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The Social Security Administration recently announced that the wage base for computing Social Security tax will increase to $147,000 for 2022 (up from $142,800 for 2021). Wages and self-employment income above this threshold aren’t subject to Social Security tax.

Background information

The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees and self-employed workers — one for Old Age, Survivors and Disability Insurance, which is commonly known as the Social Security tax, and the other for Hospital Insurance, which is commonly known as the Medicare tax.

There’s a maximum amount of compensation subject to the Social Security tax, but no maximum for Medicare tax. For 2022, the FICA tax rate for employers is 7.65% — 6.2% for Social Security and 1.45% for Medicare (the same as in 2021).

2022 updates

For 2022, an employee will pay:

• 6.2% Social Security tax on the first $147,000 of wages (6.2% of $147,000 makes the maximum tax $9,114), plus
• 1.45% Medicare tax on the first $200,000 of wages ($250,000 for joint returns; $125,000 for married taxpayers filing a separate return), plus
• 2.35% Medicare tax (regular 1.45% Medicare tax plus 0.9% additional Medicare tax) on all wages in excess of $200,000 ($250,000 for joint returns; $125,000 for married taxpayers filing a separate return).

For 2022, the self-employment tax imposed on self-employed people is:

• 12.4% OASDI on the first $147,000 of self-employment income, for a maximum tax of $18,228 (12.4% of $147,000); plus
• 2.90% Medicare tax on the first $200,000 of self-employment income ($250,000 of combined self-employment income on a joint return, $125,000 on a return of a married individual filing separately), plus
• 3.8% (2.90% regular Medicare tax plus 0.9% additional Medicare tax) on all self-employment income in excess of $200,000 ($250,000 of combined self-employment income on a joint return, $125,000 for married taxpayers filing a separate return).

More than one employer

What happens if an employee works for your business and has a second job? That employee would have taxes withheld from two different employers. Can the employee ask you to stop withholding Social Security tax once he or she reaches the wage base threshold? Unfortunately, no. Each employer must withhold Social Security taxes from the individual’s wages, even if the combined withholding exceeds the maximum amount that can be imposed for the year. Fortunately, the employee will get a credit on his or her tax return for any excess withheld.

We can help 

Contact us if you have questions about payroll tax filing or payments. We can help ensure you stay in compliance.

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Graphs, performance dashboards and other visual aids can help managers, investors and lenders digest complex financial information. Likewise, auditors also use visual aids during a financial statement audit to quickly identify trends and anomalies that warrant attention.

Powerful tool

Your auditor uses many tools and techniques to validate the accuracy and integrity of your company’s financial records. Data visualization — using a picture to show a relationship between two accounts or how a metric has changed over time — can help improve the efficiency and effectiveness of your audit.

Microsoft Excel and other dedicated data visualization software solutions can be used to generate various graphs and charts that facilitate audit planning. These tools can also help managers and executives understand the nature of the auditor’s testing and inquiry procedures — and provide insight into potential threats and opportunities.

4 Examples

Here are four examples of how auditors might use visualization to leverage your company’s data:

1. Employee activity in the accounting department. Line graphs and pie charts can help auditors analyze the number, timing and value of journal entries completed by each employee in your accounting department. Such analysis may uncover an unfair allocation of work in the department — or employee involvement in adjusting entries outside of their assigned area of responsibility. Managers can then use these tools to reassign work in the accounting department, pursue a fraud investigation or improve internal controls.

2. Activity in accounts prone to fraud and abuse. Auditors closely monitor certain high-risk accounts for fraud and errors. For example, data visualization can shine a spotlight on the timing and magnitude of refunds and discounts, highlight employees involved in each transaction and potentially uncover anomalies for additional scrutiny.

3. Journal entries prior to the end of the accounting period. Auditors analyze and confirm the timing and magnitude of your journal entries leading up to a month-end or year-end close. Timeline charts and other data visualization tools can help auditors understand trends in your company’s activity during a month, quarter or year.

4. Forecast vs. actual. Line graphs and bar charts can show how your company’s actual performance compares to budgets and forecasts. This can help confirm that you’re on track to meet your goals for the period. Conversely, these tools can also uncover significant deviations that require further analysis to determine whether the cause is internal (for instance, fraud or inefficiency) or external (for instance, cost increases or deteriorating market conditions). In some cases, management will need to revise budgets based on the findings of this analysis — and potentially take corrective measures.

