5 Important Things To Know About US Payroll Taxes

July 18, 2023

Taxes. Even just saying the word can be scary.  There isn’t much that could be worse than opening your mail to find a tax notice from the IRS or a state agency.  The best thing you can do to prevent that fate would be to work closely with your tax advisor. 

HR and Payroll professionals deal with taxes daily.  Here we discuss the five most important things you should know about payroll taxes.

1.    There is a big difference between “taxable wages” and “taxes withheld.”

Taxes withheld are simple; it’s the taxes that you see deducted from your check each week. Taxable wages are a little more complicated. Taxable wages are the paid earnings that are eligible to be taxed. These earnings are usually eligible earnings minus any pre-tax deductions you have (for example, medical insurance or 401(k)). Not all deductions impact taxable wages equally; section 125 deductions like medical, dental, and vision reduce federal income tax and social security/Medicare, while a 401(k) deduction only reduces income tax! However, when making a necessary adjustment to an employee’s check or refunding a deduction, it is critical to consider how this will impact their taxable wages, not just their taxes withheld.

2.    Tax reciprocity between two states doesn’t work the same everywhere.

When an employee lives in one state and works in another to avoid taxing them in both states, there is an agreement known as “tax reciprocity.” This reciprocity is well-known to most HR payroll professionals. What surprises many people is that there isn’t a universal rule for this in the US, and the reciprocity tax rules could vary depending on where your employees live and work. In some scenarios, all the money might go to the state where the employee works. Sometimes, the taxes go to both states, but one applies a credit for the taxes you paid in the other. Some reciprocity agreements allow an employee not to have taxes withheld in one of the states, but only after they fill out a certain state form for the employer to receive.

A common example is New York and a second state.  New York taxes and the other state taxes are both withheld, but New York state taxes are withheld at a reduced rate to compensate for the taxes withheld in the second state. 

The bottom line is that tax reciprocity depends on the relationship between the states, where the employee works, and where the employee lives.

A New York example: Normally, an employee’s salary would have $200 in New York taxes withheld, but they are also paying $140 taxes to New Jersey, which means you pay $140 to New Jersey and $60 to New York.  New York essentially applies the $140 you paid to New Jersey as a credit to what you pay to New York.

3.    Constructive receipt is a critical concept for the IRS.

The concept of ‘Constructive receipt’ states that taxes belong to the period when an employee can access their funds. For example, if the employee worked from December 16 to December 31, 2022, but got paid on January 15, 2023, those would be 2023 wages! Virtually all individual taxpayers report their income on a cash basis, when the employee receives their wages. For the payroll professional, that is when your tax deposits are due. Again, this due date is based on the constructive receipt concept.

Getting it right is important. Give extra thought to the check date and the date the employee worked when you are paying manual checks or creating adjustments.

4.    What jurisdiction were the wages earned? Is trailing liability a tax issue you need to consider?

Taxes could be due in a different jurisdiction for an employee than where they currently reside or earn wages. While all tax topics are important to engage with your tax advisor, “trailing liability” often additionally requires the help of a mobility payroll specialist. Some earnings (for example, vested stocks) have a concept of trailing liability. This tax concept means the employee should be taxed in a jurisdiction where they are no longer located.

Trailing liabilities happen when the employee is in a different jurisdiction when the wages were earned. Or as in my previous example, when the stocks became vested. If your employees move a lot this tax situation gets very complicated. If this is an issue in your company, there are tax advisors and third-party systems specializing in mobility payroll. 

5.    Adjustments (typically) must be done by the vendor that filed them originally.

A big issue that can happen is that after moving to a new vendor, the payroll department discovers a problem with a prior check or W-2. Often, companies believe they will no longer have access to the vendor after implementing a different system. That limitation usually only extends to the software. Generally speaking, a new vendor will not usually do an amended tax return for a period they did not do the original tax return. You will need to work with the prior vendor to get changes made. If you switched vendors mid-year it is even more complicated. If you need to amend a quarter in that year that you were with the prior vendor, you will most likely need to make two adjustments with both the prior vendor (to correct the quarterly return) and the current vendor (to correct the year-to-date data).

Working with a tax professional is always step one when dealing with tax issues. However, if you’re unsure where to start or just need some extra hands to help, certified software consultants can always assist your company.   We would be glad to help. Contact us here.

Understanding the complexities of your tax situation is critical to long-term success. If you are shopping for a new HCM system, we can help you with evaluation and selection. Any HCM systems strategy should include any complex payroll tax situations. HRchitect can help you construct the correct strategy and consider these complexities and your organization’s goals. 

About the Author

Author and Senior HCM Consultant Ryan Gillen

Ryan Gillen is a Senior HCM Implementation Consultant who brings nine years of payroll and HCM experience to HRchitect. Ryan worked at Ultimate Software/UKG for 6 of those years. While at Ultimate Software, Ryan was nominated for the Ulti-Excellence Award for multiple quarters. In addition, Ryan was nominated as “Employee of the Year” at a former HCM consulting firm, and a two-time “Payroll MVP” winner at ADP. He is a certified FPC and CPP (American Payroll Association. Ryan received a Bachelor of Arts from Kennesaw State University and a Masters in History from Valdosta State University.

Learn more about Ryan on LinkedIn.