Amid the complexities of each year-end (YE) cycle, effective use of analytics can achieve compliance and reduce corrections.
To learn more about using analytics to improve your payroll operations, consider attending one or all three of PayrollOrg’s Payroll Analytics Series (Foundations of Payroll Analytics, Intermediate Payroll Analytics, and Advanced Payroll Analytics).
Whether your payroll application has built-in analytical tools or your organization licenses a separate one, payroll professionals always have access to the analytical tools needed to ensure an effective YE. This article suggests practical ways to use the analytical functions in the widely-available product, Microsoft Excel.
Each quarter—and at the end of the year—identify employees with the following conditions to make your YE processes more efficient:
- Negative wages or taxes for the quarter or year
- State and/or local wages that differ from federal wages
- A residence address that differs from the state income tax withholding state
- A residence address that differs from the state unemployment insurance (UI) state
- Wages exempt from social security and Medicare taxes
Using analytics with every quarter’s reporting cycle will reduce your efforts required at YE.
Negative Wages or Taxes
Negative wages or taxes occur when a prior quarter’s payment is voided or adjusted in the current quarter, but the employee has no wages or taxes in the current quarter. Negative wages or taxes also occur when a prior year’s payment is voided or adjusted, and the employee has no wages or taxes in the year the payment is voided—then the employee may have negative wages or taxes for that year.
When an employee’s wages are less than zero (negative) for a quarter or year, the quarterly or annual reports to federal/state tax or unemployment agencies are likely to be either rejected or cause an out-of-balance situation, as the tax agency will make the negative amount positive.
Prior to finalizing quarter-end or YE reporting, a review of wages and taxes should be completed to ensure there are no negative amounts included in the report.
After downloading the quarterly or annual data, use Excel’s FILTER feature on the data for the quarter or year to produce employees with wages equal to or less than $0.00.
If employees are identified with wages of $0.00 or less, adjustments will be required to ensure that the quarter-end or YE reports are not $0.00 or less.
State/Local Wages Differing From Federal Wages
In most cases, state and local taxable wages should equal federal taxable wages. However, there are situations where the state/local taxable wages and federal wages on an annual wage and tax statement will differ. The following are some examples:
- New York: Requires federal and state wages reported on the annual wage and tax statement to be the same, even though the wages subject to New York state income tax withholding may be less than the federal wages if the employee has worked in multiple states
- Pennsylvania: Pretax contributions to qualified retirement plans reduce federal wages but do not reduce Pennsylvania wages
To ensure that state and local taxable wages are reported correctly on quarterly and annual wage and tax statements, you should conduct a regular review of employees whose state/local taxable wages differ from federal wages. If feasible, conduct this analysis with each pay process; fewer adjustments or corrections will be needed at the end of the quarter or at YE.
The data elements required for this review should include the following:
- Federal taxable wages
- State taxable wages for each state
- Local taxable wages for each locality
After downloading the quarterly or annual data, use Excel’s FILTER feature to allow the comparison of the data in the federal wages column and the state or local wages columns. After executing the FILTER feature, employees with differences will be displayed.
Next, review the documentation for the listed employees to determine whether the differences between federal and state wages are appropriate.
Residence Address That Differs From State Income Tax Withholding, UI State
Most payroll systems will retain the following data:
- The state and the amount of income tax withholding for each state
- The state to which wages are reported for unemployment tax purposes
- The state in which the employee resides
Consistency among these factors will be evident for most employees and will limit the employer’s risk in an audit by a state tax agency. Occasionally, there are the following situations where the employee:
- Has income tax withheld for one state
- Has wages reported to another state for unemployment taxation
- May be a resident in another state
For state income tax, the rule of thumb is that state and local withholding occurs in the state/locality where the employee works. However, there may be exceptions where the employee’s work state and residence state have a reciprocal agreement that allows withholding only in the employee’s residence state.
Finally, if the employee works in one state and has residence in another state that does not have a reciprocal agreement, and the employer has nexus (a business connection) in the employee’s residence state, the employee may have income tax withheld in both states. Unfortunately, state unemployment taxes and income taxes do not use the same rules and methodologies to determine which state’s rules apply when an employee works in multiple states and resides in another state.