Show and tell

Data visualization allows your data to talk. Auditors use these tools to better understand your operations and guide their risk assessment, inquiries and testing procedures. They also use visual aids to explain complex matters and highlight trends and anomalies to management during the audit process. Some graphs and charts can even be added to financial statement disclosures to communicate more effectively with stakeholders. Contact us for more information about using data visualization in your audit and beyond.

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With the increasing cost of employee health care benefits, your business may be interested in providing some of these benefits through an employer-sponsored Health Savings Account (HSA). For eligible individuals, an HSA offers a tax-advantaged way to set aside funds (or have their employers do so) to meet future medical needs. Here are the important tax benefits:

• Contributions that participants make to an HSA are deductible, within limits.
• Contributions that employers make aren’t taxed to participants.
• Earnings on the funds in an HSA aren’t taxed, so the money can accumulate tax free year after year.
• Distributions from HSAs to cover qualified medical expenses aren’t taxed.
• Employers don’t have to pay payroll taxes on HSA contributions made by employees through payroll deductions.

Eligibility rules

To be eligible for an HSA, an individual must be covered by a “high deductible health plan.” For 2021, a “high deductible health plan” is one with an annual deductible of at least $1,400 for self-only coverage, or at least $2,800 for family coverage. (These amounts will remain the same for 2022.) For self-only coverage, the 2021 limit on deductible contributions is $3,600 (increasing to $3,650 for 2022). For family coverage, the 2021 limit on deductible contributions is $7,200 (increasing to $7,300 for 2022). Additionally, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits for 2021 cannot exceed $7,000 for self-only coverage or $14,000 for family coverage (increasing to $7,050 and $14,100, respectively, for 2022).

An individual (and the individual’s covered spouse, as well) who has reached age 55 before the close of the tax year (and is an eligible HSA contributor) may make additional “catch-up” contributions for 2021 and 2022 of up to $1,000.

Contributions from an employer

If an employer contributes to the HSA of an eligible individual, the employer’s contribution is treated as employer-provided coverage for medical expenses under an accident or health plan. It’s also excludable from an employee’s gross income up to the deduction limitation. Funds can be built up for years because there’s no “use-it-or-lose-it” provision. An employer that decides to make contributions on its employees’ behalf must generally make comparable contributions to the HSAs of all comparable participating employees for that calendar year. If the employer doesn’t make comparable contributions, the employer is subject to a 35% tax on the aggregate amount contributed by the employer to HSAs for that period.

Taking distributions

HSA distributions can be made to pay for qualified medical expenses, which generally means expenses that would qualify for the medical expense itemized deduction. Among these expenses are doctors’ visits, prescriptions, chiropractic care and premiums for long-term care insurance.

If funds are withdrawn from the HSA for other reasons, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it’s made after reaching age 65, or in the event of death or disability.

HSAs offer a flexible option for providing health care coverage and they may be an attractive benefit for your business. But the rules are somewhat complex. Contact us if you’d like to discuss offering HSAs to your employees.

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On October 25, the Financial Accounting Standards Board (FASB) issued a simpler accounting option that will enable private companies to more easily measure certain types of shares they provide to both employees and nonemployees as part of compensation awards. Here are the details.

Complex rules

Many companies award stock options and other forms of share-based payments to workers to promote exceptional performance and reduce cash outflows from employee compensation. But accounting for these payments can be confusing and time-consuming, especially for private companies.

To measure the fair value of stock options under existing U.S. Generally Accepted Accounting Principles (GAAP), companies generally use an option-pricing model that factors in the following six variables:

1. The option’s exercise price,
2. The expected term (the time until the option expires),
3. The risk-free rate (usually based on Treasury bonds),
4. Expected dividends,
5. Expected stock price volatility, and
6. The value of the company’s stock on the grant date.

The first four inputs are fairly straightforward. Private companies may estimate expected stock price volatility using a comparable market-pricing index. But the value of a private company’s stock typically requires an outside appraisal. Whereas public stock prices are usually readily available, private company equity shares typically aren’t actively traded, so observable market prices for those shares or similar shares don’t exist.

To complicate matters further, employee stock options are also subject to Internal Revenue Code Section 409A, which deals with nonqualified deferred compensation. The use of two different pricing methods usually gives rise to deferred tax items on the balance sheet.

Simplification measures

Accounting Standards Update (ASU) No. 2021-07, Compensation-Stock Compensation (Topic 718): Determining the Current Price of An Underlying Share for Equity-Classified Share-Based Awards, applies to all equity classified awards under Accounting Standards Codification Topic 718, Stock Compensation.

