Any bonus given to a company’s employees is a transfer from taxpayers to its business partners. To make sure that American workers receive all of their due, the Internal Revenue Service (IRS) requires employers to withhold 30 percent of compensation and pay that amount into the employee’s pay check. As a result of the Earned Income Tax Credit (EITC), taxpayers are given an additional 10 percent of their income (meaning a 40 percent tax credit or $1,600 in 2016).
As a general rule, if your organization gives its employees something, you have to pay Social Security and Medicare taxes on it. Employers with net earnings of $500,000 or more for tax years 2011 through 2015 can use a maximum EITC amount of $6,318 ($487.50 for tax year 2016). Employers with net earnings of $600,000 or more for tax years 2011 through 2015 can use a maximum EITC amount of $5,969 ($535.50 for tax year 2016).
While many companies might try to minimize employee compensation, it is important for all companies to understand the IRS’s rules for wage withholding. This is especially the case when the company’s labor force is comprised of non-exempt employees, who are not required to withhold income taxes, yet take up to 40 percent of the value of the bonus, no matter how much they actually receive in compensation.
The IRS, in a recent proposed ruling, has increased the EITC eligibility levels to encourage the use of the EITC for ECD workers, including workers in salaried jobs and those who are paid by the hour or on a commission basis. As a result, there has been a change in how the EITC is calculated for workers in contingent positions, such as contractors and consultants.
PRE-OWNED companies are claiming a new ERC for workers in post-employment benefit plans, and it is especially hard to tell whether an employer is eligible to claim the ERC for workers in post-employment benefit plans. Although the law was changed in 2013, as of September 2016, employers who provide health care for their employees and also provide at least half of the cost of their employees’ health insurance (called a benefit-cost ratio) are ineligible to claim the EITC for ECD employees.
In contrast, employers who provide health care for their employees and do not provide at least half of the cost of their employees’ health insurance (known as a flat rate ratio) are eligible to claim the EITC for ECD employees. The “pre-owned” companies that are claiming the ERC for workers in post-employment benefit plans are probably either sole proprietorships or certain LLC’s (defined as partnerships organized for the primary benefit of its members). The IRS has not updated the definition of “LLC” or “sole proprietorship” since 2013.
Although the IRS has not issued any rules to address the EITC for Post-Employment Benefit Plan Workers yet, the 2013 law did address the rules for the so-called “semi-employers” and those classified as independent contractors. Employers who offer retirement or health insurance are not eligible to claim the EITC for Post-Employment Benefit Plan Workers, as they are not considered to have any workers.
As mentioned in the previous article, the EITC for Post-Employment Benefit Plan Workers in 2012 was increased from a $1,000 to $2,000. The following year, it was increased to $2,400. If you do not withhold taxes, you will get back $190 for each $1,000 of wages paid, up to a maximum of $2,400. If your company pays more than $2,400 in wages, you must pay the back taxes by filing Form 8949 and sending it to the IRS.
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For most employees, the EITC is a valuable tax-saving tool, as it increases the amount of income that may be subject to tax. In most cases, employees will receive a percentage of their wages. This percentage is called the “Social Security deduction” and is averaged over the payroll tax period (not over a year). For workers who receive their wages directly, the percentage is usually withheld at the end of the pay period. If the employer pays employees their wages as a lump sum, then there is no Social Security deduction and the employee will receive the full amount of the W-2 wages as income tax.
The IRS has removed the Social Security deduction for Social Security for 2016, as the IRS wants employees to be able to claim a larger portion of their income and some of it is already exempt. For the 2016 tax year, if you receive Social Security benefits, they will count as income, but you will only get 85% of your W-2 wages as tax. So if you receive less than $12,000 in wage income, then you will not get any Social Security deduction for that amount and you will only get 85% of your W-2 wages as income tax. If you receive more than $12,000 in wage income, you will get a Social Security deduction for the portion that is subject to income tax.
PEG-owned portfolio companies are the exception to the Social Security exclusion. The IRS does not want the Employer and Post-Employment Benefit Plan to be treated as a single employer for Social Security tax purposes, so it has excluded the Social Security deduction from EITC for ECD employees as an added incentive to get workers to work for companies that provide post-employment benefits.
Next time you look at your W-2s, remember that you may be eligible for an EITC for ECD workers. If your company is involved in a PEG transaction, you may want to claim the EITC for ECD workers to increase your take home pay. ERC claimed by PEG-OWNED companies is subject to the Social Security exclusion. That means you can get a tax deduction for as much as 85% of your W-2 wages. The PEG-OWNED businesses must have at least two employees working for at least one month at all PEG-OWNED companies for the year to claim EITC for ECD employees.
Why PEG-owned Portfolio Companies Are Favorable for Employee Retention Credit?
The PEG-owned companies benefit from the deductions for the Employee Retention Credit if they are using post-employment benefits, like retirement plans, health insurance, and 401k plans. At PEG, when employees reach retirement age, the company implements a 401k plan for their employees. PEG sends the money collected in payroll taxes directly to the 401k plan as contributions. PEG then puts the money collected from the employer taxes and social security tax into the 401k. This gives the employees a tax-deferred account where the money can grow tax-free.
The employer does not pay for this money. Instead, the taxes are paid by the employee, which makes the plan more valuable to the employee. Employer and employee contributions are both tax deductible and tax-free for federal income tax purposes. After age 50, participants can contribute additional money without being limited by the salary cap.
