Payroll basics: The bonus method
Hello, my name is Anne Mathew and I will be your presenter today. The purpose of this presentation is to help employers understand when and how to use the bonus method to calculate income tax from certain types of payments. In particular, we will look at vacation pay, overtime payments, lump sum payments and bonuses, and how to calculate and withhold income tax under these circumstances. We will also discuss how to register for your payroll account, and how to remit amounts to the CRA.
This is the third presentation in a series of four. The previous presentations will soon be available on CRA’s website.
In our last presentation – “How payroll works”, we introduced the payroll cycle. As you can see, the employer has to calculate the gross pay of an employee, and then figure out the amounts to withhold, which are - the Canada Pension Plan contributions, Employment Insurance premiums and income tax, so they can calculate the employee’s net pay.
Today, we will build on the last presentation by showing you different ways for calculating source deductions depending on the type of payment you make to your employees. We will briefly touch on the more common methods used when an employer pays salary or wages, vacation pay and overtime pay to an employee. We will talk about when and how to use either a lump sum withholding rate or the bonus method.
And we will also discuss how to remit your source deductions to the CRA, which means that you will need to register for a payroll account. We’ll show you how to do both of these things today. We will also briefly touch on penalties.
As an employer or payer, you are responsible for deducting income tax from the salary, wages or other income you pay to your employee.
There are a number of different methods for calculating the amount of income tax to deduct from your employee’s pay. The one that you use depends on the type and frequency of the payment, and the employee’s TD1 claim code.
In the last webinar we showed you how to calculate deductions using the Payroll Deductions Online Calculator (PDOC for short) and we talked about the payroll tables for withholding payroll deductions. We discussed when to use the regular method and manual method for income tax calculations.
Just to recap.
Pay period basis or regular method is used when you make regular payments to your employee such as salary, wages, commissions, overtime pay, taxable benefits and allowances, pension, etc.
The manual method is used when the employee’s personal tax credits on their TD1 are more than $29,424.01. As of this year, you can use PDOC to calculate how much income tax to deduct.
The bonus method and lump-sum rates seem to cause the most confusion. Today, let’s look at these a little closer.
In addition to the regular types of payments such as salary, wages, etc., employers may pay employees other types of payments.
What if, you pay your employee:
- a bonus,
- a retroactive pay, or
- other types of irregular payments.
If you would simply add the irregular payment to the employee’s salary, the employee would have too much tax taken from his or her paycheck. To understand which method to use, let’s talk about when and why we use the bonus method to calculate tax.
The bonus method of calculating income tax is used when the payment to your employee:
- is a bonus, a retroactive pay, or an “out of the ordinary” or an atypical payment; and
- if added to the employee’s regular pay, in a pay period, it would result in excess tax deductions at source.
Why do we use this bonus method?
We use this method to calculate the amount of income tax to deduct from “out of the ordinary payments” because this method will result in a tax deduction that better approximates the amount of tax the individual will owe on the employment income when filing his or her personal income tax return.
Therefore, using the bonus method, results in a fairer tax deduction because the payment is spread over the year and taxed accordingly.
Let’s look at a visual example of how to calculate the amount of tax to deduct from bonus.
Anyone using their own payroll program will not have to do this manual calculation but it is still nice to know how the tax is calculated.
Remember Mary from our previous webinar? We bring her back in this webinar and on the screen. As you know, she earns a gross pay of $500 at the end of each week. Remember that Mary is a 16 year-old and is exempt from making CPP contributions. In addition to her wages, Mary is eligible to receive a bonus of up to 10% of her gross pay. She exceeds your expectations and in October, you give her a bonus of $2,600.
Her province of employment is Ontario.
The claim code on her TD1 federal and provincial forms is "1".
We will show you how income tax is calculated on this ‘bonus’ that Mary received in addition to her weekly pay of $500.
This is for illustration purposes only.
We do not recommend this method because if we were to simply add the $2,600 to Mary’s $500 regular pay and calculate the income tax using the regular method on the total of $3,100, the amount of income tax deducted would be $1,036.73.
The net amount Mary would receive in this pay period would be $2,004.99.
To determine how much income tax to deduct from bonuses or retroactive pay increases, take the total remuneration for the year (including the bonus or increase) and subtract certain amounts such as:
- pension contributions;
- union dues;
- And other similar amounts.
For more information on amounts you should subtract, please go to the CRA website.
After subtracting the required amounts, if the total remuneration for the year, (including the bonuses or increase), is $5,000 or less, deduct 15% tax or 10% in Quebec from the bonus or retroactive pay increase.
If the above result is more than $5000 use the bonus method.
The steps that I’m about to review happen “behind the scenes” when you use your PDOC. For all of you visual people out there, I thought that it might be interesting to show you how the calculation actually works by manually going through an example.
