The employee’s W-2 is a once a year report identifying gross wages, federal income taxes withheld; Social Security and Medicare contributions, and state income taxes paid. This report also tells the employee other contributions or payments made for benefits. It is one of the few reports the Internal Revenue Service requires accuracy to within pennies per line item. To successfully prepare this annual report the bookkeeper must regularly reconcile the other payroll cycles.
It all starts with the regular payroll run.
Regular Payroll Activity
In Lesson 31 I illustrated the entire payroll process for a single payroll period. The work required is detailed and documentation is extensive. Depending on the frequency of payroll determines the amount of work involved for the bookkeeper. The following covers the frequency issue in more detail.
- Weekly – A weekly payroll is very common in certain industries like construction and landscaping; this is due to a high turnover rate of employees.
- Bi-Weekly – When a payroll is processed every two weeks it is called bi-weekly. It reduces the time commitment by the bookkeeper to almost 60% of the weekly requirement. This frequency is more common with well established small businesses.
- Semi-Monthly – Processing payroll twice a month is common with professional and non-profit organizations. It actually reduces overall time in comparison to the bi-weekly payroll period because there is no triple payroll every sixth month as found with bi-weekly payroll. Therefore reconciling payroll is easier and interim financial reports are not skewed with higher labor costs every sixth month.
- Monthly – This is rarely used but is normal in higher education like colleges and universities. This cycle is designed to match budgets in these institutions.
I personally encourage the semi-monthly cycle as it makes reconciling both monthly and quarterly reports easier. In addition, tax payments to authorities are much simpler to track because of the regular frequency involved.
At the end of each month the bookkeeper must do the following:
- Record the payroll runs to a tab in an Excel payroll worksheet; this must match against the actual payroll runs.
- File any monthly reports with the state’s department of revenue and pay any balances due.
- Determine Form 941 balances due and payments made to the IRS for that respective month.
- If the balance for FUTA exceeds $100, make a payment to the IRS using the EFTPS system.
The quarterly reports are absolutely the most important of all the cycle requirements. I can’t emphasize this enough. Make sure you get this cycle correct every quarter. The importance of this is tied to the federal government reporting (compliance) periods. It starts with Form 941.
Form 941 is a summation report of all activity for payroll during that quarter. The quarters end on March 31, June 30, September 30 and at year-end on December 31. Notice these quarters are calendar based and not fiscally derived. It is possible that financial reports have a different quarterly ending date than payroll. Payroll must end on these respective dates. It is the law; I didn’t make the rules; my job is to help educate you about them.
There are four pieces of information provided to the IRS.
- Gross wages paid to all employees during the quarter, down to the penny. It is one of the few IRS tax compliance returns that requires the information be reported including cents. Now you understand why the monthly cycles are important to assist in getting the quarterly report correct.
- Federal income taxes withheld from the employees is reported too. Again, this is reported to the penny.
- Social Security and Medicare taxes withheld and the corresponding matching amount from the employer is reported in a separate section of Form 941. What is interesting with this value is that the IRS allows the actual amount withheld and match to be a few pennies off from the aggregated calculation. This is important to understand; this happens because computer algorithms will round up or down to the penny for each employee depending on the programmed formulas from the software manufacturer. But the basic formulas are:
- Social Security at 12.4% of gross wages (6.2% withheld from the employee and the matching 6.2% paid by the employer)
- Medicare at 2.9% of gross wages (1.45% withheld from the employee and the matching 1.45% paid by the employer)
In total it is 15.3% of gross wages. The IRS allows an adjustment to the total of up to $1.00 for computer/calculator algorithms. If you are off by more than 25 cents; something is wrong in the math for one or more employees. The most I have ever seen is 9 cents on a $140,000 gross wage base over 70 employees for a quarter.
- The fourth piece of information is a schedule attached to the Form 941. Schedule B identifies the tax obligation dates for the respective payrolls during the quarter. The IRS uses this to identify the failure to pay the taxes on time. Tardiness of even one day is a penalty of 2% to start. Imagine a simple $2,000 obligation for a $10,000 payroll means a penalty of $40 for being one day late. It is egregious but the IRS emphasizes the need to pay the taxes on time; especially payroll taxes. It total taxes exceed $2,500 for the quarter (about 3 employees), the tax payments are due within 72 hours of the actual pay date. If the total taxes are less than $2,500 for the quarter; the taxes are due and payable monthly. I encourage employers to always pay the taxes within 72 hours no matter the size of the payroll for a small business.
The 941 serves as the primary report for payroll purposes. If filed incorrectly or inaccurately, it takes several months and about half a dozen interactions with the IRS to correct. It is important to get it right. There is a separate lesson addressing the proper Form 941 preparation in this series and I also touch base with some additional items in the advanced series of bookkeeping (a payroll series that covers retirement plans and medical plans etc. as adjustments for the Form 941). This lesson is merely and introduction to the Form.
In addition the four quarterly reports (Form 941) are used as the basis for the annual report. The four reports must match to the penny the values reported on the summation report (Form W-3) for the W-2’s. Failure to reconcile can generate penalties and in some cases serious civil and possible criminal charges.
Other quarterly reports include:
- SUTA – Each state requires an unemployment tax return and payment to the state of origin and their respective department of unemployment or revenue division. Some states do not use the entire value of gross wages so ask your CPA for the correct guidelines.
- State Income Tax Withheld – Again, 41 states assess income tax on earnings. These states require a report identifying the amounts withheld and paid in the aggregate for the quarter. In most cases, a sub report is filed for each payroll run; the quarterly report is a summation of the total sub reports for the quarter.
- Form 940 Payment (FUTA) – The actual report is an annual report; but the payments are at a minimum paid each quarter.
This brings us to the annual cycle reports.
The annual cycle is centered on one single report – Form W-2. The W-2 is the employee’s annual tax document identifying gross wages, the corresponding federal income taxes withheld along with withholding for Social Security and Medicare. It also includes other auxiliary information including state income taxes withheld, payments for benefits and retirement contributions. The W-3 is a summation report filed along with copies of the W-2 to the Social Security Administration for the purpose of recording earnings to this individuals account with Social Security. The W-3 is filed by mailing a signed form to the Social Security Administration in Wilkes-Barr, PA. It takes about one year and the administration synchronizes with the IRS and the four quarterly reports filed for totals. Any discrepancy generates a love letter from the Administration for the purpose of forcing reconciliation and the filing of amended Form 941’s or an amended W-3. Believe me; this is a time-consuming process; so it is best to get it right throughout the year than to address filing amended forms. Both the Social Security Administration and the IRS are not easy to deal with as it relates to filing amended payroll based forms.
The W-2’s are mailed to employees. Trust me, they know how much they earned and were paid throughout the year. Any errors there and they will let the bookkeeper know.
Other annual reports include:
- Form 940 – The annual unemployment tax document reconciling wages to the FUTA base along with tax owed and payments made;
- State Withholding Schedules – Reconciliation to monthly and quarterly state reports.
Summary – Payroll Cycles
The multiple payroll cycles focus on the one annual report, W-2’s, that go to employees and the Social Security Administration. The bookkeeper must understand the importance of each payroll cycle and their corresponding reports to avoid financial penalties and the time-consuming process of filing amended payroll forms. Act on Knowledge.