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Principles of Paycheck
Calculations
CHICAGO CHAPTER OF THE
AMERICAN PAYROLL
ASSOCIATION
SPRING 2014
Income and Employment
Taxes Defined
When employee compensation is described as
“taxable,” this means:
• it is subject to federal income tax and the
employer must withhold the tax from the
employee’s pay and remit it to the Internal
Revenue Service, and
• it is subject to social security and Medicare
taxes under the Federal Insurance
Contributions Act (FICA), as well as federal
unemployment tax under the Federal
Unemployment Tax Act (FUTA) – these
taxes are often referred to as employment
taxes.
Gross Income
 Compensation for services, including fees,
commissions, fringe benefits, and similar
items.
Wages
 All remuneration for employment, including
the cash value of all remuneration (including
benefits) paid in any medium other than
cash.
Fringe Benefits
 “Fringe Benefits” or “Perks” are generally
included in income and subject to income
and employment tax withholding, deposit,
and reporting requirements unless the IRC
says otherwise.
Fair Market Value
IFBA = FMV – (EPA + AEL)
IFBA = Includable Fringe Benefit Amount
FMV = Fair Market Value
EPA = Employee-Paid Amount
AEL = Amount Excluded by Law
Fair Market Value
Example
Harry’s employer pays for Harry’s parking space in
a commercial parking lot next to the employer’s
premises. The employer’s cost for the space is
$300 per month in 2013 which is the same fee
charged to all monthly payers. Harry pays nothing
for the parking space and has access to it every day.
Up to $245 per month of employer-provided
parking is excluded from income by law in 2013.
Harry’s taxable income from the parking benefit is
determined as follows:
IFBA = $300 – ($0 + $245)
IFBA = $300 – 245
IFBA = $55 per month
Special Valuation Method
Commuting Valuation
This method allows an employer to value an employee’s personal
commuting use of an employer-provided vehicle at $1.50 per one-way
commute and $3.00 per round trip if the following conditions are met:
1.The vehicle is owned or leased by the employer and is provided to the employee for
use in connection with the employer’s trade or business.
2.The employer, for non-compensatory business reasons, requires the employee to
commute to and/or from work in the vehicle.
3.The employer has a written policy prohibiting the employee (and the employee’s
spouse and dependents) from using the vehicle for personal use other than commuting
or de minimis personal errands, and the policy is enforced.
4.The employee is not a control employee. In the private sector, a control employee
who:
Is a corporate officer earning at least $100,000 in 2013 (indexed annually to the
next lowest multiple of $5,000);
Is a director;
Earns at least $205,000 in 2013 (indexed annually to the next lowest multiple of
$5,000)l or
Is a 1% owner.
In the public sector, a control employee is an employee who:
Is an elected official; or
Earns more than a federal employee at Executive Level V ($145,700 through April
6, 2013; $146,400 after April 6, 2013).
Annual Lease Valuation Method
Under this method, the fair market value of an employee’s personal use
of a company-provided car is determined by multiplying the annual
lease value of the car (as found in Table 3.1 following) by the
percentage of personal miles driven. Here are the steps the employer
must take:
1. The employer must determine the fair market value of the car as of
the first day it was made available to any employee for personal use.
For employer-owned vehicles, this is the total cost of the car to an
individual in an arm’s length transaction (including sales tax and
title fees.) For employer-leased vehicles, the value can be
determined by using a nationally recognized pricing source, such as
the “blue book.” Whether the car is owned or leased by the
employer, its value must be recalculated after four full calendar
years. If the vehicle is transferred to another employee, the annual
lease value may be recalculated based on the car’s fair market value
on January 1 of the calendar year of the transfer.
2. Find the car’s fair market value in Table 3.1.
3. Calculate the percentage of personal miles driven during the year
(personal miles driven ÷ total miles driven).
4. Calculate the fair market value of the employee’s personal use of the
car that must be included in the employee’s income (annual lease
value x percentage of personal miles.
Annual Lease Value
Example
Employee Gilbert drives an employer-provided car that he
uses for both business and personal driving. Gilbert drove
17,000 miles during the year – 12,300 business miles and
4,700 personal miles. The car’s fair market value is $16,200.
The amount of the car’s fair market value that must be
included in Gilbert’s income for the year is calculated as
follows:
ALV of $16,200 car (from table)
$4,600
% of personal miles = $4,700 ÷ 17,000 = .2765
27.65%
FMV of personal use = $4,600 x .2765
$1,271.90
Vehicle Cents-Per-Mile
Under this method, the fair market value of an
employee’s personal use of a company-provided vehicle
is determined by multiplying the IRS’s business standard
mileage rate by the number of personal miles driven.
The business standard mileage rate in 2013 is $.565
(56.5 cents) per mile (indexed annually). To use this
method for standard passenger automobiles, the
following conditions must be met:
1. The employer must expect the employee to
regularly use the vehicle while conducting the
employer’s business, or the vehicle must actually be
driven at least 10,000 miles annually 9including
personal use) and be used primarily by employees.
2. The fair market value of the car cannot exceed
$16,000 for cars placed in service in 2013 (indexed
annually). The maximum values of cars placed in
service in earlier years are: (Please reference Page 323)
Vehicle Cents-Per-Mile
Example
Employee Margaret drives a qualifying car
16,000 miles during 2013, including 7,600
personal miles. If Margaret’s employer pays
for the gasoline for the car, the fair market
value of her personal use of the car is
calculated as follows:
FMV of personal use = 7,600 personal miles x
$0.565 = $4,294.00
If Margaret pays for the car’s gasoline, the fair
market value of her personal use of the car is
calculated as follows:
FMV = 7,600 x ($0.565 - $0.055) = $7,600 x
$0.51 = $3,876.00
Group Term Life
The value of employer-provided group-term
life insurance up to $50,000 is excluded from
an employee’s income.
