You can’t code an employee’s pay and deductions properly without an employee pay profile, said Jonathan Stone, managing director of KPMG LLP. Stone shared his insights with attendees at PayrollOrg’s 41st Annual Congress.
Know the pay codes
Earnings and deductions codes are crucial because the information flows through to employees’ pay, W-2s, and the government, Stone said.
But what you pay and what you deduct from an employee’s salary depends on their profile—their basic demographic information, their W-4s, their Social Security numbers, their work state, and their home state. This starts with onboarding new employees, but the advent of employee self-service portals makes this an ongoing responsibility, Stone added.
It all comes down to this: If an employee’s pay profile is incorrect, their pay codes will be incorrect and their pay will be incorrect.
There’s a code for each wage type, and there are three principal wage types:
- Regular wages, which are always turned on for regular pay cycles
- Supplemental wages, which can be coded for 22% federal income tax withheld
- Special payments, like equity payments—nonqualified stock options and restricted stock units.
Deduction code dilemmas
There’s also a code for each pretax and after-tax deduction. According to Stone, the order in which deductions are taken must be a consideration. And employees often muddle the priorities, he commented. For example, he encountered a situation where an employee wanted 100% of his net pay to go into his 401(k) account. But doing this would have left him with a negative deduction for health insurance.
Employees control how their information is entered in their ESS, but in the end, it’s your responsibility to adjust it and reset the priorities, Stone said.
W-2 mapping ensures that every pay and deduction code maps to particular W-2 boxes. And here’s another instance where wrong information in an employee’s pay profile is the source of an unforced error. If an employee’s home state is wrong in their employee profile and they work remotely, you will not withhold and report the proper state’s income taxes.
You need to configure deduction codes properly for the states not following the federal rules, Stone said. These deductions typically include the following:
- Moving expenses (taxable at the federal level, but not in certain states)
- Health benefit deductions made through IRC 125 cafeteria plans (tax-free at the federal level, but taxable in New Jersey)
- Pretax deductions for 401(k) plans (tax-free at the federal level, but taxable in certain states)
Pay and deduction codes should be reviewed periodically to ensure they’re configured correctly so they capture the correct W-2 information, Stone added. And any new earnings codes should be reviewed and tested before you activate them.
Downstream ramifications of incorrect codes
Incorrect earnings codes lead to incorrect W-2s, which lead to corrections on Forms W-2c and 941-X, Stone pointed out.
Once you cross calendar years, you can’t correct income tax withholding. As for corrections to FICA taxes, the only way FICA taxes can be paid is through withholding, Stone said. You must now go through the employee consent process, which requires you to make two attempts at securing employees’ consent to obtain their FICA overpayments before you can file Form 941-X to obtain a refund of your own FICA overpayment.