Employee Benefits and Payroll Tax Computations
Sample Salary & Benefit Rate Statistics
Benefits/Taxes Percent of Salary - use this information in calculating your overhead and O&M budget assignment line items.
|Social Security and Medicare||0.0765 - required for all employees|
|Worker’s Compensation||0.01 - required for all employees|
|Unemployment Compensation Fund||0.017 - required for all employees|
|Arizona State Withholding||0.023 - required if in AZ or use the appropriate state withholding for your state, if applicable)|
|Health & Life Insurance||0.1135 - full-time employees|
|Retirement Plan||0.06 - full-time employees|
|Dependent Tuition Waivers||0.038 - optional|
|Long Term Disability||0.04 - optional|
|Employee Educational Assistance||0.032 - optional|
|Wellness Program||0.02 - optional|
Employee benefits are such a common part of the workplace terrain today that many assume these benefits are required by law. But generally, the decision about whether or not to provide such benefits is up to you.
Even though providing benefits is largely optional, enlightened employers generally do offer some type of benefit package. Offering benefits can reflect your commitment to keeping a satisfied workforce and can help you remain competitive in attracting competent workers.
Because the federal tax laws allow an employer to deduct the cost of many employee benefits as a business expense, the financial burden of providing these benefits is greatly reduced. Benefits that qualify for favorable tax treatment include health and dental coverage, term life insurance disability insurance, approved pension plans, educational assistance programs and dependent care assistance. But if a benefit plan is rigged to favor the owners of a business or employees who receive the highest compensation, the plan may not qualify for a tax deduction. If you opt to provide healthcare coverage or pension plans, federal laws may impose requirements on these plans.
For an excellent introduction to the full range of employee benefits, see J.K. Lasser's Employee Benefits for Small Business, by Jane White and Bruce Pyenson (Prentice Hall). Price: $12.00.
A. Healthcare Coverage
Healthcare coverage is the benefit most employees covet. Medical treatment is expensive today and it's difficult for an individual seeking coverage to find some that's affordable. Of course, employees enjoy the greatest benefits if the employer foots the entire bill. But even if an employer pays none of the cost of coverage or just a part of it the employee benefits by being able to participate at relatively low group rates.
1. Types of Coverage
Traditionally, employers who have provided healthcare coverage have done so through an indemnity or reimbursement plan which pays the doctor or hospital directly, or reimburses the employee for medical expenses he or she has already paid. Blue Cross/Blue Shield is a traditional type of plan.
While traditional coverage allowing employees to seek out their preferred medical provider is still widely used, a growing number of employers today provide coverage through the alternatives of a health maintenance organization (HMO) or a preferred provider organization (PPO).
An HMO is comprised of hospitals and doctors who provide specified medical services to employees for a fixed monthly fee. Within the HMO service area, covered employees must use the HMO hospitals and doctors unless it's an emergency or they receive permission to go elsewhere.
A PPO is a network of hospitals and doctors who agree to provide medical care for specified fees. Often the network is put together by an insurance company that also administers it. Employees usually can choose between using the network's hospitals and doctors or going elsewhere.
2. Making the Best Choice
If you choose to provide health insurance coverage to employees, explore all the alternatives: group health insurance policies, HMOs and PPOs. Until you compare, you won't know which arrangement will be least costly to both your business and the employee.
Under some plans, employees pay for a portion of their medical expenses usually called copayments. The theory is that employees will seek only essential treatment if they're paying some of the cost.
Your business must decide on who will pay the monthly, quarterly or semi-annual premium for healthcare coverage. Among the choices for who pays the tab:
Your business can pick up the full amount.
¥ You can split the cost of premiums with the employee perhaps paying 80% and having the employee pick up the other 20% through a paycheck deduction.
¥ You can pay in full for the employee's coverage, but require the employee to pay the extra cost of covering his or her dependents.
¥ You can require the employee to pay the entire charge although that won't be perceived as much of a benefit by the employee even though the group plan will undoubtedly be cheaper than individual coverage.
