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What’s on my paystub?
Paystubs provide employees with a breakdown of their compensation earned within a pay period. There are six fundamental components to a paystub:
Gross income
-Pre-tax deductions
=Taxable income
-Taxes
-After-tax deductions
=Net pay
Gross income is the total of all compensation items received during the pay period.
Pre-tax deductions are amounts subtracted from gross income in arriving at taxable income. These amounts correspond to items that receive tax-favored treatment, such as traditional 401(k) contributions and health insurance premiums.
Taxable income added across all pay periods during a tax year is shown on Form W-2, box 1. Tax withholding is calculated based on this amount.
Taxes are amounts required to be withheld and deposited by the employer.
After-tax deductions are other amounts subtracted from taxable income in arriving at net pay. These amounts correspond to items that do not receive tax-favored treatment at the time of contribution. Some of these items, such as Roth 401(k) contributions, receive tax-favored treatment at the time of distribution.
Net pay is the amount of cash the employee receives through their paycheck or bank account deposit.
Many payroll providers issue paystubs that display a consolidated version of the components listed above. For instance, some may show three categories (gross income, deductions, and net pay). Regardless of the format, the underlying data is based upon the framework described here.
How do per diems work?
Per diems are daily amounts provided by employers to their employees to cover the cost of meals, incidental expenses, and lodging when the employees travel for business. To be eligible, an employee receiving a per diem must travel outside of their “tax home,” which is the metropolitan area in which they ordinarily work. (This is usually, but not always, the same metropolitan area in which they live.) Per diem amounts are established by the General Services Administration (GSA), rather than the IRS.
There are two types of per diems: meals and incidental expenses (M&IE) and lodging. Employers may choose to pay for either or both expense types. The GSA establishes per diems using a base rate across the US. Higher per diem limits apply in locations with a greater cost of living, known as non-standard areas (NSAs). There are approximately 300 NSAs in the US.
Per diems give employers a simple and cost-effective way of covering employee travel expenses. When these amounts are provided below or equal to statutory limits, there is no taxable income to the employee. Further, the employee is not required to substantiate the expenses, meaning they do not need to submit expense reports or receipts to their employer.
Per diem amounts in excess of statutory limits result in taxable income unless the accountable plan rules are satisfied. These rules are as follows:
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The expense must have a substantial business purpose.
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The employee must substantiate the expense within 60 days of when the expense was incurred, meaning they must submit an expense report and receipts to their employer.
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The employee must return any excess reimbursement to their employer within 120 days of when the expense was incurred.
Employers should maintain a written policy for per diems and reimbursements which indicates that they intend on complying with the accountable plan rules.
What are estimated payments and why do they matter?
Estimated payments are amounts paid by individuals to the IRS throughout a tax year. These payments are made to cover portions of any projected Federal income tax liability not already withheld and deposited by the individual’s employer. Estimated payments are commonly made by individuals that are self-employed or retired, as they are not employed by another entity and thus do not have their estimated tax liability prepaid through the withholding process. These payments are due to the IRS based on a staggered quarterly schedule, with deadlines of April 15, June 15, September 15, and January 15.
Employees generally have the majority of their estimated tax liability withheld by their employer from wages and deposited with the IRS. If employees have taxable income obtained outside their job that is not subject to withholding, it may be necessary for the employees to make estimated payments. Employees can reduce the need to make estimated payments by reviewing their withholding periodically and submitting a new Form W-4, Employee’s Withholding Certificate, when appropriate. Form 1040, U.S. Individual Income Tax Return, functions as a reconciliation between an individual’s estimated tax liability (based on their withholding plus estimated payments) and their actual liability as calculated on the return. The difference between these amounts results in a balance due or refund.
Failure to make estimated payments when required can result in assessment of a penalty by the IRS. To avoid this penalty, the combination of withheld amounts plus estimated payments must exceed certain thresholds. Taxpayers can evaluate their year-to-date withholding and estimated payments using the IRS Tax Withholding Estimator. Individuals with complex tax situations may choose to have a pro forma return prepared mid-year. This process results in a comprehensive analysis which can be used to derive the optimal estimated payment amounts.
Disclaimer: The purpose of this blog is to provide educational content regarding topics relevant to individual taxpayers and employers. This content is intended to be general in nature and should not be relied upon with respect to any taxpayer’s specific situation.