If you run a business with even one employee, you’ve probably been asked some of these payroll questions. In fact, you’ve probably asked them yourself.
- What are all these deductions coming out of my paycheck?
- When can I have my W-2 so I can file my taxes?
- I didn’t get a tax refund. Why aren’t you taking enough taxes out of my check?
- Why don’t I earn overtime pay?
- What does exempt status mean?
And while constantly being asked these questions can be frustrating, or at times overwhelming, it’s important for your employees to understand their wages, taxes, and deductions. Let’s face it, most people don’t go to work for the great coffee.
So, if it’s important that your employees understand their paychecks, it’s important for you to know how to explain the information to them. This will make life easier for you, and more clear and comfortable for your employees. It’s a win-win!
As a small business, we understand your pain. We get asked these same questions. Fortunately, we have a team of accountants and decades of experience successfully dealing with the Internal Revenue Service (IRS). So we have these answers down to a science.
And we’re going to break it down for you by following the advice of the great philosopher The Office’s Michael Scott. “Why don’t you explain this to me like I’m five.”
(Warning: If your 5-year-old understands the following, there is a tiny accountant inside trying to get out!)
Questions your employees will ask you on repeat
1. Why are there no taxes coming out of my paycheck?
Two main reasons:
- The employee has not earned enough money during the pay period to meet the Federal Government’s minimum threshold requiring taxes to be withheld.
2. The more likely answer is that the employee selected a Form W-4 filing status that requires less Federal withholding or did not note the appropriate number of dependents, claims, or deductions on the form.
Have the employee review their most recent Form W-4 to determine if a mistake has been made because an employer is LEGALLY required to follow an employee’s Form W-4 even if it is incorrect.
2. What are all these (mandatory) deductions on my paycheck?
Or as Rachel from Friends so aptly put it, “Who’s FICA? Why is he getting all my money?!”
Unless you are a kid with a corner lemonade stand, the government is going to tax your wages. And frankly, if the government could find a way to tax those sticky, little cups of sugar water, they would.
You’ve heard it a million times. Ben Franklin nailed it when he said nothing is certain but death and taxes. And as an employer, it’s paramount you know and understands the taxes you and your employees are required to pay. No one needs the IRS on their backs.
These are the Mandatory deductions on earned wages:
- Federal income tax – determined by the employee’s completed and signed W-4 and their annual salary.
- FICA (Federal Insurance Compensation Act) – funds Social Security benefits. Tax is 6.2 percent of the employee’s gross income. You, as the employer, will also contribute 6.2 percent of the employee’s gross income in your quarterly payroll tax filing.
- Medicare – funds Medicare benefits. The tax is 1.45 percent of the employee’s income and just like FICA, the employer contributes an equal amount.
- State income tax – Nine of our glorious 50 states do not tax earned wages.
- Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming have no state income tax.
- If your business is based in one of the above-listed states, you do not have to worry about deducting state income tax, even if one of your employees lives in a state with state income tax.
This typically comes into play when an employee lives in an income-tax-free state, but works in a state that taxes earned wages. And now that telecommuting is increasing in popularity, this issue should be on your radar if you have any remote employees.
Here’s an example: Say you run a small business in Southaven, Mississippi (an income tax state), and you have employees who reside in Memphis, Tennessee (a non-income tax state). The Tennessee residents working in Mississippi will be required to pay taxes on their wages.
As the business owner, you’ll get the fun task of adding these deductions to your employees’ paystubs. And as Tennessee residents with no state income tax, they will probably ask you why they have to pay Mississippi taxes. And you can explain to them that since they earn money from a Mississippi-based business (even if they are sitting in their Tennessee homes), they have to fork over income tax to the Magnolia State. It’s the law; it’s not your fault.
Now if the opposite were true, and your business is based in the Volunteer State, and some of your employees live in Mississippi, you do NOT have to concern yourself with state income tax deductions. Yay!
Of course, if you are a kind and benevolent boss, you might mention to your Mississippi-living employees that they will be responsible for reporting all the wages they earn in Tennessee on both their Federal and State (Mississippi) tax returns.
Common (but not mandatory) paycheck deductions
Other common standard deductions are health insurance premiums and retirement plan contributions. If you employ more than 50 people, you are required to offer health insurance benefits, according to the Affordable Care Act.
Additionally, union dues and premiums for voluntary benefits, like life insurance or accidental death or dismemberment plans, are also common paycheck deductions.