Another way to shift some costs to the employee is through a deductible plan which requires the employee to pay a specified amount of medical bills each year $500 for example before the plan's coverage kicks in.
Consider Flexible Coverage Arrangements
Depending on where your business is located and the number of employees in it, you may be able to offer several different choices of coverage to employees. For example, some employers opt to pay 100% of coverage
under an HMO. If their particular HMO doesn't require all employees to join, some employers allow those employees who wish to do so to buy their own coverage. Then the employers reimburse them at the HMO rate.
Depending on the required co-payments, deductibles and other plan features, employees who select a different plan may pay a bit more or less than the HMO rate.
You should decide, too, whether to cover employees who work part-time. You might, for example, provide full benefits for those who work 30 hours or more per week, and prorated benefits for those who work at least 20 hours but less than 30. Such an approach may help you qualify for cheaper group rates.
Children May Have Rights, Too
If you have a group healthcare plan, a child of a divorced employee may have a right to coverage even if the child doesn't live with the employee or isn't a financial dependent of the employee. An employee's child will be covered if a domestic relations settlement agreement or a court order requires such healthcare coverage and contains specific information required by ERISA. If you receive a copy of such a settlement agreement or court order and are unsure about what to do, check with the plan administrator or an employee benefits lawyer.
3. Coverage Limitations
The Americans With Disabilities Act (ADA) is designed to eliminate workplace discrimination against people with disabilities. (See Chapter 9.) The ADA doesn't require you to offer healthcare benefits to employees, but it does require you to give people with disabilities the same healthcare benefits you offer to others. If your business is covered by the ADA, you may not deny insurance coverage or limit benefits based on a worker's disability.
Your plan will usually violate the ADA if it excludes specific disabilities, such as deafness, AIDS or schizophrenia. Similarly, it's generally illegal to exclude groups of disabilities for example, cancers, muscular dystrophy and kidney diseases or to exclude all conditions that substantially limit a major life activity.
Some insurance restrictions that may at first seem to discriminate against disabled workers are allowed under the ADA.
a. Physical condition restrictions
Healthcare plans often provide more liberal benefits for treating physical conditions than for treating mental and nervous conditions. Similarly, some plans provide fewer benefits for eyecare than for other physical conditions.
These broad distinctions are allowed by the ADA. They may have greater impact on some people with disabilities, but they're not intentionally discriminatory.
b. Preexisting conditions
It's generally permissible to offer a healthcare plan that doesn't cover preexisting conditions. However, your plan will violate the ADA if it excludes specific preexisting conditions such as blood disorders. In EEOC parlance, such exclusions are "disability based" and therefore not permissible.
c. Treatment restrictions
A plan that doesn't cover experimental drugs or treatment or that excludes elective surgery doesn't violate the ADA. Similarly, it's not a violation to put a monetary cap on certain types of treatment for example, to limit payments for X-rays or blood transfusions even though such a cap may adversely affect people with certain disabilities.
The U.S. Equal Employment Opportunities Commission (EEOC) the agency that enforces the ADA has issued guidelines to help employers determine if a healthcare plan meets the ADA requirements. To order the Interim Enforcement Guidance on the Application of the ADA to Disability Based Provisions of Employer Provided Health Insurance, call 800/669-3362.
4. Continuing Coverage for Former Employees
A federal law called the Consolidated Omnibus Budget Reconciliation Act or COBRA (29 U.S.C. 1162) applies to your business if you have 20 or more employees and you offer a group healthcare plan. If COBRA applies to your business, you must offer employees and former employees the option of continuing their healthcare coverage if their coverage is lost or reduced because:
¥ their employment has been terminated for any reason except gross misconduct
¥ their hours have been reduced, or
¥ they've become eligible for Medicare.