There are four factors used to determine which state wages will be reported for UI purposes if the employee works in multiple states. In answering each of the following questions in order, the first question answered YES will be used to identify the employee’s state for UI purposes:
- Are services localized in one state?
- Does the employee have a base of operations in a state where services are performed?
- Does the employee work in a state where they receive directions or control?
- What is the employee’s state of residence?
More information on the four tests can be found in PayrollOrg’s The Payroll Source®, §7.2.
Even though these situations may not occur often, employee records must be reviewed when an employee’s state of residence differs from their state of income tax withholding or UI tax reporting. This ensures that withholding and reporting these taxes are correct.
After downloading the quarterly or annual data, use Excel’s IF formula to allow the comparison of the data in the resident state column and the state income and unemployment tax state columns. After executing the IF formula, employees with differences will be displayed.
Next, review the documentation for the listed employees to determine whether the differences between the residence state and the states for state income and unemployment tax are appropriate.
Wages Exempt From Social Security, Medicare Taxes
Under the Internal Revenue Code (IRC), certain types of compensation, benefits, and employment are exempt from social security and Medicare taxation. The following are examples of such exemptions:
- Workers’ compensation
- Sick/disability benefits that are paid more than six calendar months after the employee last worked
- Payments made under a §125 cafeteria plan
- Noncash payments to agricultural workers
- Wages paid to an employee’s beneficiary in the year after the employee’s death
- Value of meals and lodging provided by the employer
- Work done by a student enrolled and regularly attending classes at the educational institution where they are working
- Work performed by nonresident aliens under F-1 (students), J-1 (exchange visitors), M-1 (nonacademic or vocational students), or Q-1 (cultural exchange visitors) visas
A complete list of exemptions can be found in PayrollOrg’s The Payroll Source®, §§6.7-6 and 6.7-7.
A regular review should be conducted—ideally each pay period—of employees whose wages are not subject to social security or Medicare tax.
As the social security tax is limited to the social security wage base ($184,500 in 2026), and all wages are subject to the Medicare tax, it is preferable to review employees who have no wages subject to the Medicare tax each pay period. When employees with no Medicare wages are identified, drilling down into the employee’s earnings data will allow review of the earnings types to determine whether the wages are exempt.
In addition, for certain types of employment exempt from social security and Medicare taxes, most payroll systems will include a code that exempts the employee from these taxes.
After downloading the quarterly or annual data, using Excel’s ability to nest the IF and AND formulas allows identification of data that does not meet both components (Medicare wages equal to 0.00 and FICA exempt Yes). Most payroll systems will identify employees with wages exempt from social security and Medicare taxes using two fields (Medicare wages and FICA exempt).
After executing the IF/AND formula, employees with no Medicare wages and No in the FICA exempt field will be displayed. The next step is to review the documentation for the listed employees to determine if the documentation supports the exemption from social security and Medicare taxation.
By regularly completing these analytical steps, your quarter-end and YE processes will be streamlined.
Jim Medlock, CPP, serves as PayrollOrg’s President and works as a Payroll Compliance Educator with Medlock & Associates. A former Education Advisor for PayrollOrg, he continues to contribute to the organization as a PayrollOrg Ambassador and active volunteer across numerous committees and groups. He has also been featured on PayrollOrg’s “PayTalk” Podcast®.
Mark Thornton, CPA, CPP, is the Payroll Tax Supervisor at Southern Company. He volunteers on PayrollOrg’s Finance and Audit Committee and National Speakers Bureau. He was also a guest on PayrollOrg’s “PayTalk” Podcast® and received PayrollOrg’s Meritorious Service Award in 2022.
For more articles like this, read PAYTECH magazine (available in both printed and digital formats), free for PayrollOrg members.
Look to PAYTECH’s “Sheet Smarts” feature for more Excel tips!
Not a member of PayrollOrg®? Check out the many benefits you get when you join!
