The Year-End Payroll Process
The T4 is the centre of the payroll solar system, the sun around which all of the other reporting paperwork rotates. And as year-end approaches, you’ll need to ensure your T4 filings are accurate. Here’s how.
What the Law Requires
The CRA guide RC4120, “Employers’ Guide: Filing the T4 Slip and Summary” sets out the instructions to follow in completing the T4. CRA guides aren’t laws. But RC4120 is the next closest thing. According to sub-section 200(1) of the Income Tax Regulations, the instructions in the guide carry the force of law. So failing to follow those instructions can lead to penalties (under sub-section 239 of the Income Tax Act).
Technically, section 239 allows for penalizing a “person who has made. . . false or deceptive statements” in filing a return. The scary part of this requirement is that: (i) A payroll manager is considered a “person” under the law; and (ii) Simple errors in completing the T4 can be treated as false statements.
In other words, it’s not just those who deliberately cheat who can get into trouble for T4 inaccuracies. However, as a practical matter, it’s highly unlikely that CRA would actually go after a person for making false statements on a T4 without at least some evidence of fraudulent intent.
HOW TO COMPLY
STEP 1: GATHERING EMPLOYEE INFORMATION
There are several employee identification boxes on the T4 slip. Getting the information in these boxes right is just as important as providing accurate information in other parts of the T4.
The Social Insurance Number
The federal government uses the SIN to identify individual employees. Report the wrong SIN on a T4 and the employee may not be properly credited with CPP contributions. This can lead to a number of adverse consequences, including loss of CPP retirement benefits that the employee has legitimately accrued. A SIN faux-pas can also cause employees to receive benefits to which they’re not entitled and might ultimately have to repay.
How to Comply: It’s important to check the accuracy of SINs, especially when employees are first hired. Under both the Canada Pension Plan (section 98 ) and the Employment Insurance Act Regulations (section 89), employers must ask to physically see an employee’s SIN card. Keep a photocopy of each employee’s SIN card in the employee files to verify that you’ve complied with this obligation. Payroll can also rely on the photocopy to enter the employee’s SIN information into the payroll system. Getting a photocopy of the SIN card also reduces the risk of careless errors that can easily get made when payroll staff transcribes a particular employee’s SIN information manually.
You also need to verify the validityof the employee’s SIN. One way to do this is to use the formula provided by the CRA in guide T4127, “Payroll Deductions Formulas for Computer Programs.” When implementing a new payroll system, it’s a good idea to specifically check that this test works properly. Use a spreadsheet that implements the check-sum formula given in T4127. You should also make sure that your system doesn’t allow for the same SIN to be used for more than one employee.
What happens when it’s necessary to hire employees who don’t have a SIN card? Most payroll systems allow either for the SIN field to be left blank or entered with a dummy value, such as all zeros. The year-end process should include running a check of the payroll system for employees without a valid SIN. If you identify any such employees, ask them to produce a valid SIN card and put a copy of your request in the employee’s files. By showing that you made the request, such documentation may enable you to avoid penalties for failing to supply the SIN on the employee’s T4.
You must also report the employee’s name correctly on the T4. That’s not as simple as it sounds.
How to Comply: First, you must list the employee’s legal name as it appears on the SIN card. For example, if the SIN card lists the employee’s first name as “John,” don’t list “Jack” on the T4 even though that’s what everybody in the office calls him. Matching the name on the SIN with the name used for payroll also enables you to verify that new hires aren’t using someone else’s SIN.
The law requires employers to report employees’ addresses on the T4. Unfortunately, it doesn’t specifically require employees to provide this information to employers. And, unless payroll cheques or direct deposit statements are mailed on a regular basis, employees don’t have any real incentive to give employers their current addresses.
How to Comply: Getting an employee’s address will be easier if employees are provided with self-service access to update their own contact information.One way employers can validate an employee’s addresses is to match postal codes against Canada Post’s databases. Canada Post lists software vendors on the business section of its website (Search for “Address Validation and Correction Software”) that offer this service.