Members of the employee's family must also be given the opportunity to continue their coverage. The chart below depicts the circumstances qualifying events that trigger an employer's obligation to allow continuing healthcare coverage under a group plan. COBRA gives rights to different people, depending on the qualifying event. How long the benefits must be continued is determined by the qualifying event and whether the covered employee is disabled.
The employee must pay for continuing coverage under COBRA, including both your share and the employee's share. You can charge 102% of the premium cost using the extra 2% to cover administrative costs. The cost to the employee or the employee's family for continuing coverage must be similar to the cost of covering people still on your payroll.
COBRA covers HMO and PPO plans in addition to traditional group insurance plans. COBRA also covers all other types of medical benefits, including dental and vision care and plans under which an employer reimburses employees for medical expenses.
If your business is covered by COBRA and has a group healthcare plan, the plan administrator the person who handles the plan's paperwork must give employees and their spouses a written explanation of their
COBRA rights when they first become eligible to participate in the plan. A single notice can be sent to an employee and spouse if they live at the same address. Otherwise, the spouse is entitled to a separate notice.
Help Is Available
Small businesses usually find it convenient to let the insurance company serve as the plan administrator and coordinate COBRA notices. The insurance company can provide even more help and information, including a clear explanation of how the plan meets the requirements of COBRA and similar state laws. Any reputable company should be able to provide clear, concise explanatory materials that you can hand out to your employees and, if asked, may send representatives to conduct training seminars and answer employee questions.
When a qualifying event occurs that gives an employee or family member the right to continue coverage, you must notify the plan administrator within 30 days. The plan administrator then has 14 days to notify the beneficiaries of their rights under COBRA. These beneficiaries have 60 days following the notice to let you know if they want to continue their coverage. If so, the employee or eligible family member sends you the premium each month and you send it on to the insurance company. If the beneficiaries don't send the payment when due or within the grace period you can cut off coverage.
Several states also have laws giving former employees the right to continue group healthcare insurance coverage after leaving a job. These state laws generally require continuation of healthcare plans that provide benefits through an insurance company such as Blue Cross/Blue Shield. They don't, however, require continuation of a self-insured plan even one that's administered by a commercial insurance provider. Some of these laws cover smaller employers than COBRA does.
5. Reducing Costs
Small businesses often feel overwhelmed by the spiraling costs of providing healthcare benefits to employees. But there are some steps you can take that may hold down costs, mostly by eliminating unnecessary medical expenses.
Look for a healthcare plan that practices managed care requiring participants to get a second opinion before they have surgery or requiring pre-approval by the insurance company for expensive diagnostic procedures.
Requiring employees to pay a part of the monthly coverage fee as well as a portion of each medical bill may encourage employees to be judicious in seeking treatment.
Look into offering coverage through a Health Maintenance Organization (HMO) or Preferred Provider Organization (PPO) instead of traditional insurance or reimbursement coverage. But be sure to shop around to see if the overall cost of a PPO or HMO plan is really lower than traditional coverage.
Money put into preventive care is well spent. You can, for example, call in experts to teach employees the benefits of a healthy diet, exercise and preventive care. Beyond that, you can set a good example by making low-fat food available in your lunchroom and installing exercise equipment in an unused area of the workplace. Also consider paying for seminars to help employees quit smoking and encourage periodic physical checkups perhaps offering to pay part of the usual deductible payment.
B. Retirement Plans
Retirement plans provide income to older people when they're no longer part of the workforce. If the plans you offer meet certain IRS guidelines, your contribution to the benefits qualifies as a business expense and is deductible from your company's gross income.
1. Defined Benefit Plans
In a defined benefit plan, you promise to pay an employee a fixed amount of money, usually in monthly increments, after he or she retires. You may base the payments on a formula that combines the number of years the employee has worked and the amount of his or her earnings. You may also choose some other method of setting the timing and amount, such as a fixed monthly sum not tied to length of service or earnings.
To fund a defined benefit plan, you typically invest money in stocks, bonds and mutual funds that you expect will grow over the years. You must contribute enough to the plan to pay the promised benefit. Otherwise, you'll have to make up the difference if the plan's investments go bad.
