You probably know that today is Leap Day and that 2016 is a leap year, which occurs every four years. According to 5th century Irish tradition, leap year is a good year for women to make marriage proposals to men. However, according to the ancient Greeks, it is unlucky for couples to marry during a leap year. And, while ancient Chinese tradition claims that leap year babies – “leaplings” – are unlucky and poorly behaved, other cultures believe exactly the opposite.
All kidding aside, did you know that a leap year can increase your payroll costs depending on the day of the week you designate as payday? Did you also know that costly extra pay periods caused by normal changes in the calendar can occur in any given year anyway?
If not, fortunately you still have time to decide how to handle these calendar-based extra paydays or pay periods so you do not end up surprised at the end of the year upon discovering you have blown your annual payroll budget. A little planning will go a long way to keeping your payroll costs in check while ensuring that you have paid your employees every penny they are due, despite any tricks the calendar may pull in a leap year or any other year.
Planning is Key
While a normal payroll year consists of 52 weeks plus one day, a leap year has 52 weeks plus two days. The extra day in a leap year may translate into an extra paycheck if it falls on an established payday.
Leap years aside, an employer with biweekly paydays will have an extra pay period about every 11 years, and an employer with weekly paydays will have an extra pay period every five or six years. Whether the extra pay period falls within the current year or in the next will depend on which day of the week is the designated payday.
Regardless of whether an extra pay period occurs due to a leap year or a calendar-based anomaly, an employer must decide how it will deal with the extra pay period. The decision should be made well in advance of the extra pay period too, because corporate budgeting and potentially increased tax liability are stake.
Choose Your Weapon
An employer has three methods from which to choose when deciding how to manage extra pay periods, each with different risks and rewards:
• Ignore the extra pay period and continue to pay on a biweekly, or weekly, basis (i.e., 27 or 53 pay periods, respectively);
• Divide employees’ annual salaries by 27 (or 53) weeks, instead of 26 (or 52) weeks as in a normal year; or
• Divide employees’ annual salaries by the appropriate calendar year divisor (26.0893 for biweekly pay periods, or, 52.1786 for weekly pay periods).
If you choose the first option, and ignore the extra pay period, you must reprogram your payroll system to accommodate the 27th (or 53rd) pay period and budget for the additional pay.
If you reduces exempt employees’ pay, make sure this does not violate an employment contract or leave employees with pay that is less than that required for exempt status under the Fair Labor Standards Act.
If you use the right calendar year divisor, you will not have to adjust your payroll system to account for the additional pay period, but your employees will not receive the same amount of annual pay as in the prior year.
Calculate Payroll Taxes
Because the IRS does not make adjustments to account for the taxes due for an extra pay period, you must make your own payroll program adjustments. You can either:
• Use a formula based on 26 biweekly pay periods, with the extra pay period added in, but risk underwithholding income taxes from employees’ pay; or
• Calculate biweekly paychecks based on 27 biweekly pay periods, making sure to readjust the formula to 26 biweekly pay periods for the next calendar year.
Account for Annual Benefit Elections and Accruals
Some popular employee benefits are capped at annual maximums. Similar to income tax withholding, the IRS does not adjust the annual caps to account for the 27th pay period in years where that occurs. In addition, an extra pay period will impact accruals for benefits you provide to employees, if they accrue on a pay-period basis (i.e., sick leave, vacation leave or personal time off).
Regardless of whether an employee is exempt or nonexempt, you can either:
• Divide the value of the annual benefits and accruals by 27 to keep the deductions constant for the year (and change the formula back the next year); or
• Stick with a schedule of 26 pay periods, but suppress the deductions for the extra check in your payroll system.
Most employers prefer to use the same method for employee benefit elections and accruals.
What do you think is the best strategy to manage extra pay periods? I’d love to hear from you! Please comment below.