The value of coverage in excess of $50,000,
minus any amount paid for the coverage by the
employee after taxes, must be included in the
employee’s income.
The value of the excess coverage is subject to
social security and Medicare taxes, but is not
subject to federal income tax withholding or
federal unemployment (FUTA) tax.
Group Term Life
Calculating Excess Group-Term Life
Insurance
The value of group-term life insurance in
excess of $50,000 must be included in income.
It is determined by using IRS Section 79 Table
1 and the uniform premiums it provides, rather
than the actual cost to the employer. Table I
lists the value of each $1,000 of group-term
life insurance coverage per month, broke down
in five-year age brackets.
Group Term Life
Calculating Excess Group-Term
Life Insurance
Here are the steps an employer must take in computing the monthly
value of excess group-term life insurance to include in an employee’s
income.
1. Determine the total amount of the employee’s group-term life
insurance coverage under the employer’s plan (including coverage
purchased by both the employer and the employee). Most plans
figure coverage as a multiple of the employee’s base salary, which
may increase during the year if the employee gets a raise. That is
why many employers use the employee’s base salary as of January
1 of each year as the base amount for determining life insurancecoverage. Many companies also have a maximum amount of
employer-provided coverage.
2. Calculate the excess benefit over $50,000.
3. Divide the excess insurance amount by $1,000.
4. Determine the employee’s age as of December 31 of the calendar
year during which the benefit is taxable.
5. Use IRS Table I to calculate the fair market value of one month of
excess insurance per $1,000 and multiply it by the answer
obtained from Step 3.
6. Deduct any after-tax contributions by the employee from the
value of the insurance.
7. Add the excess amount to the employee’s income, withhold and
pay social security and Medicare taxes, and report the amount as
required.
Group Term Life
Example
Valerie was born April 23, 1954. Her employer’s non-discriminatory groupterm provides her with coverage equal to 2x her annual salary as of January
1., and her salary as of 1-1-3-13 was $65,000. Her employer’s plan has a
maximum coverage amount of $125.000. Valerie contributes $25 per month
in after-tax dollars toward the insurance premiums.
Step 1: 2 x $65,000 = $130,000
maximum coverage amount = $125,000
Valerie’s coverage = $125,000
Step 2: $125,000 - $50,000 = $75,000
Step 3: $75,000 ÷ $1,000 = 75
Step 4: Valerie will be 59 years old on 12-31-13
Step 5: $.43 x 75 = $32.25
Step 6: $32.25 - $25.00 = $7.25 per month of taxable income in 2013.
If Valerie did not pay anything for the group-term life insurance, or paid with
only pre-tax dollars, the entire $32.25 would be included in her income each
month.
Gross-Up
•
Gross-Up
Regular Gross Up
• Generosity, Inc. wants to give employee
Linda a $6,000 year-end bonus in 2013. To
ensure that Linda receives $6,000,
Generosity agrees to pay her federal and
state income and social security and
Medicare taxes on the bonus, which is
treated as supplemental wages (see Section
6.4-4). Here is how the employer would
calculate the gross payment to Linda and the
amounts that must be withheld, assuming
Linda has been paid $50,000 so far in 2013
and the state supplemental wage withholding
rate is 3.5%:
Gross-Up
Regular Gross-Up Answer
•
Gross-Up
Gross-Up When Crossing the Social
Security Wage Base
Assume the same facts as in Example 1,
except that, at the time the bonus is paid,
Linda has already been paid $111,700
during 2013. Here is how the employer
would calculate the gross payment to Linda
and the amounts that must be withheld:
Gross-Up
When Crossing the Social Security Wage Base
Social Security Wage Base for 2013 = $113,700; Tax Rate = 6.2%
Amount of Bonus Subject to SS tax = $113,700 - $111,700 = $2,000
SS tax on $2,000 = $2,000 x .6.2% = $124.00
Total amount for gross-up calculation = $6,000 + $124.00 = $6,124.00
Total tax % = 25% FITW + 3.5% SIT + 1.45% MED = 29.95%
Gross-up rate = 100% - 29.95% = 70.05%
Gross earnings on $6,124 = $6,124 ÷ 70.05% = $8,742.33
Gross-Up
Gross-Up With 401(k) Plan Salary
Reduction From Bonus
Assume the same facts as in Example 1, Also, Linda
has elected to defer 5% of her wages into
Generosity, Inc.’s §401(k) plan, so she should end
up with a net payment of $5,700 ($6,000 x 5% =
$300; $6,000 - $300 = $5,700).
Gross-Up
Gross-Up With 401(k) Plan Salary Reduction
From Bonus
Amount deferred into §401(k) plan = $6,000 x 5% = $300
Amount subject to SS and Medicare taxes = $6,000
Amount subject to federal and state income taxes = $5,700
SS tax on $300 = $300 x 6.2% = $18.60
Medicare on $300 = $300 x 1.45% = $4.35
Total amount for gross-up calculations = $5,700 + $18.60 + $4.35
= $5,722.95
Total tax % = 25% FITW + 3.5% SITW + 6.2% SS + 1.45% MED
= 36.15%
Gross-up rate = 100% - 36.15% = 63.85%
Gross earnings subject to FITW AND SITW = $5,722.95 ÷ 63.85%
= $8,963.12
Gross earnings subject to SS and MED = $8,963.12 + $300 =
$9,263.12