2. Defined Contribution Plans
In a defined contribution plan, you set up an account for the employee and contribute to it. At retirement, the employee gets whatever is in the account. You don't promise that the employee will receive a specific amount of income after retirement.
You may structure the defined contribution plan as a money purchase pension plan, in which case you'll promise to contribute a specific amount per employee each year, such as five cents for each hour worked. Or you may structure it as a profit sharing plan in which you have the discretion to decide each year how much to contribute, with your contributions allocated to the employees' accounts in a specified way usually in proportion to their pay. In either case, the size of the pension checks an employee receives each month after retirement will vary according to the interest rate paid on the employee's pension account and other economic factors.
Keep It Simple
Retirement plans seem to thrive on paperwork and complexity not a pleasant prospect if you're running a small business. So take a close look at Simplified Employee Pensions (SEPs) which can eliminate much of the pain and drudgery. A SEP is basically an individual retirement account (IRA) that you fund for each employee. To keep it really simple, you can set up your SEP with a respected mutual fund group such as Fidelity or Vanguard.
Employees can choose the particular mutual funds they want in their accounts, using the dollars you contribute annually. Each year, you can contribute an amount equal to up to 15% of an employee's pay but you can't contribute more than $22,500 for any one employee.
3. 401(k) Plans
A 401(k) plan consists of a retirement account for each employee who participates. An employer can choose whether or not to make contributions, and how extensive those contributions will be. You might, for example, choose to contribute only if company profits reach a certain level or to match contributions of only the lower paid employees. You can contribute an amount equal to up to 15% of an employee's salary to an employee's 401(k) account, but your contribution can't exceed $22,500 a year.
But whether or not you contribute to the 401(k) plan, it still constitutes a valuable benefit to employees because it helps them save for retirement with tax-deferred dollars. If you set up an employee funded 401(k) plan, employees can defer the income tax on the money they stash away, which allows their investments to grow faster. A typical plan, administered by a major mutual fund company, calls for regular payroll deductions of from 1% to 15% of an employee's earnings, as specified by the employee. To comply with the tax laws in 1996, the employee's contribution can't exceed $9,500 a year. The limits are adjusted periodically for inflation. The employee gets to allocate his or her account among several different mutual funds and to change the mix from time to time. The funds on the menu run the gamut from conservative to aggressive, so the employee can choose the level of risk with which he or she feels most comfortable. Be aware, however, that it may cost you a few thousand dollars to set up a 401(k) plan for your business and there may be ongoing expenses for plan administration.
Special Protection for Older Employees
The federal Age Discrimination in Employment Act (29 U.S.C. ¤621) generally prohibits you from providing reduced benefits to older people in your retirement plan. But the Act does allow for some lesser coverage for
certain benefits, such as health and disability insurance, if you can show there's a rational cost reason for doing it.
4. Meeting IRS and ERISA Requirements
For your contributions to a retirement plan to be tax deductible as a business expense, you must meet the requirements of the Internal Revenue Code. You must comply with the Employee Retirement Income Security Act or ERISA (29 U.S.C. ¤1001 and following), which is intended to protect the rights of employees.
a. Tax law requirements
While you don't have to include all workers in your retirement plan, you can't structure the plan to benefit only the top executives or to otherwise discriminate against lower paid workers. A retirement plan that passes muster with the IRS is called a qualified plan meaning your contribution qualifies as a tax deductible business expense. Your contributions won't be taxed as income to employees until they actually receive the benefit. The IRS will review a proposed plan and let you know if it meets the tax law requirements.
For a helpful introduction to these requirements, see IRS Publication 535, Business Expenses, available at no charge from the nearest IRS office.
C. Other Employee Benefits
Here's a rundown of several other benefit programs that the IRS recognizes as tax-deductible business expenses.