This is a four step process when using the bonus method to calculate tax deductions.
In Step 1 the amount of Mary's bonus payment is divided by the number of pays she receives in the year, $2,600/52 gives you $50.
In Step 2, for calculation purposes only, add the $50 to Mary’s regular pay in the pay period to get her combined bonus and pay amount.
You will need to have this combined amount for the next step.
In step 3, we determine the federal tax to deduct.
Please remember, that this is a manual calculation.
Using Guide T4032 your Payroll Deductions Tables, find the federal tax that you deduct on $550 per week. It is $41.25.
Now, find the federal tax that you would deduct on $500 per week. It is $34.55.
Subtract one from the other.
The result is the federal tax you have to deduct on the additional $50 per week which is $6.70.
In Step 3, the provincial tax to deduct, do the same thing you did for the Federal income tax calculation in the previous slide, but use the provincial tables now.
Find the provincial tax that you deduct on $550 per week. It is $22.15.
Subtract the provincial tax that you deduct on $500 per week = $19.90.
The result is the provincial tax you have to deduct on the additional $50 per week which is $2.25.
This is the final step. Remember we pay haven’t actually deducted any income tax yet.
In this step we do the math to calculate the income tax to deduct on the $2,600 bonus payment.
We know from step 3 that the additional federal income tax is $6.70 and the additional provincial income tax is $2.25 per pay period.
Multiply these two amounts by the number of pay periods that you divided the bonus by in the first place. In this case it was 52 because Mary is paid weekly. The total of these two amounts is $465.40. This is the income tax that you would deduct from the bonus.
Please note that there is a slight discrepancy, $20 in this situation, if you were to use the PDOC. This is because the payroll tables use a range of earnings whereas the PDOC is able to calculate a more exact amount.
This is a good time to mention that, if the employer pays an additional bonus payment a second time, follow the same steps except that in Mary's case her base pay will now be $550. Having said this, if the employer pays more often, there may be a point in time where the employer would just add the bonus amount to the employee’s income in the pay period and deduct tax on both instead of using the bonus method.
This slide shows the difference in the amount of income tax deducted using the regular and bonus methods.
The regular method means that the employer adds the bonus to the employee's pay to calculate the income tax to deduct. Even though Mary in fact will receive $3,100 in the one pay period, if her employer were to simply add the $2,600 bonus to her weekly pay and enters this figure into PDOC, PDOC will assume that Mary makes $3,100 a week, every week and will calculate the tax deduction as $1,036.73.
However, using the bonus method that we just reviewed, the income tax deduction on the combined pay and bonus is only $519.68. As you can see, using the bonus method is better for Mary because that is an additional $517.05 in Mary’s net pay for this pay period.
The employee’s tax liability will be determined when they file their personal income tax return. If you used the regular method, the employee will have paid more income tax than they will owe on their employment earnings. They will receive a refund of the extra income tax. Now neither calculation is wrong, but why make the employee pay more income tax than they have to and then wait until they file their return next year to get a refund?
Now that we have discussed bonuses, let us talk about vacation pay.
There are some variables here.
Employers pay vacation pay to their employees, and the employees may take their holidays or, they can decide not to take their holidays and cash-in their vacation pay.
Bringing back Mary as an example…
Mary decides to take her holidays this month, and instead of her $500 regular pay, she just gets the same amount $500 in vacation pay.
Income tax calculations are no different on vacation pay than regular pay. Therefore, Mary’s regular salary continues, she is just on paid vacation for the week.
The deductions are exactly the same as it would be if she had worked the week.
Let’s assume that at the end of the year, Mary decides that she wants to cash out 12 days of accumulated vacation, which equals to $1,200. This is in addition to her regular pay of $500.
To calculate income tax on the vacation pay, the employer must use the ‘bonus method’.
We have already discussed how to use the bonus method.
Now this slide shows you the summary of Mary’s pay and deductions for this pay period.
It is very important that you enter the vacation pay of $1,200 in the bonus field of PDOC as you see on this slide, and not in the vacation field, as we are using the bonus method to calculate the paid vacation pay.
This will allow the PDOC to calculate Mary’s payroll deductions accurately, and this results in a fairer calculation of income tax deducted.
Now that the employer has calculated the amounts they must withhold from the employee’s pay, they can pay the employee the gross amount minus the amounts they withhold, which is the net pay.
This summarizes Mary’s regular pay, paid out vacation pay, the deductions and net pay.
Overtime Pay. This is yet another type of payment that an employer pays its employees.
Now, how income tax is calculated on overtime pay is based on the question:
Is overtime being paid in the same period in which it was worked?
If your answer is yes, then use the regular method.
If your answer is No, use the bonus method.
Now let’s look at overtime with Mary.
