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Posted by whatsupdoc205 on January 23, 2008, 1:53 pm
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(Hopefully, this is expresses my questions more clearly.)
My mother is an employer of one household worker.
Apparently there are two ways to cover the household
employee's share of employment taxes (SS, Medicare,
Calif SDI). See examples below.
Which method is more common? Do I understand the
methods, their differences, and the pros/cons
correctly? Which method would you suggest, and why?
For the following examples, assume the employee is
actually paid (that is, we write a check for) $100
per day, and she works 100 days in the year. So we
actually pay her $10,000 annually [1]. Also assume
the 2008 SDI tax rate of 0.8%.
METHOD 1 -- PAYROLL DEDUCTIONS:
We gross up the $100/day net wage to a $109.23/day
gross wage [2]. So, for the year, we deduct about $87
for SDI tax, $158 for Medicare tax, and $677 for SS
tax [3]. We report about $10,923 for federal, state, SS
and Medicare wages on Form W-2 and for "total subject
wages" (wages subject to CA SDI, UI and ETT taxes)
on Calif Form DE 3HW.
METHOD 2 -- EMPLOYER PAYS IN LIEU OF PAYROLL
DEDUCTIONS:
(a) For Calif, we report about $81 for SDI tax on
Forms W-2 and DE 3HW, based on $10,081 for "total
subject wages" [4]. We report about $10,852 for
state wages on Form W-2 (box 16) [5].
(b) For federal, we report $145 in Medicare tax and
$620 in SS tax on Form W-2 [6]. We report $10,745
for federal wages (box 1) and $10,000 for SS and
Medicare wages on Form W-2.
QUESTION:
For Method 2, should we use (about) $10,081 instead
of $10,000 for the FICA computation and for SS and
Medicare wages on Form W-2? That is, should we
add the employee's share of state payroll taxes to
actual wages, even though it was paid by the employer
in lieu of payroll deductions? [7]
(Arguably, there is a third method: don't report
employment wages and taxes. But of course, that is
not following the law, although it might be the most
common method <g>.)
OBSERVATIONS:
1. I am surprised by the apparent complexity of
Method 2 and by the differences in reported figures
between the two methods. I expected that they were
simply two ways to crack the same nut. So I expected
to compute employment taxes simply by grossing up the
actual paid wages. But the different treatment of SS
and Medicare wages and FICA taxes is quite clear in
IRS Pub 926 [8] and Calif EDD Pub 231Q [9].
2. I am also surprised by the Calif formula for
computing PIT wages for Method 2 [5]. It seems
mysterious and non-intuitive. I expected that:
(a) we would gross up "total subject wages" by the
FICA tax rate, following Example 3 in EDD Pub 231Q;
or (b) we would increase "total subject wages" by
the amount of the FICA tax computed by the federal
method [4].
3. It appears that Method 2 results in less employer
tax as well as less employee income tax. That is a
good thing, I suppose. Perhaps that is its appeal
for some people. But ....
4. It appears that Method 2 results in less SS and
Medicare wages, which might reduce SS benefits in the
long-run. My mother's household employee is expressly
interested in increasing eventual SS benefits.
CONCLUSIONS:
If my understanding is correct, it seems that Method 1
is the better choice for us. We do not need the savings
that Method 2 offers. We do need the simplicity of
Method 1.
----------
End Notes:
[1] For simplicity here, most example calculations are
based on annual wages, even though for Calif, state
employment taxes and wages are reported quarterly.
[2] 100 / (1 - 6.2% - 1.45% - 0.8%) = 109.23
Of course, it is more common to set a gross wage,
then determine the net wage by subtracting payroll
deductions etc. But my mother wants the net wage
to be a round dollar amount. So we gross up the
net wage.
[3] SDI tax: 100 * (109.23 * 0.8%) = 87.38
Medicare tax: 100 * (109.23 * 1.45%) = 158.38
SS tax: 100 * (109.23 * 6.2%) = 677.22
[4] Following Example 1 in Calif EDD Pub 231Q, "total
subject wages" (wages subject to SDI, UI and ETT
taxes) are:
10000 / (1 - 0.8%) = 10080.65
SDI tax: 10080.65 - 10000 = 80.65
[5] Following Example 1 in Calif EDD Pub 231Q, PIT
wages are:
10000 * (1 + (7.65% + 0.8%) * 10080.65 / 10000)
[6] Following example in IRS Pub 926 (p. 5),
Medicare tax: 10000 * 1.45% = 145
SDI tax: 10000 * 6.2% = 620
[7] Normally, the employee's share of state payroll
taxes are included in SS and Medicare wages, as
demonstrated by Method 1. But arguably, perhaps
federal regulations include state payroll taxes only
if paid by the employee, just as they include federal
payroll taxes only if paid by the employee, according
to IRS Pub 926 [8]. I don't know; I have not looked
at the regulations themselves. (I would appreciate a
citation to the regulation.)
[8] IRS Pub 926, p. 5, parag "Not withholding the
employee's share" states: "The social security and
Medicare taxes that you pay [...] are not counted as
social security and Medicare wages or as federal
unemployment (FUTA) wages".
[9] EDD Pub DE 231Q, parag 2: "When a household
employer [...] pays Social Security and Medicare
(FICA) without deduction from an employee's wages,
the additional amount is not considered an increase
to the employee's wages when calculating the
Unemployment Insurance (UI), Employment Training
Tax (ETT), or SDI taxes".
[10] Online publications:
IRS Pub 926
http://www.irs.gov/pub/irs-pdf/p926.pdf
Calif EDD Pub DE 8829
http://www.edd.ca.gov/taxrep/de8829.pdf
Calif EDD Pub DE 231Q
http://www.edd.ca.gov/taxrep/de231q.pdf
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