The updated guidance allows private companies to determine the current price input in accordance with the federal tax rules, thereby aligning the methodology used for book and federal income tax purposes. Sec. 409A is referenced as an example, but the rules also include facts and circumstances identified in Sec. 409A to consider for reasonable valuations. The practical expedient will allow private companies to save on costs, because they’ll no longer have to obtain two independent valuations separately for GAAP and for tax purposes.

Right for your company?

Private companies that take advantage of the practical expedient will need to apply it prospectively for all qualifying awards granted or modified during fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Early application, including application in an interim period, is permitted for financial statements that haven’t yet been issued or made available for issuance as of October 25, 2021. Contact your CPA for more information.

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Are you planning to launch a business or thinking about changing your business entity? If so, you need to determine which entity will work best for you — a C corporation or a pass-through entity such as a sole-proprietorship, partnership, limited liability company (LLC) or S corporation. There are many factors to consider and proposed federal tax law changes being considered by Congress may affect your decision.

The corporate federal income tax is currently imposed at a flat 21% rate, while the current individual federal income tax rates begin at 10% and go up to 37%. The difference in rates can be mitigated by the qualified business income (QBI) deduction that’s available to eligible pass-through entity owners that are individuals, estates and trusts.

Note that noncorporate taxpayers with modified adjusted gross income above certain levels are subject to an additional 3.8% tax on net investment income.

Organizing a business as a C corporation instead of as a pass-through entity can reduce the current federal income tax on the business’s income. The corporation can still pay reasonable compensation to the shareholders and pay interest on loans from the shareholders. That income will be taxed at higher individual rates, but the overall rate on the corporation’s income can be lower than if the business was operated as a pass-through entity.

Other considerations

Other tax-related factors should also be considered. For example:

• If substantially all the business profits will be distributed to the owners, it may be preferable that the business be operated as a pass-through entity rather than as a C corporation, since the shareholders will be taxed on dividend distributions from the corporation (double taxation). In contrast, owners of a pass-through entity will only be taxed once, at the personal level, on business income. However, the impact of double taxation must be evaluated based on projected income levels for both the business and its owners.
• If the value of the business’s assets is likely to appreciate, it’s generally preferable to conduct it as a pass-through entity to avoid a corporate tax if the assets are sold or the business is liquidated. Although corporate level tax will be avoided if the corporation’s shares, rather than its assets, are sold, the buyer may insist on a lower price because the tax basis of appreciated business assets cannot be stepped up to reflect the purchase price. That can result in much lower post-purchase depreciation and amortization deductions for the buyer.
• If the entity is a pass-through entity, the owners’ bases in their interests in the entity are stepped-up by the entity income that’s allocated to them. That can result in less taxable gain for the owners when their interests in the entity are sold.
• If the business is expected to incur tax losses for a while, consideration should be given to structuring it as a pass-through entity so the owners can deduct the losses against their other income. Conversely, if the owners of the business have insufficient other income or the losses aren’t usable (for example, because they’re limited by the passive loss rules), it may be preferable for the business to be a C corporation, since it’ll be able to offset future income with the losses.
• If the owners of the business are subject to the alternative minimum tax (AMT), it may be preferable to organize as a C corporation, since corporations aren’t subject to the AMT. Affected individuals are subject to the AMT at 26% or 28% rates. 

These are only some of the many factors involved in operating a business as a certain type of legal entity. For details about how to proceed in your situation, consult with us.

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Auditing standards require external auditors to consider potential fraud risks by watching out for conditions that provide the opportunity to commit fraud. Unfortunately, conditions during the COVID-19 pandemic may have increased your company’s fraud risks. For example, more employees may be working remotely than ever before. And some workers may be experiencing personal financial distress — due to reduced hours, decreased buying power or the loss of a spouse’s income — that could cause them to engage in dishonest behaviors.

Financial statement auditors must maintain professional skepticism regarding the possibility that a material misstatement due to fraud may be present throughout the audit process. Specifically, Statement on Auditing Standards (SAS) No. 99, Consideration of Fraud in a Financial Statement Audit, requires auditors to consider potential fraud risks before and during the information-gathering process. Business owners and managers may find it helpful to understand how this process works — even if their financial statements aren’t audited.

Doubling down on fraud risks

During planning procedures, auditors must conduct brainstorming sessions about fraud risks. In a financial reporting context, auditors are primarily concerned with two types of fraud:

1. Asset misappropriation. Employees may steal tangible assets, such as cash or inventory, for personal use. The risk of theft may be heightened if internal controls have been relaxed during the pandemic. For example, some companies have waived the requirement for two signatures on checks, and others have reduced oversight during physical inventory counts.

