As companies begin planning for tax compliance in the coming year, they are finding 2015 to be a mixed bag. The good news is that payroll and other tax law changes are minimal; the bad news is that some companies may see hikes in their tax rates.
“Thankfully, this year is a relatively quiet one in terms of tax law changes,” says Adam Lambert, managing director and national leader for Grant Thornton’s employment tax services practice. That means now is an ideal time for payroll and tax departments to go back and take a look at any improvements they may want to make—such as ensuring new benefits they provide to employees are captured appropriately, or that all employees’ taxpayer ID numbers are up-to-date—so that they can feel more confident about their employment tax filing process going into 2015, he says.
For tax law changes that are on the horizon, however, companies will need to be properly prepared. Some are in for a rude awakening.
Employers in certain states, for example, may soon be assessed more than five times the amount of federal unemployment tax than normally would apply if those states did not have a Federal Unemployment Tax Act (FUTA) credit reduction. FUTA is an employment tax imposed on employers used to fund the federal unemployment trust fund reserve.
For employers in credit reduction states, 2014 marks the first year for which a new FUTA cost—the Benefit Cost Rate (BCR) add on—will be imposed. States potentially losing credit include California, Connecticut, Delaware, Indiana, Kentucky, Ohio, North Carolina, New York, and the Virgin Islands.
“A well-trained and connected employment tax department can effectively facilitate compliance and reduce overall corporate risk and maintain employee confidence.”
Scott Schapiro, Principal, KPMG
BCR add-on potentially applies to employers in those states that have had an outstanding loan balance from the federal unemployment trust fund reserve of at least five consecutive years (as of Jan. 1, 2015), that still have a balance as of Nov. 10, 2014, and that did not successfully apply with the Department of Labor for relief from a BCR add-on prior to July 1, 2014.
“Several states submitted waivers, and some states are still trying to pay off their loan amount entirely by Nov. 10,” Wendy Seyfert, vice president of agency relations at payroll solutions provider ADP, explained during a recent Compliance Week Webcast.
“From a practical standpoint, this means that employers in certain states will see higher effective FUTA tax rates and associated taxes for 2014, as states continue to struggle with low state unemployment reserves and their loan repayments,” Scott Schapiro, principal at KPMG, says.
“As of this point, it is anticipated that no more than 10 states will have a 2014 FUTA credit reduction, though that number may change,” Schapiro says.
The specific states requiring employers to reduce their credit and the amount of credit reduction will not be known for certain, however, until the Labor Department makes a final determination after the loan payoff deadline of Nov. 10. Employers will be required to note those states and the appropriate credit reduction using Schedule A (Form 940) for 2014.
The only exception is Connecticut, which is the only state that has had a loan balance for at least five years and opted not to submit a waiver request. Instead, it will impose on all employers a .5 percent FUTA tax increase for 2014.
Form W-2 Changes
Some companies may also have some work to do on cleaning up data on employee records. Beginning with electronic W-2 and W-2C forms filed for tax year 2014, the Social Security Administration (SSA) will no longer accept forms with invalid employer identification codes. Traditionally, the SSA would make some attempt to correct invalid employer identification codes—but that’s all about to change. “If you have an overall invalid record format, the entire file will be rejected and will need to be resubmitted once the errors are corrected,” Seyfert said.
FUTA Credit Reduction
Below is an explanation of a credit reduction state and how it affects employment tax.
A state is a credit reduction state if it has taken loans from the federal government to meet its state unemployment benefits liabilities and has not repaid the loans within the allowable time frame. A reduction in the usual credit against the full FUTA tax rate means that employers paying wages subject to UI tax in those states will owe a greater amount of tax.
The FUTA tax levies a federal tax on employers covered by a state’s UI program. The standard FUTA tax rate is 6.0% on the first $7,000 of wages subject to FUTA. The funds from the FUTA tax create the Federal Unemployment Trust Fund, administered by the United States Department of Labor (DoL).