Employees must give written permission to employers for all payroll deductions beyond those mandated by the federal, state, or local government. This is where those Form W-2s come in handy, and why it’s imperative your employees fill them out correctly.
3. When can I have my W-2? (this is often said to the tune of “Are we there yet?”)
Even though the IRS doesn’t accept electronic tax filings until the end of January, employees can sometimes begin asking for their W2s right after the ball drops on New Year’s Eve. And while most W2s are ready to distribute by January 2, we DO NOT recommend giving them out until at least mid-January to allow time for amendments and corrections.
You can explain to your employees that the creation of W2s is not simply completing one form, but a reconciliation of all payroll content for all employees for the fiscal year. A year’s worth of deductions, wage calculations, employer tax filings, and personal employee data goes into creating a complete, IRS-worthy W2.
After you calculate everything, you have to double-check it all. We are talking about the most significant financial document employees get all year. We are talking about taxes and the IRS. There is no room for error here, folks.
And if their pants are still on fire to attempt filing a tax return the first week of January, remind them they can legally file using their final paystub of the year.
Here at Whirks, we tell our employees that their W2s will be readily available by January 31 and aim to have them distributed by mid-January.
4. What is the difference between overtime and holiday pay?
In the simplest terms, overtime pay is paid for hours worked above the standard 40-hour workweek. Holiday pay is paid for hours the company closes due to a federal or religious holiday.
Overtime is typically 150 percent of the employee’s regular rate of pay and is calculated based on the number of hours worked.
For example, an employee worked 36 hours (during a 40-hour period) and received eight hours of holiday pay. While this totals 44 hours, it is not 44 hours worked, so no overtime would be paid.
Some companies pay worked-holiday pay when an employee works on a company-wide holiday. Those hours would count toward overtime pay.
Let’s say it’s Christmas Day; a standard holiday. But not every business can close on Christmas Day, meaning someone has to work. Many businesses pay time and a half wages to employees who work on major holidays. And although holiday pay rates and overtime pay rates are the same, they are not considered the same thing.
For example, if an employee works 44 hours during a standard 40-hour week and that includes working on Christmas Day. Even though you paid the same rate (time and a half) to the employee working the eight hours on Christmas Day, those hours and that pay rate are NOT considered overtime. Only the hours worked over the 40-hour workweek count as overtime.
If your company has a specific policy about paying a premium on certain holidays, then you do not have to pay overtime pay on top of premium pay.
For tough cases, consider consulting a labor attorney.
5. What is the difference between exempt and non-exempt regarding overtime pay?
Exempt means an employee is eligible not to earn overtime. In simpler terms, the employee is exempt from earning overtime pay. Unfortunately, it’s not always that cut and dry. A salaried employee could be exempt or not depending on their duties and salary.
The Fair Labor and Standards Act (FLSA) has allowed for certain duties to be exempt from being eligible for overtime pay. Duties that fall under Administrative, Executive, Professional, or Outside Sales cannot be paid overtime. This is not based on job title, but actual primary duties.
For a more in-depth breakdown of job duties that are exempt from overtime pay, check out what the U.S. Department of Labor says about it here: Fact Sheet #17A: Exemption for Executive, Administrative, Professional, Computer & Outside Sales Employees Under the Fair Labor Standards Act (FLSA) | US Department of Labor.
Fortunately, the rule for hourly employees is much simpler. Hourly employees are always non-exempt, meaning they are eligible for overtime pay. If an hourly employee works 45 hours in a standard 40-hour workweek, you must pay them the overtime rate of pay on the five hours they worked after working the standard workweek.
Can I make all of this disappear?
Sadly, no. While this information is not exactly dinner party material, it is essential to running a successful business. But we do have a suggestion for calming the madness.
Review all pay stub information during a new employee’s onboarding. And consider creating a brief training session to remind employees to review their paystubs and explain the information it contains.
“The more you educate them on the front end, in the long run, you’ll get a lot of gains because you won’t get the questions,” Matt Patrick, Whirks’ Fearless Leader, said.
Use the explanations spelled out in this article to answer the repetitive (but significant) questions your employees ask about their paychecks. Bookmark this link to refer back to when you get asked one of these questions.
As an accounting firm and a payroll partner, we have done the heavy lifting of reading and re-reading IRS documents and figuring out what kind of employees have exempt overtime status. Use the information we’ve gathered to make your life easier.
And if you have more questions about processing payroll or educating and training your employees, please check out some of our podcasts to learn more.