Appendix F - Deferred Income Plans, 401(K)

 

Overview

When deferred income plans are included in a payroll system, it is necessary to establish codes differently from a system that does not. Income placed in a deferred income plan such as a 401(K) plan is not 100% taxable for Federal and state income tax purposes, but still must be taxed fully for FICA purposes.


Total Code Definition

For a deferred income plan to work properly, there must be at least two total codes established. (Refer to the Total Code maintenance task in the Operations section and Payroll Total Codes in Appendix C.) Total code 01, Gross Earnings, and total code 02, Taxable Earnings, must be established.


Pay Code Definition

In the Pay Code maintenance task, all pay codes are defined with two entries under the Total To and Operator fields.


       Total To        Operator

       01, Gross Earnings        +

       02, Taxable Earning        +


All pay codes must be assigned to both of these total codes. These entries direct all earnings to be accumulated in both the 01 and 02 total codes.


Deduction Code Definition

In the Deduction Code maintenance task, a code must be defined for the 401(K) deduction named 4K. When the basis for the 401(K) calculation is the employee’s gross earnings, the total code entry is 01, Gross Earnings.

During payroll calculation, the taxable earnings of each employee must be reduced by the result of the 401(K) calculation (i.e., the 401(K) amount). Therefore, in the Deduction Code Maintenance task, the Total To entry is specified as 02, Taxable Earnings, with a negative Operator entry of ’-’. This entry directs the Payroll Calculation task to subtract the resulting 401(K) amount from the 02, Taxable Earnings total.


Tax Code Definition

In the Tax Code maintenance task for Federal taxes, the total code must be specified as 02, Taxable Earnings, from which the 401(K) deduction is subtracted, so that Federal taxes are calculated on taxable earnings rather than gross earnings.

In the Tax Code maintenance task for FICA taxes, the total code must be specified as 01, Gross Earnings, so that FICA taxes are calculated on the employee’s gross earnings.

 

Any other tax code would be directed to either the 01, Gross Earnings total code or to the 02, Taxable Earnings total code, depending on which of these amounts is to be the basis for that particular tax. (Refer to the applicable Tax Guide to determine the applicable basis for each tax.)


Section 125-Cafeteria Plans

Employee payments to a “Cafeteria Plan” reduce the taxable basis of wages in a way that is similar to that of a 401(k) plan. Salary that is deducted for a cafeteria plan is not taxed for FICA, FUTA, federal withholding, or state withholding. Most, but not all, states also allow reduction of taxable basis for state unemployment calculation. Verify this allowance for your state, as well as the treatment of any local taxes.


NOTE: When an employee receives cash in lieu of cafeteria plan benefits, this money is fully taxable.


Total Code Definition

Use of a cafeteria plan requires that an additional total code be established.


01        Gross Earnings

02        Taxable Earnings less Section 125 Deduction


When a 401(k) plan is also in use, total code 03 will be required also. This is because you cannot reduce FICA basis by the 401(k) deduction amount, but you may reduce the FICA basis by the section 125 amount.


  1. Taxable Earnings less Section 125 Deduction less 401(k) Deduction

Pay Code Definition in the Pay Code maintenance task, define all pay codes with two entries under the Total To and Operator fields (or with three entries, When a 401(k) plan is also being used).


       Total To        Operator

       01, Gross Earnings        +

       02, Taxable Earning less Section 125        +

       03, Taxable Earning less Section 125 less 401(k)        +


All pay codes must be assigned to each of these codes, in order that all earnings be accumulated to each of them.


Deduction Code Definition

In the Deduction Code maintenance task, define a code for the cafeteria plan deduction. A suggested code identification is CP. When the basis for the cafeteria plan calculation is gross earnings, the total code entry will be 01, Gross Earnings.

During Payroll Calculation, the employee’s taxable earnings must be reduced by the cafeteria plan deduction. To tell the Payroll Calculation task where to accumulate the amounts for this deduction, the Total To field in the Deduction Code Maintenance task must be 02, Taxable Earnings less Section 125 Deduction, with a negative accumulator in the Operator field.

 

When a 401(k) plan is in place, another Total To entry must be made: 03, Taxable Earnings less Section 125 less 401(k), with a negative accumulator in the Operator field.


Tax Code Definition

In the Tax Code maintenance task, use total code 02, Taxable Earnings less Section 125 Deduction, for FICA, FUTA, federal withholding, and state withholding. The same is true for state unemployment, when applicable, and any other tax that allows the taxable basis to be reduced by a cafeteria plan. Use total code 03, Taxable Earnings less Section 125 less 401(k) for taxes such as federal and state withholding. This allows both 401(k) and cafeteria to be deducted.

 

For any tax for which the taxable basis may not be reduced by the cafeteria plan deduction, use total code 01, Gross Earnings.

 



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