Q. I am having a problem with the way my company pays my commission and I'm wondering if I can tell them it’s illegal. I work in advertising sales for a relatively small company. We get commission on sales plus a base salary. Since the company refuses to cut checks for less than $1,000, if a commission check is less than $1,000 net they just lump the commission money into our base salary paycheck.
I have pointed out to them that by doing so I get taxed more on the commission than I would if they just cut me a check for the commission only.
Here's the breaking point: Recently they miscalculated my commission by about 50% therefore making the check less than 1,000 so they lumped the commission into my salary check. I told them about their mistake and they said they would put the remaining commission on my next paycheck (again with the higher tax rate).
A. You seem to be confusing tax withholding with tax liability.
You are not being taxed any differently on straight commission checks than you are on your “draw”. Both amounts are combined on your Form W-2. You pay tax on the total combined amount based on your particular federal and state tax brackets, determined after deductions and exemptions.
The FICA (Social Security and Medicare) tax is withheld at the same rate on a straight commission check, a straight base pay check, or a “combination” check – 7.65%. Any state unemployment and disability contributions are also withheld at the same rate from any payroll check. However, this type of withholding usually has a relatively low income threshold and you will have the maximum withheld during the first half of the year.
Where you see a difference is in the federal and state income tax withholding.
The amount of federal and state income tax withheld as a percentage of gross pay is based on tables published by the Internal Revenue Service and your individual state, your withholding status, and the number of exemptions you claimed on the Form W-4 you provided to your employer.
The problem arises when the amount of your check varies from pay period to pay period, as it would if commissions are added to base pay on a sporadic basis. The tax tables are based on the concept that you will receive the same amount of gross pay each pay period, and calculate withholdings accordingly.
Here’s a simplified example. If your base pay is, say, $500 per week the tables will assume that your gross income for the year is $500 x 52 or $26,000. If you claimed “Single-1” on your Form W-4 the tables will basically determine the annual tax liability for a single individual with $26,000 in income who is claiming one exemption for himself/herself and divide that amount by 52. This is the amount of income tax that is withheld.
If your employer includes $800 in commissions in with the normal $500 base pay one week, the tables will assume your gross income for the year is $67,600 ($1,300 x 52) and determine the amount of income tax to withhold accordingly. Because this calculation would push the assumed annual income into a higher tax bracket, a higher percentage of the income is withheld.
Your employer is doing nothing illegal or even wrong. Click here to see the IRS instructions for payments of “supplemental” income such as commissions. And you have not lost this money. The additional amount of federal and state income tax withheld on “combined” checks will either result in an increased refund or a reduced tax due when you file your tax returns next month.
If you feel that you are having too much federal and/or state income tax withheld you can always submit a new Form W-4 to your employer so that you have less tax withheld. The greater the number of exemptions you claim the less you will have withheld.
You can go to www.paycheckcity.com and use their paycheck calculators to see how a change in withholding exemptions will affect your take home pay.
Q. I have always used a Flexible Spending Account and been proud to say that I have never left any money "trapped" in the account at year end and have been good about estimating my costs each year to maximize the benefit. This year, I know that I will have a large medical expense, about $11K. So, when filling out the forms for 2008 benefits last month, I opted for the maximum $5000 FSA contribution, again, very proud of myself.
Then, last week, a friend of mine who recently had a large medical expense made the comment, "well, at least it was fully deductible." I read up, and lo and behold the $11K should be deductible, because it would be more than the 7.5% of my AGI. But, I was looking on the IRS's web site, and as far as I can tell, I may have actually shot myself in the foot here, since it seems I can't include the full $11K in calculating the 7.5%, only the $6K NOT in the FSA. Is that correct? $6K alone is not enough to meet the 7.5% test for me. If that is the case, it seems I am actually being penalized for having the FSA? I feel pretty stupid now, but no one has ever raised the idea to me that taking out an FSA would not be the best option in some cases. Any thoughts or advice?
I plan to call my benefits group to see if I can reverse the election, but they usually do not make changes. If this is true, I really feel that there should be a caveat about needing to make sure it's right for you if you have high medical expenses in all the benefit literature. I have been trying to research this online, and all I find is advice about how great these accounts are. Hopefully, I am wrong about this!
A. Don’t feel stupid. In your situation the $5,000 medical Flexible Spending Account (FSA) contribution was indeed your best option. Do not, I repeat, do not reverse your election!
Contributions to a medical FSA automatically reduce your federal taxable wages, your FICA (Social Security and Medicare) wages, and possibly your state taxable wages. If your gross wages are $90,000 and you contribute $5,000 to a medical FSA you are only paying tax on $85,000. Click here to view the appropriate IRS publication.
In addition your Adjusted Gross Income (AGI) is reduced by $5,000, which could increase a variety of deductions and credits and also reduce exclusions that are affected by AGI. See my posting on “The Most Important Number on Your Tax Return”.
By contributing $5,000 to your medical FSA you have received a $5,000 “above-the-line” tax deduction for your medical expenses. An "above the line" deduction is always better than a "below the line" (i.e. itemized) deduction.
Let’s say your gross wages are $90,000, FSA contributions are “pre-tax” for state income tax purposes, you are in the 25% federal and 5% state tax bracket, and you have no other taxable income. The $5,000 contribution to the FSA would save you 37.65% in total taxes (25% federal, 5% state and 7.65% FICA) or $1,883. You would not be able to deduct any of the remaining $6,000 in medical expenses because 7½% of your $85,000 AGI is more than $6,000.
If you did not made the $5,000 FSA contribution your AGI would be $90,000. You would be able to deduct $4,250 in medical expenses on Schedule A ($11,000 less $90,000 x 7.5%). At most you would save $1,275.00 in combined federal and state income taxes ($4,250 x 30%).
In the above example by contributing the $5,000 to your medical FSA you saved over $600 in taxes!
As you had indicated, medical expenses not paid or reimbursed through a medical FSA can be claimed as an itemized deduction on Schedule A, subject to the 7½% of AGI exclusion. You stated that the $6,000 remaining expenses in your situation would not exceed the exclusion. Be sure you include all your allowable medical expenses. My special report DEDUCTING MEDICAL EXPENSES ON YOUR 2007 FORM 1040 provides a detailed listing of all allowable expenses. Click here for more information.