2. Financial misstatement. Intentional misstatements, including omissions of amounts or disclosures in financial statements, may be used to deceive people who rely on your company’s financial statements. For example, managers who are unable to meet their financial goals may be tempted to book fictitious revenue to preserve their year-end bonuses. Or a CFO may alter fair value estimates to avoid reporting impairment of goodwill and other intangibles and triggering a loan covenant violation.

Identifying risk factors

Auditors must obtain an understanding of the entity and its environment, including internal controls, in order to identify the risks of material misstatement due to fraud. They must presume that, if given the opportunity, companies will improperly recognize revenue and management will attempt to override internal controls.

Examples of fraud risk factors that auditors consider include:

• Large amounts of cash or other valuable inventory items on hand, without adequate security measures in place,
• Employees with conflicts of interest, such as relationships with other employees and financial interests in vendors or customers,
• Unrealistic goals and performance-based compensation that tempt workers to artificially boost revenue and profits, and
• Weak internal controls.

Auditors also watch for questionable journal entries that dishonest employees could use to hide their impropriety. These entries might, for example, be made to intracompany accounts, on the last day of the accounting period or with limited descriptions. Once fraud risks have been assessed, audit procedures must be planned and performed to obtain reasonable assurance that the financial statements are free from misstatement.

Following up

Auditors generally aren’t required to investigate fraud. But they are required to communicate fraud risk findings to the appropriate level of management, who can then take actions to prevent fraud in their organizations. If conditions exist that make it impractical to plan an audit in a way that will adequately address fraud risks, an auditor may even decide to withdraw from the engagement.

Contact us to discuss your concerns about heightened fraud risks during the pandemic and ways we can adapt our audit procedures for emerging or increased fraud risk factors.

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QUESTION:

Our company was targeted by payroll scammers that resulted in data theft of employee W-2 information. What should we do?

ANSWER:

Time is of the essence in this situation. Quickly, but thoroughly summarize all the information that was compromised. Next, email the IRS at dataloss@irs.gov, and put “W2 Data Loss” in the subject line. Don’t include any of the personal information that was compromised. Instead, provide your company name and contact phone number so someone at the IRS can call you.

Don’t forget to reach out to your state taxing authorities to report the data breach and let affected employees know so they can immediately take steps to limit its impact.

QUESTION:

I received a monetary settlement from a malpractice claim. Is the money I received taxable?

ANSWER:

Generally, successful litigants in a legal malpractice case are taxed on their gross settlement or award amount. Before the 2017 Tax Cuts and Jobs Act (TCJA), attorney’s fees you incurred to litigate your case would have been deductible as non-business-related legal fees on Schedule A as a miscellaneous itemized deduction. But the TCJA eliminated this class of write-off, making the entire compensation amount taxable.

Monetary settlements for other types of malpractice claims (e.g., medical) generally aren’t taxable if they compensate you for economic losses from medical expenses or lost wages.

Backup withholding is a tool the IRS uses to collect federal taxes on income that’s not ordinarily subject to withholding, ensuring taxpayers ultimately pay all taxes they owe.

NO IDENTIFICATION

One of the most common scenarios where you’ll see backup withholding is with payments to contractors. Typically, you’re not required to withhold taxes from disbursements you make to non-employees.

However, when using contractors in your business, you’ll need to get their taxpayer identification number (TIN), which is most commonly obtained with Form W-9. This information is required so you can report their payments on Form 1099 at the end of the year. But if any contractor fails to provide a TIN, the employer is required to withhold a flat 24% from all fees paid to that individual. This 24% is called backup withholding.

In some cases, you may have received a TIN and filed a 1099, but the IRS later notifies you that the TIN and the name of the business shown on the form don’t match. In these situations, you’re also required to make the backup withholding. And you’ll report any tax withheld on the following year’s 1099.

Open Enrollment Tips For Employees – carefully review benefit offerings to ensure you take full advantage of choices.

Financial Health Checklist For Small Business Owners – decision making without considering goals and your future may be something you might regret in the future.

October 2021 Client Profile

Negotiate a Raise – asking for a raise can be nerve-wracking.

Employer Essentials for Open Enrollment – tips that may help your open enrollment go smoothly.

What is Backup Withholding? – a tool the IRS uses to collect federal taxes on income that’s not ordinarily subject to withholding

October 2021 Questions and Answers

October 2021 Short Bits