STEP 2: BALANCING PAYROLL & ACCOUNTING SYSTEM AMOUNTS
The next phase of T4 compliance is to balance year-end payroll amounts tovalues from 3 other parts of your payroll or accounting systems:
- Remittances recorded as received on CRA PD7A statements;
- Employee payments for the year; and
- YTDs in the General Ledger (GL) payroll expense accounts for the year.
The balancing process is where the real year-end effort is required. The remainder of this article will show you how to do it, step by step.
BALANCING PHASE 1: PREPARING YTDs
Before you begin the actual balancing, you must prepare the payroll YTDs you need. Unless you have a payroll system capable of providing the figures you need as a report, you’ll need to enter the following into a spreadsheet. Note: List the current totals from each payroll register, not separate amounts by employee:
- Source deductions—with separate columns for income tax, CPP, EI and employer or employee portions;
- The gross pay and taxable benefits that make up box 14 employment income;
- Net pay—if your payroll register doesn’t show this is as a single figure, use separate colums for gross pay and employee deductions; and
- Gross pay, employee benefits and employer portions that are payroll costs debited to GL expense accounts. Note that some benefits included in employee taxable income, such as automobile standby charges, aren’t direct employer costs and should be excluded for balancing purposes.
If your employees are paid through a payroll service bureau, particularly if the service bureau debits you once each period for a total of net pay, source deductions and their fees, you’ll need to enter all of the information listed above plus the fees you pay to the service bureau in each period.
Key Pointer: Enter the current totals from each pay period or payroll register, rather than just relying on the YTD totals on the last payroll register in the year. There are three reasons to do this:
- You’ll have the detail you need in case you have to trace down any discrepancies that you find in the balancing process.
- Some payroll registers don’t include YTD values on the payroll register for employees who don’t have current values in the register. The best way to test for this is to take two sequential payroll registers, where some employees in the first register don’t appear in the second register. For example, this would be the case for employees who terminate on the first register. If the YTDs on the first register, plus the current values on the second register don’t equal the YTDs on the second register, you can’t rely on the payroll register YTDs for balancing purposes at year-end.
- What you need are the actual values processed through payroll, before any year-end adjustments for taxable benefits. Employers commonly adjust final payroll register YTD values for taxable benefits at year-end. Any such adjustments should only be made after YTD register values have been balanced. Otherwise, such adjustments will just make the balancing process more complex.
Insider Says: We’ll refer to these payroll YTDs as “the YTD spreadsheet,” even though you may actually take them from the final payroll register or some other payroll report.
BALANCING PHASE 2: PD7A REMITTANCE STATEMENTS
Once the preparation is done, you can proceed to the actual balancing. The first step is to compare the YTD spreadsheet values to your CRA PD7A statements. This ensures that employees are properly credited on the T4 with the actual income tax, CPP and EI amounts deducted from their pay. Explanation: Each month, the CRA provides employers with a statement of remittances received. For all but Threshold 2 remitters, this is the PD7A, “Remittance Voucher—Statement of Account for Current Source Deductions.” As the name implies, the statement has two parts:
- A voucher for the next remittance; and
- A statement of the prior remittances credited to your account by the CRA.
For Threshold 2 remitters the equivalent form is the PD7A(TM), “Remittance Voucher [Accelerated Remitter]—Statement of Account for Current Source Deductions.”
Step One: Enter and total on another spreadsheet the remittances shown as received on each monthly PD7A or PD7A(TM) (for the sake of simplicity we’ll use “PD7A” to refer collectively to both). This should only be the remittances for current year income tax, CPP and EI. Don’t include amounts used to pay any interest or penalties assessed during the year by the CRA.
Step Two: Check these remittance amounts against the similar amounts in the YTD spreadsheet. What do you do if the YTD spreadsheet values don’t match the remittances from your PD7A statements? It depends on how your remittances are made:
If you make your own remittances, trace the remittance from each payroll register on the YTD spreadsheet (which is why you entered them separately by register) through your accounting system. If payments are made by cheque, the easiest thing to do is to access the accounts payable files where the vendor payment back-up is kept. If payments are made electronically, via online banking, your accounting system should be able to list the payments made to the CRA.