Mary works some overtime hours this week and makes $200 in overtime pay. How would we go about calculating income tax on that?
As you know, the first question that needs to be asked is: Are the amounts paid in the same period in which it was worked?
If that is the case, then the overtime pay is added to Mary’s regular pay and the deductions are calculated using the total of $500 + $200. Therefore, calculate the deductions on $700 using the regular pay period method that we have already discussed.
If you were to include the information in PDOC using the regular method of calculating deductions, this is what the results would look like.
This slide summarizes the gross pay, the deductions and net pay for Mary in this pay period.
Looking at Mary’s situation again, where Mary earns $200 in overtime pay, in addition to her regular pay of $500.
Revisit the question when overtime is paid…let us ask the question again.
Are the overtime amounts paid in the same period in which it was worked? We just saw how it is calculated when your answer to this question is ‘Yes”. We used the ‘regular’ method of calculating deductions.
What if your answer is “No” and the overtime payment is paid in a later pay period?
When the overtime is paid in a later pay period, you should treat the overtime pay as a bonus. Deductions are to be made using the bonus and retroactive pay increases method. That brings us back to the bonus method we already discussed. We know how to calculate income tax using the bonus method.
If you were to put Mary’s information in PDOC, this is what it would look like.
It is important to note that, in this situation, the overtime pay is calculated the same way as a bonus payment, therefore, when you include the information on PDOC, put the $200 overtime pay in the bonus box.
If we were to add the overtime pay in a period after in which Mary earns it, this is what Mary’s gross pay, deductions and net pay would look like.
Lump-sum payments are yet another type of payment that an employer may pay employees.
Retiring allowances or certain payments out of registered plans such as Registered Retirement Savings Plans, Registered Pension Plans, etc. would be considered lump-sum payments.
As an employer, you are more likely to pay retiring allowances.
Many payers think that anytime they make a one-time payment the taxes should be withheld using these lump sum rates. However, the lump sum tax rates apply to these very specific types of payments only.
Rates are dependent on the amount of the payment. Therefore, combine all lump-sum payments that have been or are expected to be paid in the calendar year when determining the composite rate to use.
- 10% on amounts up to and including $5,000;
- 20% on amounts over $5,000 up to and including $15,000; and
- 30% on amounts over $15,000
There are different rates if the payments are made in Quebec. For more information on Quebec rates, please visit our website.
These rates are just an estimate and the employees may still owe tax at the end of the year.
Now that we have an understanding of the different types of payments and how to withhold income tax on them, we will discuss how to remit your payroll deductions.
To remit your payroll deductions, you will have to register for an account with the CRA. So, in this section of our webinar, we will look into registration of a Business and Payroll account with the CRA and make your remittance or payment to the CRA.
You have to register for a payroll program account before the first remittance due date.
If you already have a business number (BN), you only have to add a payroll account.
If you do not have a BN, you have to register for a BN and a payroll account.
You can register an account with the CRA using 3 different options:
- Online at CRA’s website.
- By mailing or faxing your completed RC1 form, Request for a Business Number.
- And last but not least, you can phone at 1-800-959-5525.
You will have to have some personal and business information handy to complete the application process.
Now that you have registered for your payroll account let us talk more about how and when to remit.
Remember the payroll cycle from the previous webinar?
The employer calculates the employee’s gross pay and withholds the CPP, EI and income tax from the employees. It is very important to note that the amounts the employer withholds from their employees are funds held in trust for the Government of Canada.
The CRA does not specifically require the employer to keep the funds in a separate bank account, but they must be held separate and apart from the business operating funds.
The employer must also then contribute their portion of CPP contributions and EI premiums. Together, these will form the remittance amount that the employer must send to the CRA.
Remember to calculate the deductions, you can either use: PDOC, provincial or territorial tax tables, or manual calculation for CPP and EI.
The PDOC can help you figure out your share, as well. At the bottom of the results page, you have the option to print an employer remittance summary.
It is important to understand that it does not matter when the employee worked. What matters is when the employer paid the employee because that is the date that the employer withheld the source deductions.
Employers have to remit these amounts to the CRA on a regular basis. How often an employer remits their source deductions depends on when they pay their employees and how much they withhold.
If the due date is a Saturday, Sunday or a public holiday, your remittance is due the next business day.
There are different types of remitters that are determined by your average monthly withholding amount of two calendar years ago.
Most new employers are regular remitters. That means that they have to make their remittance to the CRA no later than the 15th of the month following the month in which they withheld the source deductions.
For example, for the month of September, if an employee is paid weekly on Fridays, the employer withholds the source deductions every Friday. As a regular remitter, the employer must add up all the amounts withheld during the month of September, plus add their portion of CPP and EI, and remit that amount to the CRA by October 15, 2015.