1. Life Insurance
One of the least expensive benefits you can offer to employees is group term life insurance. This is life insurance that pays off only if the employee dies during the policy term usually 5, 10 or 20 years. You can deduct the premiums you pay for up to $50,000 of group term life insurance for each employee. And employees don't pay tax on the premiums you pay.
But to qualify for this tax treatment, the group insurance plan can't be discriminatory, meaning it can't be weighted in favor of highly paid employees.
Encourage Employees to Participate
Some employers pay for the first $10,000 or so of term life coverage, giving the employee the option of buying additional coverage under the same group plan. This allows employers to offer a growing benefit without having to put out a growing outlay of cash.
In selecting a group insurance policy, look for one that allows a terminated employee to switch to an individual policy without having to prove that he or she is still insurable. Of course, after such a conversion, a former employee becomes responsible for paying the premiums.
2. Disability Insurance
Consider offering disability insurance to help employees offset income lost if they suffer a serious injury or illness. You can probably find a group policy under which you pay part of the premium and the employee pays part. Some plans give employees the option of continuing their coverage after they leave your business. They then become responsible for the entire premium.
Your business can take a tax deduction for the premiums it pays, but if an employee receives payments under the insurance policy, the employee will owe income tax on those payments. If the employer and employee each pay part of the premium, the employee will owe income tax on part of the payments received.
3. Educational Assistance Programs
You may want to pay all or part of the cost of schooling that employees pursue outside working hours. You can set up a written plan with guidelines for the type of continuing education your business will finance, how much you're willing to spend and the point at which you'll reimburse an employee for tuition.
Under such a plan, you can deduct as a business expense up to $5,250 per year for the educational costs you pay for an employee and these costs are not included in the employee's taxable income.
A few restrictions apply.
¥ The education assistance program can't favor high paid employees or their spouses or dependents.
¥ No more than 5% of the program's payments during a year can be used to benefit a business's shareholders or owners or their spouses or dependents.
¥ You can't offer employees a choice between receiving the educational assistance or other payment that's includable in the employees' gross income.
¥ Assistance can't be used for courses involving sports, games or hobbies. This tax break ended on December 31, 1994, but Congress may continue it as it has in the past.
4. Dependent Care Assistance
The tax laws let your business deduct expenses you pay for assistance to employees who must care for their dependents a major concern today with more workers having to take care of young children, aging parents, or both. Your payments qualify for the tax deduction if they enable an employee to care for:
¥ a dependent age 12 or younger for whom the employee can claim a personal exemption
¥ a dependent who's physically or mentally incapable of taking care of himself or herself, or
¥ the employee's spouse if the spouse can't take care of himself or herself.
The amounts you deduct can be for bills you pay or money you reimburse to an employee for:
¥ at-home child care
¥ in-home care for elderly or disabled adults who live with the employee
¥ care at a licensed nursery school or kindergarten, or
¥ care at a dependent care center that provides day care for more than six people.
You can also provide dependent care assistance at your own on-site facility.
Dependent care payments up to $5,000 a year ($2,500 for a married employee filing a separate return) are tax-free to the employee; as noted, your business can deduct these payments as a business expense. For employees with lower household incomes, there's a dependent care tax credit that's more valuable to them than dependent care assistance provided by an employer even though the care the employer provides is not included in the employee's income for tax purposes. If you offer a dependent care plan, let employees know about tax credit alternatives so they can choose the best option.
Total Employee Benefit Rate 27.54%
Employee Annual Salary $25,000
Benefit Rate 27.54%
Cost of Benefits 6,885
Total (Salary & Benefits) $31,885
Budgeting Employer Taxes
social security = 6.2% of earnings
Medicare = 1.45% of earnings
FUTA (Federal unemployment) = 6.2% of earnings
Arizona State Withholding Tax = 0.023% of earnings
If your business or organization is set up as a sole proprietorship or general partnership you must also pay this tax.
15.3% of earnings up to 62,700
2.9% of earnings over
You must budget these taxes "as a line item" in your budget; plus the employee compensations costs which you will estimate as a percentage of your employee expenses.
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