If your remittances are made by a service bureau, verify the payments to your service bureau for the current year’s remittances against the remittances received by the CRA and reported on the PD7A.
Step Three: If you or the service bureau uncover payments made and not shown as recieved on a PD7A statement, you must contact the CRA to clarify the missing payment(s). The CRA will normally want proof of payment, such as the front and back of any cleared cheques.
Step Four: If the payments made do balance to the payments recorded as received on the PD7A statements, the discrepancy lies in your accounting system, somewhere between producing payroll registers and the remittances made for them. The most obvious sources of these are employee payments that have been voided or cancelled. For example, an employee payment could have been voided before making the remittances for the period concerned. This would mean that the remittances shown on the register no longer balance to the remittances actually made to the CRA. If necessary, these will be shown as reconciling items between your payroll registers and the PD7A statements.
BALANCING PHASE 3: EMPLOYEE CHEQUES & DIRECT DEPOSITS
In the next phase of the balancing process, balance the net pay shown in your YTD spreadsheet to employee cheque and direct deposit payments. This ensures that amounts you report on T4s have actually been paid to employees. The method you use to do this balance will depend on how you process payroll:
If you process payroll in-house, balancing at year-end will be a much simpler task if you dedicate a separate GL balance sheet account, i.e., a permanent account not closed out at year-end the way income and expense accounts are, to payroll.
Example: Harbour Publishing does its payroll in-house and pays its employees by direct deposit. There are two payroll-related GL journal entries made each pay period. First, from the payroll register, total net pay is credited to a payroll-only suspense account in the GL. Second, when employee direct deposits are journalized, the GL cash account is credited and payroll suspense is debited. Harbour doesn’t use a separate bank account for payroll purposes. If an employee direct deposit is returned to Harbour’s bank account, the receipt is journalized in the GL by debiting cash and crediting the payroll suspense account.
If you use a payroll service bureau, you may find that a bank account dedicated to payroll makes your T4 balancing tasks easier. If your payroll service bureau debits your bank account directly for payroll, it might also be a prudent step to limit its access to a bank account dedicated to payroll.
Whichever of these models you use, balancing net pay to employee payments involves reconciling any such payroll bank or GL suspense accounts. Reconciling means fully explaining any discrepancy between two sets of figures or the make-up of an account balance. If you use a payroll suspense account in the GL, any balance in the account must be fully explained. For each bank account used for payroll purposes, any discrepancy between the bank statement and its corresponding GL account balance must be fully explained.
One common source of such discrepancies are employee payments that have been voided or cancelled. If an employee direct deposit has been returned to your bank account, and this hasn’t been journalized, the return will stand out as an entry on the related bank account reconciliation. Similarly, if you use a payroll suspense account in the GL and the return of an employee direct deposit has been journalized, the returned direct deposit will stand out in the suspense account, unless the payment has since been replaced or the corresponding payroll expenses reversed.
Having your payroll bank accounts or GL suspense accounts reconciled means that net pay has been balanced to employee payments or that any differences between the two have been fully identified. Payments to employees flow through such bank or suspense acounts. If anything remains, these accounts aren’t reconciled until all of the remaining amounts have been fully explained. You can’t fully explain any such remaining amounts without uncovering any differences between net pay on your YTD spreadsheet and the total of employee payments.
BALANCING PHASE 4: PAYROLL EXPENSE ACCOUNTS IN GL
The final step in year-end balancing is to check YTD spreadsheet values for employer payroll expenses against the matching expense account balances in the GL. The reason for doing this is the same as for balancing net pay against employee payments: to ensure that employment income is only reported on T4s if it has actually been paid to employees.
As previously mentioned, voided employee cheques or returned direct deposits are a frequent source of discrepancies between YTD spreadsheet net pay and actual employee payments made. When payroll cheques are voided by the employer or direct deposits are returned to the employer, if these have been replaced or the corresponding expenses reversed out of the GL, such payments won’t stand out in a reconcilition of the related bank or suspense accounts. Replacing or reversing the related expenses will clear any such entries out of these accounts.