It’s very important to understand that the CRA must receive the remittance by October 15. It’s not good enough to mail a cheque by the 15th. If the CRA receives the remittance later than the 15th, the employer may have to pay a penalty and interest on the late payment.
Starting in 2016, certain new employers will be able to remit their payroll deductions on a quarterly basis. This would apply to new employers who have a monthly remittance of less than $1,000. They must maintain perfect compliance on their payroll and GST/HST account while they are a quarterly remitter.
Please keep in mind that this probably will not apply to you unless your first pay date is after December 31, 2015.
The CRA will let new employers know if they can remit quarterly when we send the employer their first remittance form. So, unless you are advised by the CRA that you qualify as a quarterly remitter, please continue to remit monthly.
The CRA will determine the eligibility when employers open their payroll account. You might be asking yourself, how will we do this when the account is brand new? Well, it will depend on the information you as the employer provide on your payroll account application form.
Due dates for these quarterly remitters is exactly the same as the due dates for the existing quarterly remitter category: on or before the 15th of April, July, October and January.
Payroll and GST accounts will be reviewed quarterly to ensure the new employer continues to be eligible. If, in the quarter, the employer’s monthly remittance is $1,000 or more, or, during the previous 12 months, the employer is no longer compliant with their Payroll or GST/HST obligations, they will revert to regular remitters and must send in their remittances on a monthly basis. The CRA will advise you, the employer of this by letter.
Some employers qualify to remit their payroll deductions every quarter, rather than every month. This is the case for existing employers whose average monthly withholding amount is less than $3,000 and who have at least one year of perfect compliance history.
If you were with us in our previous webinar, you will remember that John and Mary are the only employees of this particular employer. For this employer, the average monthly withholding amount is below $3,000. After one full year of withholding, remitting, and filing correctly and on time, this employer would be eligible to become a quarterly remitter.
To recap, the due dates for all quarterly remittances to the CRA are the 15th of April, July, October, and January.
Talking about remitter types, some employers have to remit their payroll deductions more frequently. They fall under the ‘accelerated’ remitter category and their due dates can be sooner after the end of their pay period. However, most new employers will not be affected by the accelerated frequency, so we will not be discussing those obligations in this webinar. If you want more information about accelerated remitters, you can find it on the CRA website.
So, now that we know when to remit, the next question is how to remit?
Sending in your remittance if you already have a remittance form is easy.
However, some of you may not yet have a payroll account or a remittance form.
This slide shows you how to make your remittance if you don’t have an account or you don’t have a remittance form.
Send a cheque or money order to any tax centre. Make the cheque or money order payable to the Receiver General. Make sure you print your payroll program account on the front.
Include a letter stating:
- that you are a new remitter;
- the period the remittance covers;
- your complete business name, address, and telephone number; and
- your payroll program account number.
We will send you a remittance form in the mail after you register and after each remittance. If you do not receive a form in time for your next remittance, or you lost or misplaced your remittance form, send in your remittance as described in this slide. In your letter, be sure to tell us that you did not receive your remittance form, if that is the case.
Now that you have your remittance ready and if you are wondering how to make that remittance to the CRA, there are several methods.
You can use online payment methods such as:
- Online banking
- Debit card
- Credit card
- Pre-authorized debit
- Or third-party service provider
There are also other payment methods such as:
- At a financial institution
- Wire transfers
- Or by mail
Something to think about here is that, making your remittances has never been easier. Consider paying online. You can make your payment anytime, from anywhere.
We discussed payroll remittances and methods, and how making a payment online is convenient. Now we can talk about how securely accessing your account anytime, anywhere using My Business Account or (My BA for short).
My BA - What is it? And how can this be useful to all of you, business owners?
My BA is a secure online portal that provides an opportunity to interact electronically with the CRA on various business accounts. Business accounts include GST/HST, payroll, corporation income taxes, excise taxes, excise duties, and more.
My BA is convenient, and is available to you 21 hours a day, 7 days a week. It is easy to use. So after registering, simply log in with your CRA user ID and password. And it is fast. You have up-to-the-minute information and transactions processed immediately. It can be used for a variety of services like the ones listed on this slide.
To register or to read more about what you can do on My BA go to the CRA website.
What happens when the CRA receives your remittance after the due date?
If you do not remit on time, depending on how late your remittance is, you may be charged a penalty of 3, 5, 7, or 10% of the amount of the remittance.
If you are assessed one of these penalties more than once in a calendar year, the second or subsequent failures, may result in a penalty of 20% of the amount you should have withheld or paid.
This might seem severe but these are trust funds that you deducted from your employees and we have to make sure you remit them on time.
As you already know, if your remittance is due on a Saturday, a Sunday, or a public holiday, your remittance is due on the next business day.
On the screen, are the references that you will find useful and where you will find more information on what we talked about today.
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