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Deduction of ER's share of payroll taxes on cash basis

Technical topics regarding tax preparation.
#1
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The question------ when are the employer's share of payroll taxes (FICA, Medicare, unemployment) deductible by cash basis employer when such are not paid within the tax year of accrual.......or even two years later?

I have the situation of employer who has not paid his share of payroll taxes for over two years, and has delinquent income tax returns.

Looks to me like those taxes are deductible only at the point of payment..........but reflection says we have never had the problem, since previously late paying employers have always cleaned things up prior to the end of the year.

Therefore.......late payments have not been "highlighted"......and therefore the problem has not had to be considered.

In this case---- I "feel" like an examination will be coming on this person.......and I just don't want to be blind-sided.

Thanks.
 

#2
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Cash basis taxpayers take deductions when paid, although a lot of us technically use a hybrid system where we accrue payroll taxes, and deduct them in the year accrued. Regardless if not paid then the previously deducted expenses become income.
 

#3
Gjkycpa  
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Agree with TaxMonkey. That is how we do it.
 

#4
JR1  
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Exactly as TM said.
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#5
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Cash basis taxpayers take deductions when paid, although a lot of us technically use a hybrid system where we accrue payroll taxes, and deduct them in the year accrued.

That’s some hybrid system…for a cash basis taxpayer! Accrue (certain) expenses and don’t accrue revenue.
Regardless if not paid then the previously deducted expenses become income.

I didn’t follow this either. If a cash basis taxpayer (improperly) accrues an expense in this situation, you’d set up a liability. I’m pretty sure the payment of the liability never becomes income.
 

#6
makbo  
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It's better for everyone if ER payroll taxes are deposited at the same time as paychecks are issued. Too bad that's not the law.

On a related note, what about a SEP-IRA contribution for a one-shareholder S-corp, cash basis? It doesn't have to paid until after the end of the tax year, so I show it as a deduction, and a liability on the year-end balance sheet, is this a really bad error, or common practice?
 

#7
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makbo: IIRC, there might be a statutory provision that provides for exactly that result...
 

#8
Nilodop  
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It's common practice because it's not an error. See section 219(f)(3). Or is a SEP-IRA not covered by 408(a)? I thought it is.

Oops. 219(b)(2) says it doesn't. Guess I should look again.
Last edited by Nilodop on 7-Sep-2017 5:48pm, edited 1 time in total.
 

#9
Lmaris  
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TaxMonkey wrote:Cash basis taxpayers take deductions when paid, although a lot of us technically use a hybrid system where we accrue payroll taxes, and deduct them in the year accrued. Regardless if not paid then the previously deducted expenses become income.


We only accrue them if they are actually paid when due. If not, we don't.
 

#10
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Or is a SEP-IRA not covered by 408(a)?

While the SEP provisions are contained in Sec 408(k), the timing of deductions for contributions are found in Sec 404(h)(1)(B). The timing of deductions for employer payroll taxes, for a cash basis taxpayer, are governed by Sec 446. And the Regulations under that Section would tell you that the “hybrid” method TaxMonkey speaks of is bogus. From Reg. Sec. 1.446-1(c)(1)(iv)(a):

However, a taxpayer who uses the cash method of accounting in computing gross income from his trade or business shall use the cash method in computing expenses of such trade or business. Similarly, a taxpayer who uses an accrual method of accounting in computing business expenses shall use an accrual method in computing items affecting gross income from his trade or business.
We only accrue them if they are actually paid when due.

Huh? You guys need to stop making up your own accounting methods. Seriously. There are rules, you know.
 

#11
Coddington  
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As far as FICA goes, the issue has been directly addressed by the Tax Court:

We now turn to the third issue, which concerns the deductibility of the FUTA taxes and of the employer's portion of the FICA taxes. Secs. 3301, 3111. Petitioner incurred liability for these taxes with respect to wages paid to the employees of his law practice. On Schedule C of their tax returns, petitioners deducted these taxes for the year in which the liability accrued (i.e., the year in which the wages were paid), even though petitioner did not pay the tax until a later year. Petitioners argue that this treatment was proper and was in compliance with section 1.461-1(a)(1) and (3), Income Tax Regs. We disagree. Section 1.461-1(a)(1), Income Tax Regs., provides deductions for depreciation, amortization, depletion, and losses under sections 167, 611, and 165. Nothing in section 1.461-1(a)(3), Income Tax Regs., allows a cash basis taxpayer to deduct a tax before the year of payment. See also Rev. Rul. 74-70, 1974-1 C.B. 116 (for cash basis taxpayers, FICA and FUTA taxes are deductible for the tax year in which they are paid). Accordingly, petitioners may not deduct either the FUTA taxes or petitioner's share of FICA taxes until the year in which he paid such taxes.Tippin v. Commissioner, 104 T.C. 518, 532 (1995)


Off the top of my head, I'm not sure if there is an automatic change to fix this, so if you're deducting accrued FICA on a cash basis return, you might need to disclose the position until a non-auto change can be made.
-Brian
Tax accounting methods and credits consultant for hire.

http://www.coddingtontax.com
 

#12
makbo  
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OK, so accruing is not OK for cash basis taxpayer, if I understand the cites provided correctly. Yet, we have multiple responses saying we commonly do that (and also see a quote below I found from 3 years ago, at the Quickbooks community site). So why the disconnect? Because in the company books, even a cash basis taxpayer is going to accrue the liability until they make their deposit, and if payday is Dec 31, they most likely won't be making a same-year deposit.