However, if the related GL expenses are reversed, you must be sure that there’s been a corresponding reversal in the amounts that are T4 reportable. There are generally two ways to do this:
The first is by making an adjusting entry, typically via the time data entry process, reversing out the gross pay and related deductions. In this situation, normal payroll cycle processing will adjust the employee YTD balances. And this will also be reflected in your YTD spreadsheet used in balancing.
The second way to accomplish a reversal is to directly edit the payroll system’s YTD balances to reverse out the related gross pay and deductions. Some payroll systems permit this, but it’s generally not recommended because the direct manual overwriting of emloyee YTDs can lead to errors. Unlike entering a reversal through the data entry process, there’s usually no paper trail if YTD balances are directly manipulated. Also, directly changing employee YTD balances means that payroll registers no longer match YTD values stored in the payroll system.
For balancing purposes, you must identify all voided or returned payments, reversed in the GL, that have been reversed in payroll by directly editing employee YTDs. You also must uncover any errors that might have been made in such a direct editing of employee YTDs. The reason this is necessary is because your YTD spreadsheet was built from the current values shown on each payroll register. Most payroll systems prepare T4s by reporting on YTD values stored by employee. If these YTDs have been directly edited, they won’t match your YTD spreadsheet.
You can idenfity all voided or returned employee payments, reversed in the GL, by looking at the related GL payroll expense accounts. It should be fairly easy to identify reversals since these will be credits, whereas most payroll entries to such expense accounts are debits. Reversals will also be noticeably smaller amounts than other entries. They’ll also be easier to find if there’s a standard journal entry description for them, such as “Reverse cheque XXXX to employee XXXXX.”
When you have found these, the debit balance in these GL payroll expense accounts, plus the total of any expense reversals in the GL, should equal the employer expense balance in your YTD spreadsheet. If not, trace how the employer expense on each payroll register was journalized in the GL.
BALANCING PHASE 5: FINAL STEPS
After you complete each of the four phases described above, print your trial T4s and T4 Summary from your payroll system. These should balance to your YTD spreadsheet less any reversals directly made to YTDs in the payroll system. If they don’t, ensure that any directly edited reversals were done correctly in payroll. Add up the valid payments to each affected employee and make sure these total the YTDs stored in payroll.
After the trial T4s and your YTD spreadsheet balance, adjust individual employee T4s as follows:
- Add taxable benefits not processed during the year;
- Add or subtract any adjustments between taxable benefit provisions and YTD actuals;
- Subtract any voided or returned employee payments, which haven’t or aren’t going to be replaced, and which haven’t yet been reversed in payroll; and
- Add or subtract for any errors found in directly editing employee YTDs in payroll.
AT A GLANCE
The 5 Phases of the Payroll Balancing Process
PHASE 1: Enter the current totals from each register or pay period needed for balancing into a YTD spreadsheet.
PHASE 2: Balance PD7A Remittance statements:
l Step 1: Enter the remittances recorded as paid on CRA PD7A statements into another spreadsheet.
l Step 2: Compare the PD7A remittance totals to the remittances on your YTD spreadsheet.
l Step 3: If necessary, match your actual payments to the CRA to the remittances they show as received on the PD7A.
l Step 4: I f necessary, identify any voided or cancelled payments required to reconcile between the payroll registers and the remittances made.
PHASE 3: Reconcile all bank accounts or General Ledger suspense accounts used in payroll to identify any voided or cancelled employee payments that haven’t been replaced or reversed out of the GL.
PHASE 4: Balance the payroll expenses shown in the YTD spreadsheet to the year-end debit balances of the matching GL expense accounts. Identify any employee payments that have been reversed in payroll through directly editing employee YTDs. These will be reconciling items between your YTD spreadsheet and the debit balances of the GL payroll expense accounts.
PHASE 5: Print and balance your trial T4s to your YTD spreadsheet, taking into account any reconciling items found above. After balancing adjust employee T4 values for any:
l Taxable benefit adjustments required;
l Voided or cancelled payments not yet reversed out of payroll; and
l Any errors found in manually editing employee YTDs.