax rate for these individuals will remain at 1.45%. This change only affects the employee portion of Medicare. The employer portion remains unchanged at 1.45% for all employees’ wages.
Employee misclassification (EE vs. 1099 contractor)
Small business owners may have the option to hire workers as independent contractors or as employees. As a general rule, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.
One of the most common mistakes made by small business owners is not properly classifying workers as employees versus 1099 contractors. Properly classifying workers can alleviate confusion and possible fines. It is critical that small businesses understand the distinction between an employee and an independent contractor.
For more information about worker classification, refer to the IRS web page, “Independent Contractor (Self-Employed) or Employee?”
Temporary reduction of Social Security rate
The Middle Class Tax Relief and Job Creation Act of 2012 temporarily extends the 2 percentage point payroll tax cut for employees through the end of 2012. Workers will continue to benefit from a lower Social Security tax withholding rate of 4.2%, which is two percentage points less than the 6.2% rate in effect prior to 2011. Self-employed individuals will also benefit from a comparable rate reduction in the Social Security portion of the self-employment tax from 12.4% to 10.4%. For 2012, the Social Security tax applies to the first $110,100 of wages and net self-employment income received by an individual.
An employer who requires or permits a nonexempt employee to work overtime is required to compensate the employee with the appropriate premium pay for such overtime work. All nonexempt employees covered by the Fair Labor Standards Act (FLSA) must receive overtime pay for hours worked in excess of 40 in a workweek at a rate of at least one and one-half times their regular rate of pay. Employers should refer to the FLSA’s regulations to ensure appropriate classification of exempt vs. non-exempt employees and to identify those employees entitled to overtime pay.
The FLSA does not require overtime pay for work on Saturdays, Sundays, holidays, or regular days of rest, unless overtime hours are worked on such days. State laws may vary. Premium pay for working weekends or nights is a matter of agreement between the employer and the employee (or the employee’s representative). The FLSA does not require premium pay including double-time for weekend or night work.
Exempt vs. nonexempt
Some employees may be exempt from certain minimum wage and overtime requirement provisions of the FLSA. These employees may also be exempt from similar provisions under state wage and hour laws. Examples of exempt employees under the FLSA include the white collar exemptions: executive, administrative, professional, certain computer professionals, and outside sales. Exempt employees must generally be paid a minimum amount on a salary and/or fee basis, which is not subject to reduction based on the quality or quantity of work performed.
The FLSA, enforced by the U.S. Department of Labor—Wage and Hour Division, requires employers to pay nonexempt employees a minimum hourly wage rate and overtime pay for hours worked in excess of 40 in a work week of at least one and one-half times their regular rate of pay. Implementing regulations for the FLSA define working time for purposes of compensation.
Employers are encouraged to ensure proper classification of their employees under both state and federal law to avoid the possible unplanned financial burden of penalties and fines associated with wage and hour violations.
Garnishments and child support
Wage garnishment takes the form of a court order requiring an employer to withhold an employee’s earnings for the payment of a debt. Title III of the Consumer Credit Protection Act prohibits an employer from discharging employees because their earnings have been subject to garnishment for any one debt, regardless of the number of levies made or proceedings brought to collect it.
Employers must always include the employee case number with garnishment payments. This simple component of conscientious recordkeeping makes the posting process much more efficient for the garnishing agency and may save the employer from the possibility of delinquency notices.
Employers must also be mindful of federal and state new-hire requirements. New-hire reporting is the process by which an employer reports information about newly hired employees to a designated state agency shortly after the date of hire. New-hire reports are matched against child support records at the state and national levels to locate parents who owe child support monies. This is especially helpful for interstate cases (in which one parent lives in a different state from the child), which are often the most difficult cases for states to resolve. With new-hire reporting, state child support enforcement agencies can issue income-withholding orders, the most effective means of collecting child support in a timely fashion.
When multiple garnishment orders are in effect, the employer has to consider which orders take precedence over others. The employer must also be mindful of the maximum percentage of the employee’s wages that may be garnished.
Small business tax credit
The Patient Protection and Affordable Care Act (PPACA) implemented the Small Business Tax Credit. This was designed to offer small business a tax credit for offering a qualified health insurance plan to its employees, and paying at least 50% of single (not family) health care coverage for each employee.
To receive a credit (35% for small for-profit businesses and 25% for small tax-exempt employers) the employer had to employ fewer than 25 full-time equivalent employees that earned, on average, less than $50,000 per year. However, a full credit could only be obtained if the employer had 10 or fewer full-time equivalent employees earning, on average, $25,000 or less per year.
The IRS anticipated offering a tax credit to a good portion of the 4.4 million taxpayers that were notified of the credit. Had they come close to this number, a credit of upward of $2 billion would have been paid out.
The tax preparation of the credit is believed to be time-consuming for some, for the amount of credit that they are entitled to receive. For many business owners, it was difficult to easily determine if they were eligible for a credit at all. So, rather than paying for the additional time it would take to determine if there was a credit, many chose to ignore it altogether.
Paychex, anticipating this dilemma, created tools for our small business clients. A tax calculator was developed to put the taxpayer in the “ballpark” when trying to determine if he or she may be eligible for a credit and for approximately how much. Also, our small business payroll clients who had their health insurance through the Paychex Insurance Agency were afforded a year-end report with the wage and insurance premium information needed to calculate the credit. This tool was used by both employers and their accountants, greatly simplifying the calculation process. An email marketing campaign drove clients to these online tools.
Going forward, our desire is to further simplify these tools to make them even more user-friendly in order to assist even more clients in requesting their small business tax credit.
Tax agency ID requirements
Each business must have a valid, agency-assigned identification (ID) number for each tax agency. Employers without valid agency ID numbers should consult federal, state, and local tax agencies and follow the appropriate registration protocol to secure their ID. Tax returns filed and/or payments remitted without referencing a valid agency ID may delay proper posting of information to the respective employers’ account and could likely result in penalty and interest assessments.
A federal tax ID number or federal employer identification number (EIN) is similar to a Social Security number for a business. The IRS uses the EIN to identify a business and the ID must be included on all tax filings. Banks also typically require an EIN to open a business bank account. Other companies with which an employer does business may ask for an ID number to pay submitted invoices.
For information about obtaining a federal EIN or to apply for a number online, go to irs.gov/businesses/small/article/0,,id=98350,00.html
States require a unique identification number for the same reasons. For information about registering with an agency to obtain a specific tax agency ID, visit irs.gov/businesses/small/article/0,,id=99021,00.html