EITC for ECD workers works well for companies because the tax credit reduces the tax liability and reduces the employee’s take home pay. Employers can also use the credits as an incentive to have employees work for the company in the first place. With EITC for ECD employees, you can get a tax benefit for having more employees working for your company. If your company is smaller than the EITC limits, you can use a strategy to lower the company EITC limits for a specific period of time.
Every business is unique, but if your business is a PEG-owned business, it can potentially benefit from the EITC for ECD employee tax deduction. ERC ’s partnership with several accounting firms and CPAs will enable tax planning for you and your business. It ’s important to talk to your accountant about the best way to get the maximum tax benefits.
For example, the employer EITC would only apply for new hires from the year the first new hire begins working for your company and does not apply to existing employees. If a large portion of your workers are recent hires, the EITC might apply. However, if all of your employees have been with your company for some time, there might be a cap on the EITC amount.
If you receive a W-2 from a PEG-owned company, make sure you include the Employee Retention Tax Credit. You can also find out more about the EITC for ECD workers at your accountant’s office. It might also be beneficial to file a separate Form SS-4 if your business is a PEG-owned company. This form is used for reporting income and payroll taxes on an annual basis.
Benefits of Employee Retention Credit for PEG-Owned Portfolio Companies
According to ERC ’s study on the benefits of using the EITC for ECD employee tax deduction, the following are the top 10 benefits of using the Employee Retention Credit to your PEG-owned portfolio company.
- The employee’s net income is increased by $500 (the 2017 federal income tax bracket begins at $118,500).
ERC argues that this benefit is meant to offset the wage tax deductions used by a company to reduce their employee’s net income. The $500 increase for 2018 is an increase from the 2017 amount of $200. For tax year 2016, a $500 EITC benefit is only available for a new hire who is not a current employee.
- The EITC deduction is non-refundable for federal income tax purposes.
The EITC allows an employee to reduce his or her taxable income to zero for up to $24,000 for a single employee or $48,000 for a married couple. There are other tax benefits, but the $48,000 standard deduction limit is the most significant.
- There are income limitations on the EITC for ECD employees.
The EITC for ECD employee can only be claimed by new hires from the year they begin working for your company and does not apply to existing employees. However, ERC claims that there might be a cap on the EITC amount for a specific period of time.
- If the company is large enough, the company’s EITC benefits may exceed the employee’s wage tax deductions.
In addition to the $500 benefit, an employee’s net income is increased by $2,000 if he or she is an ECD employee and does not have paid employment with the company. That means that an employee can receive $4,000 in 2018 if the company does not have paid employment for the employee.
- Tax is only charged on the employee’s net income (not earnings).
The tax liability on an employee’s net income is zero if he or she does not have paid employment with the company.
- The company still has to pay tax on the employee’s net income.
If the company is large enough, the company’s EITC benefits will exceed the employee’s wage tax deductions. However, the company still has to pay taxes on the employee’s income as determined by the federal and state tax codes.
- The EITC is transferable between companies.
The EITC is a tax break for employment, so you can transfer it to your other companies without paying additional taxes. It will not reduce any taxable income the employee may have had at their prior employer.
- If you are already receiving a W-2 form, ERC says you can include the EITC for ECD employee in that.
If the company is a PEG-owned portfolio company, you can include this benefit on your W-2 income tax form. This allows you to claim this maximum benefit of $4,000 in tax year 2018. ERC recommends having the EITC form completed prior to filing the W-2 income tax form.
- If the company is small enough, you can combine this benefit with your income tax break.
To maximize the EITC for ECD employee benefit, ERC recommends a company is below the 50 employee limit or that has employees with a net income of less than $80,000. If you exceed the 50 employee limit, ERC suggests you can combine the EITC with the $2,000 non-refundable tax incentive.
- Check to see if your state or county also provides an employee retention credit.
Although federal tax credits can be claimed, most states and counties offer ERC benefits of their own. In Colorado, employers can claim a $4,000 non-refundable tax incentive and $2,000 of additional income tax credits for employees who receive an EITC.
Conclusion
PEG-owned portfolio companies should consider EITC and ERC benefits for new employees. The amount of the Employee Retention Credit benefit will vary by the size and number of employees with paid employment at your company. The tax credit for ERC is eligible regardless of the amount of employment. However, ERC is only eligible for the employees at EIC with a net income under $48,000.
Keep in mind that it is important to compare the employee tax benefit to the state or county benefit. For example, the New York State EITC for ECD employee is $6,000. If you received a $4,000 employee EITC benefit, you would still be required to pay taxes on the $2,000 paid EIC salary, assuming your total income was greater than $72,000. Your EIC employees who make under $48,000 would not be eligible for the EITC benefit.
Find out how much the state or county benefit for the same employee is and consider that tax savings when considering if the EIC benefits are worth the time and effort. Depending on the company size and number of employees, the $4,000 EIC benefits may make sense for your company. If the company needs to have employee benefits, EIC is an excellent choice.
Finally, ERC is a valuable tax savings benefit for EIC employees that allows the employee to reduce their federal and state income taxes. Do you own a PEG-owned company and do you take advantage of employee tax benefits? What benefits do you offer? If you would like to connect with an accountant, EIC, or EIC employee benefits professional, please send me your questions and contact information.