(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 .)
OBSERVATIONS:
- 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].
- 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].
- 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 ....
- 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%) = 109.23Of 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%) = 10080.65SDI 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