As an employer, understanding payroll taxes is crucial since you’re legally obligated to withhold the correct amounts and remit to the government. Non-compliance can lead to severe penalties, but Manay CPA is here to help! In this guide, we will explore each type of payroll tax, including their rates and how to calculate them.
What are payroll taxes?
Payroll taxes are taxes that employers withhold from employees’ paychecks and then pay directly to the government, and these taxes are used to finance various social insurance programs, such as Social Security and Medicare. Ideally, payroll taxes are paid by both the employee and employer, but it is the employer’s obligation to deduct and remit them to the government.
Payroll taxes include federal income taxes, FICA taxes, and FUTA taxes. We’ll discuss them in depth later in this guide.
Generally, payroll taxes normally fall into one of two main categories:
- Employee Withholdings: The taxes that employers deduct from employees’ wages before they receive their paychecks. These withholdings include income tax and contributions to Social Security.
- Employer Contributions: These are taxes that employers pay from their own funds, which are directly related to having employees. These include the employer’s share of Social Security contributions and federal unemployment tax.
What is the difference between payroll taxes and employment taxes?
The terms payroll taxes and employment taxes are often used interchangeably, but they do have distinct meanings.
Employment taxes encompass all the taxes that employers are required to pay regarding their employees, including federal income tax, Social Security and Medicare taxes (FICA), Federal Unemployment Tax Act (FUTA) taxes, and additional Medicare taxes for eligible employees.
On the other hand, payroll taxes typically refer to a subset of employment taxes – the taxes deducted from an employee’s paycheck and matched by their employer. Specifically, payroll taxes usually refer to Social Security and Medicare taxes.
The bottom line: all payroll taxes are part of employment taxes, but not all employment taxes are payroll taxes.
What is the difference between payroll taxes and employee income tax?
Although payroll taxes and employee income tax are related to an individual’s employment, they are not the same.
Payroll taxes are paid by both employers and employees – calculated as a percentage of the employee’s salary and matched by the employer. Generally, payroll taxes are made up of two main components – Social Security and Medicare taxes.
On the other hand, employee income tax is only paid by the employee. It is a progressive tax, meaning the tax rate increases as the taxable amount of an individual’s income increases. Based on the details in the employee’s W-4, employers withhold this tax from the employee’s paycheck and then remit it to the government.
Which payroll taxes do employers pay?
The payroll taxes employers are obligated to pay are:
- Social Security Tax: They must pay a flat rate of 6.2% of each employee’s wages, with a wage base limit of $168,600.
- Medicare Tax: They are required to pay a flat rate of 1.45% of all employee wages, with no wage base limit for Medicare tax.
- Federal Unemployment Tax (FUTA): Employers pay FUTA without any contribution from the employees. The FUTA tax rate is 6% on the first $7,000 paid to each employee.
- State Unemployment Tax (SUTA): This tax rate varies by state and is paid solely by the employer in most states.
What are Social Security taxes?
Contributed by both employers and employees, Social Security taxes are used to fund the Social Security program, providing benefits for retired workers, and disabled individuals, including their dependents.
The Social Security tax is shared equally by employers and employees – each contributing 6.2%. For self-employed individuals, the rate is 12.4% since they are considered both the employer and the employee. However, this is only applicable to 92.35% of their net business earnings.
What are Medicare taxes?
Medicare taxes, contributed by both employers and employees, are used to fund the Medicare program, providing health insurance for individuals aged 65 and older. It also caters to some younger individuals with certain disabilities.
Employers and employees each contribute 1.45% of the employee’s wages to Medicare taxes. Self-employed individuals contribute the full 2.9% Medicare tax as they are considered both the employer and the employee.
What is the Federal Unemployment Tax (FUTA)?
The Federal Unemployment Tax Act (FUTA) tax is a federal tax that employers pay to provide funds for paying unemployment compensation to workers who have lost their jobs. Note that FUTA is not deducted from an employee’s earnings – it’s solely the employer’s obligation.
What is State Unemployment Tax (SUTA)?
The State Unemployment Tax Act (SUTA) tax is a state tax that employers pay to fund unemployment benefits. When a worker loses their job and needs to collect unemployment, they receive payments from this fund. The specifics of SUTA vary from state to state – the rate at which SUTA tax is levied and the wage base.
The specifics of SUTA taxes can vary from state to state. For example, the rate at which SUTA tax is levied and the wage base upon which it is calculated can differ. Most states require employers to remit SUTA taxes quarterly.
What are employer payroll taxes in other countries?
Employer payroll taxes vary by country – they usually include contributions to Social Security programs, healthcare, and unemployment insurance. However, note that the rates and structures of these taxes vary. If you intend to open a business outside the United States, or if your business operates internationally, consult international tax professionals who will develop a personalized tax plan for you.
How do I calculate employer payroll taxes?
Calculating payroll taxes involves adding up all the constituent taxes that are a part of payroll taxes. Follow these steps:
- Establish the gross earnings: This is the employee’s income before any deductions – including regular hourly or salary wages, overtime, bonuses, commissions, and tips.
- Calculate Social Security tax: Multiply the gross earnings by the employer’s portion of the Social Security tax rate, 6.2%.
- Calculate Medicare tax: Multiply the employee’s gross wage by the employer’s portion of the Medicare tax rate, 1.45%.
- Calculate Federal Unemployment Tax (FUTA): Multiply the first $7,000 of each employee’s annual wages by the FUTA tax rate, 6%. In some cases, you may qualify for a credit of up to 5.4%, which can reduce the FUTA tax rate to as low as 0.6%.
