Payroll in Practice: 11.23.18

Practitioners’ questions are answered by a payroll and tax consultant who also is an enrolled agent licensed to practice before the Internal Revenue Service.

Question: Our company plans to give grossed-up cash holiday bonuses this year. The amounts would be entered into our system as a manual check before processing payroll because we have several hundred employees. The amounts would be included in the normal payroll cycle. Do we need to use the 22 percent supplemental rate for federal or should it be calculated with Form W-4 information?

Answer: As you indicated, the bonuses are supplemental pay and income tax must be withheld according to the supplemental pay rules. In general, the aggregate method or the optional flat-rate method may be applied.

For 2018, the optional flat rate on supplemental wages up to $1 million in a year decreased to 22 percent from 25 percent, and the mandatory flat rate on supplemental wages exceeding $1 million in a year decreased to 37 percent from 39.6 percent.

When grossing up the taxes and including the income tax in the gross up, the optional 22 percent flat rate gross up of supplemental pay is easier to use than determining each employee’s marginal tax rate for the bonus under the aggregate W-4 method.

However, the optional flat rate may not be used for a given employee unless income tax has been withheld from the employee’s regular pay sometime during the current year or the preceding year.

For example, if an employee did not have any regular pay during the applicable years, such as a sales representative compensated solely by commissions, the 22 percent flat rate may not be used.

Determining each employee’s federal income tax rate to use in the gross up formula is more difficult under the aggregate method because of the graduated income tax rates. This is also an issue for state income tax where the state has a graduated income tax. The problem is compounded in this case because only part of the aggregated payment, the bonus, is being grossed up.

If not grossing up the bonuses, the aggregate method could be used fairly easily by adding the bonus to the regular pay for the current pay period or the immediately preceding pay period to compute the amount of tax required to be withheld on the combined amount. The amount of tax attributable to the bonus is the difference between the withholding for the combined amount and the withholding for just the regular pay.

However, under this method, you would either have to withhold the taxes from the bonus, which I assume you do not want to do because you are paying cash, or withhold the tax from the regular payroll check for the pay period.

Keep in mind that the tax attributable to the bonus must be deposited on the deposit due date for the date the bonuses are distributed. This might be different from the deposit due date for the regular payroll.

For example, assuming a semimonthly pay cycle and a semiweekly deposit schedule, the regular pay dates might Dec. 15 and 31, but the bonuses are to be distributed Friday, Dec. 21. The deposit due date for the bonus would be Wednesday, Dec. 26. However, as long as the taxes are withheld from regular pay Dec. 31, there should not be any compliance issue.

As a compromise, only the taxes with fixed rates, such as Social Security and Medicare, could be grossed up and paid on behalf of the employee. Then compute the amount of income taxes required to be withheld. This would reduce the amount of the gross up, the employer and employee Federal Insurance Contributions Act taxes, and the amount of income tax required to be withheld from regular wages. The withholding could come from regular pay rather than the bonus.

Question: IRS guidelines indicate that reporting dental and vision coverage is optional for Form W-2, Box 12, for employer-sponsored health insurance. The guidelines also say that domestic-partner coverage included in gross income must be reported in Box 12. Does this mean that dental and vision coverage for domestic partners must be reported in Box 12 as well as the health insurance coverage?

Answer: Generally, under the Affordable Care Act, employers are required to report the cost of coverage under employer-sponsored group health plans. This information is to be reported on Form W-2 in Box 12 with code DD. Some employers are not required to report the information but may do so voluntarily. This reporting is intended to provide employees with useful and comparable consumer information on the cost of health coverage and does not mean the cost of the coverage is taxable.

One of the major issues regarding this requirement is what types of plans are included in the definition of employer-sponsored group health plans. Including the cost of vision and dental insurance in Box 12 is optional because in cases when coverage for vision and dental is integrated into another health-coverage plan, the cost may be difficult to separate.

The information is for employees. Employers may include coverage that is not integrated into a medical or heath plan, or coverage that the employee may choose and pay an additional premium where the costs are easy to separate. Reporting is optional so that an employer that has both plans that integrate dental or vision and separate dental or vision can report consistent numbers for employees covered by both types of plans.

The same rules apply to domestic partner dental and vision coverage included in employee pay. Reporting is optional if not integrated into a medical or heath plan or coverage that the employee can decline or elect and pay an additional premium. Otherwise, vision and dental coverage, along with a number of other types of coverage, are not included in the definition of health care coverage for Box 12 reporting purposes.

The guidelines are available on the IRS website in the affordable care section.

--Patrick Haggerty

Do you have a question for Payroll in Practice? Send it to phaggerty@prodigy.net.