Generally, employers may receive a credit of 5.4% when they file their Form 940 (PDF), Employer’s Annual Federal Unemployment (FUTA) Tax Return, to result in a net FUTA tax rate of 0.6% (6.0% - 5.4% = 0.6%).
Some states take Federal Unemployment Trust Fund loans from the federal government if they lack the funds to pay UI benefits for residents of their states.
If a state has outstanding loan balances on January 1 for two consecutive years, and does not repay the full amount of its loans by November 10 of the second year, the FUTA credit rate for employers in that state will be reduced until the loan is repaid.
The reduction schedule is 0.3% for the first year the state is a credit reduction state, another 0.3% for the second year, and an additional 0.3% for each year thereafter that the state has not repaid its loan in full. Additional offset credit reductions may apply to a state beginning with the third and fifth taxable years if a loan balance is still outstanding and certain criteria are not met.
DoL runs the loan program and announces any credit reduction states after the November 10 deadline each year. DoL has information about the credit reduction states and loan balances on the UI Statistics page of its Department of Labor Website.
How does the credit reduction affect employment taxes?
The result of being an employer in a credit reduction state is a higher tax due on the Form 940.
For example, an employer in a state with a credit reduction of 0.3% would compute its FUTA tax by reducing the 6.0% FUTA tax rate by a FUTA credit of only 5.1% (the standard 5.4% credit minus the 0.3% credit reduction) for an effective FUTA tax rate of 0.9% for the year.
Any increased FUTA tax liability due to a credit reduction is considered incurred in the fourth quarter and is due by Jan. 31 of the following year.
Employers who think they may be in a credit reduction state should plan accordingly for the lower credit. The IRS includes the credit reduction states, the applicable credit reduction rates, and an example in the Schedule A (Form 940) (PDF), Multi-State Employer and Credit Reduction Information. The Instructions for Form 940 (PDF) also has information about the credit reduction and deposit rules.
Employers will want to make sure that they use the SSA’s Accuwage software, which is a free tool that allows employers to submit test files to check for any invalid employer identification codes before submitting final returns to the SSA. “If you aren’t using Accuwage already to check the format of your file, you may want to start,” Seyfert advised.
For companies that are outsourcing employment tax reporting, they “need to ensure they’re not becoming too complacent,” Debby Salam, director of payroll information management services for Ernst & Young, says. They need to make sure that their vendors are using Accuwage, and then further check the test results before filing a final return.
Overall, employers should periodically review and refresh their employment tax knowledge base and internal processes and procedures, Schapiro advises. “Even in the event of a partial or total outsourcing of payroll tax processing, the company retains the overall responsibility for understanding, implementing, and maintaining federal, state, and local employment tax laws and regulations,” he says.
Keeping on top of any changes that may occur is vital. Employment tax professionals should have access to reliable news sources, and monitor them regularly, Salam advises.
“The best advice I can offer employers is to get ahead of things as much as possible as they approach year-end, so that they’re not in a position where they need to do a lot of adjustments to their Form W-2s or Form 941s come January,” Lambert says. Don’t make the mistake of getting year-end changes to the payroll department until the last minute, leaving people scrambling, he says.
Schapiro recommends that employers review such items as the company’s geographic footprint; the taxability of fringe benefits and deferred compensation treatment; information flow between internal departments; and even the depth of the employer’s relationship with its outside vendors. This enables employers to get a full picture of its employment tax responsibilities and help resolve identified issues before they turn into year-end concerns, he says.
“The ultimate responsibility for employment tax compliance always falls on the employer’s shoulders,” Schapiro adds. “A well-trained and connected employment tax department can effectively facilitate compliance and reduce overall corporate risk and maintain employee confidence.”
Concludes Schapiro: Providing employees with effective tools to remain compliant—generally some mix of formal training, legislative update materials, and professional guidance on the combined tax, benefit, and legislative issues—can help improve and maintain compliance.