- Calculate State Unemployment Tax (SUTA): The calculation for this tax varies by state. Generally, you’ll multiply a portion of the employee’s wages by the SUTA tax rate for your state.
- Total Employer Payroll Taxes: The sum of all the calculated taxes is the total amount of employer payroll taxes.
Note that this is a simplified overview of how to calculate payroll taxes. Always consult tax professionals to ensure accuracy and compliance with federal and local tax laws.
What are the penalties for not paying payroll taxes?
If you fail to fulfill your obligation regarding payroll taxes, the IRS will impose penalties. Below are the main penalties that can be imposed:
- Failure to deposit: If payroll taxes are not deposited on time, a penalty can be imposed, ranging from 2% to 15% of the unpaid tax, depending on the number of days the payment is late.
- Failure to file: If you don’t file payroll tax forms on time, a penalty can be imposed, usually 5% to 25% of the unpaid tax for each month or part of a month that a return is late.
- Trust fund recovery: If you withhold payroll taxes from employees but fail to remit them to the tax authorities, you may incur a penalty equal to 100% of the unpaid payroll taxes.
- Penalty for misclassification of employees: If you misclassify employees as independent contractors, penalties can include 1.5% of the wages, 40% of the FICA taxes not withheld from the employee, and 100% of the matching FICA taxes the employer should have paid.
How can I ensure I am compliant with payroll tax laws?
Here are some steps you can take to ensure you are compliant with payroll tax laws:
- Understand the laws: The first step to compliance is understanding your obligations as stipulated in payroll tax laws at both the state and federal levels.
- Keep accurate records: Always maintain accurate and updated records of all your employees’ income, deductions, and tax payments. These will come in handy for calculating payroll taxes accurately and providing documentation in case of an IRS audit.
- Use reliable payroll software: This will help automate the calculation, withholding, and payment of payroll taxes, reducing the instances of human error.
- Consult with a tax professional: If you are unsure of anything regarding payroll tax laws, consult a tax or legal professional to provide tailored solutions for your business. You can also hire a part-time CFO to handle your payroll taxes.
What are some tips for reducing my payroll tax liability?
Here are some strategies that may help you reduce payroll tax liability:
- Form an S Corporation: If your business qualifies, forming an S Corporation can help limit payroll tax obligations – only the salary paid to the employee-owner is subject to employment tax.
- Hire independent contractors: Unlike with employees, employers do not have to pay payroll taxes for independent contractors.
- Contribute to retirement accounts: Increasing your contributions to retirement accounts like 401(k) can reduce your taxable income.
- Use fringe benefits: Some fringe benefits like health benefits, educational assistance, etc. for employees are exempt from payroll taxes.
- Hire a payroll provider: Contracting services of a payroll provider can help ensure your business is compliant with all payroll tax laws and that you’re taking advantage of all eligible tax credits.
How can I automate my payroll tax process?
The two main components of payroll automation are:
- Find the appropriate automated payroll system that is suitable for your business.
- Integrate your business’ workflow with your automated payroll system to ensure your payroll process is streamlined and there’s no discrepancy in the data.
When are payroll taxes due?
These are the due dates for the various forms you’ll use to file payroll taxes:
- Form 940: Used to report the annual Federal Unemployment Tax Act (FUTA) tax, is due on January 31 of the year following the year being reported.
- Form 941: Used to report income taxes, Social Security tax, or Medicare tax withheld from the employee’s paychecks, and the employer’s portion of Social Security or Medicare tax, is due by the last day of the month that follows the end of the quarter. The due dates are:
- April 30 for the first quarter (January 1 to March 31)
- July 31 for the second quarter (April 1 to June 30)
- October 31 for the third quarter (July 1 to September 30)
- January 31 for the fourth quarter (October 1 to December 31)
- Form 944: For employers who owe $1,000 or less in payroll taxes for the year, and is due on January 31 of the year following the year being reported.
- Form W-3, which is a transmittal form sent to the Social Security Administration (SSA) along with Copy A of all the Forms W-2 issued for the year, is used to report total earnings, Social Security wages, Medicare wages, and withholding for all employees for the previous year. It’s due on January 31 of the year following the year being reported.
How can I file my payroll taxes electronically?
The IRS provides two options for employers who want to e-file their payroll tax forms – submit the forms yourself, or use the authorized IRS e-file provider locator service to find a tax professional who can submit the payroll tax forms on your behalf.
What are the benefits of using a payroll service provider?
Below are some key benefits of using a payroll service provider in your business:
- Saves time: A payroll service provider can automate these tasks, freeing you to focus on other aspects of your business.
- Specialized expertise: They specialize in the complexities of payroll regulations and tax laws, ensuring full compliance with payroll tax laws.
- Automation of your payroll taxes: Most payroll service providers offer integration with other systems, such as human resources, and other workflows, providing a comprehensive solution for managing your employees.
- Scalability: When your business grows, the complexity of your payroll does too. A payroll service provider can easily scale with your business as the number of your employees increases.
Conclusion
As an employer, understanding payroll tax obligations isn’t just about ensuring your business is compliant with the tax laws, it’s also about contributing to the future welfare of your employees. That’s why we’ve comprehensively discussed the different types of payroll taxes, their rates, and how to calculate them in this guide.
However, remember that payroll tax laws are complex and may change frequently. That’s why it’s advisable to always consult tax professionals when filing your payroll taxes. At Manay CPA, we’re committed to helping you through the complexities of payroll taxes. So, whether you’re just starting out or are a seasoned business owner, our team will guide you every step of the way.