The OP did not mention the trust fund portion of payroll taxes, which also may not be deposited in the same year as accrued, but I suppose the argument there is that it's already not the company's money at that point, so they have in effect paid it as of the paydate.

What is the solution, i.e. the practical way to do it correctly? If I have the QB books as of 12/31 on cash basis, it's going to have payroll liabilities if not all deposits have been made yet. Do I make M1/M2 adjustments on the 1120S (or journal entries in QB for a Schedule C)?

---------------------
Here is a similar (partly incorrect) answer provided at QB community, as an example of the prevailing position, right or wrong, of many practitioners. There was one comment disagreeing, and stating the unpaid ER payroll taxes should not be a current year deduction.

"Q: We are a cash basis tax payer. Payroll liabilities on a cash basis are recored when incurred and not when paid. Expense was recorded in 2014 instead of 2015 when paid.

A: Actually for payroll taxes the IRS accepts this (as well as for other similar liabilities).

This is because:

1) The IRS lets your treat all payroll as cash basis, even the parts of it that have a delay in the actual transfer of cash.

2) You cannot get out of the expense or liability (they to go together) for payroll taxes. For example, you basically cannot claim bankruptcy and get out of paying this money to the state and federal agencies. They will hound you almost forever, even grabbing your personal accounts or your house if it comes to that.

This is not dis-similar in logic to writing a check (which may not actually clear until next year) or making a credit card charge (which is considered same as cash though you may not actually pay it off for many years.) Both of these examples are considered cash basis events, at least for tax reporting.

3) The government considers the money you have impounded for employee taxes to belong to the employee and the money for company paid taxes to belong to the government. You get to hold on to it for a short time, but it's not yours as of the date of payroll. Since paying the taxes is a forgone conclusion, it is OK to recognize the related expense on a cash basis."
 

#13
JR1  
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I think we just like balancing the entry correctly. If you don't accrue the ER taxes and pick them up later when paid, you're bound, sooner or later, to get something messed up. When we accrue it immediately, we also know immediately when something goes wrong since we've got orphan balances or credits in the accrual account...just my .02.
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#14
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makbo wrote:OK, so accruing is not OK for cash basis taxpayer, if I understand the cites provided correctly. Yet, we have multiple responses saying we commonly do that (and also see a quote below I found from 3 years ago, at the Quickbooks community site). So why the disconnect?


Pick your poison.

(1) If we prepare payroll in QuickBooks, that's how it handles the entry, and since the software says to do it that way, it must be right! (the TurboTax defense)

(2) Literally not knowing the rules.

(3) Knowing the rules but disregarding them because of reasons (i.e. what you posted from the QB community)

(3)(a) It's not material; pass.

(3)(b) That's the way we've always done it.
(3)(b)(1) Q: Why did the accountant cross the road? A: He looked in the file and saw that's what he did last year

(4) Some other reason or combination of reasons.

The OP did not mention the trust fund portion of payroll taxes, which also may not be deposited in the same year as accrued, but I suppose the argument there is that it's already not the company's money at that point, so they have in effect paid it as of the paydate.


Yes, the trust fund taxes withheld from employee pay are deductible as wage expense as of the payment date. The basic payroll entry under the cash method would be Dr Wage Expense, Cr Cash (for amount paid to employee), Cr Payroll Liabilities (for taxes withheld from employee)

What is the solution, i.e. the practical way to do it correctly? If I have the QB books as of 12/31 on cash basis, it's going to have payroll liabilities if not all deposits have been made yet. Do I make M1/M2 adjustments on the 1120S (or journal entries in QB for a Schedule C)?


I don't love running anything through the M-1 unless it absolutely needs to because it's incredibly easy to make errors that way. My preferred method, assuming the financials are run on a tax basis in QB, is to create a contra-liability subaccount under payroll liabilities and make a journal entry to debit that account and credit payroll tax expense for the amount of unpaid employer payroll taxes at the end of the year. You can reconcile the account balance, you're less likely to make a mistake, and your tax basis year-end financials will print correctly on tax basis.
 

#15
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So why the disconnect?

Because some practitioners either (1) believe it is okay, for whatever reason, but their belief is incorrect or (2) they know it’s wrong, but do it anyway. Take your pick.
Do I make M1/M2 adjustments on the 1120S (or journal entries in QB for a Schedule C)?

I prefer the latter.
 

#16
HowardS  
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I suffer from depreciation.
 

#17
Nilodop  
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Some good reading, for old time's sake:. Just read it. Hilarious! Some old times' names in there, too. Death&Taxes. Ckenefick, Dennis, etc.
 

#18
HowardS  
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Don't forget that guy Podolin. He's aging well.
I suffer from depreciation.
 

#19
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Funny uban legend tax accounting which is probably a result of the hassle of separately accruing the EE trust fund tax from the ER tax. I'm guilty of it also. That's why I was so happy when all my clients went to payroll services that insisted on grabbing the tax money at same time payroll is run. No payroll tax payables to reconcile.
 

#20
Jake  
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Sales tax is a similar issue. Receipts including the sales tax are on a cash basis.
Payment of sales tax to the state for the last 6 months is in Jan. of the following year.
I have always justified taking that Jan. payment in the prior year as "constructive receipt".
The vendor is just holding that money for the state.
Not sure the above terminology is correct but you know what I mean.
 

#21
Nilodop  
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Isn't the treatment of sales tax governed in part by whether it is imposed on the buyer or the seller?
 


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