Among the diverse and complicated responsibilities an employer holds, handling the payroll and the associated taxes tops the list!
Whether it is ten employees or a thousand, if you are into running a business, there is a high probability that you have buried your head inside the nuances of payroll taxes. 'What goes where' and 'who pays what' are some of the basic queries; trust me, there is a lot more going on inside.
This blog can help you get a better understanding of payroll taxes.
What is Payroll Tax?
Payroll tax is the percentage tax the employer deducts from an employee's salary to pay to the government. These belong to the class of employment tax.
Among these are taxes paid by the employer, employee, and both. Payroll tax is contributed towards both federal and state funds.
What is the difference between payroll tax and income tax?
Employer payroll taxes have flat rates. They help fund specific public programs like Medicare, social security, etc. On the other hand, income taxes are imposed on the total income.
Income taxes have progressive rates that vary with the income and serve the purpose of funding different government initiatives.
Employment payroll taxes are sent directly to the funding program for which they are intended. Alternatively, income taxes are first sent to the US Treasury Department, unlike employer payroll taxes, where they may be used for funding.
Who Really Pays Payroll Taxes?
It is a well-kept secret. The burden of payroll taxes is always on the employee!
Even the part employers consider to be their contribution, in reality, comes from the employee's gross salary.
Wondering how? Well, that's the magic of lowering wages. The employers calculate the salary and offer less than the actual wage for the employees, thus saving the employer's tax amount from their employees' compensation.
Thus technically, the burden of payroll taxes comes on the employees, irrespective of by whom it is paid.
Payroll Tax Rates
Whosever pocket the money comes from, the responsibility of deducting and paying the right amount of employment tax is on the employer. It includes figuring out what percent of tax goes from the employee, what percentage you have to pay as an employer, and which categories need payment from both.
Speaking of the payroll tax rates included in the payroll, let's take a look at the major ones:
FICA or Federal Insurance Contributions Act tax is the significant payroll tax deduction, which covers social security and medicare tax and uses them for various schemes.
- Social security - covers schemes for retirement benefits, dependents of retired workers, the disabled, and their dependents.
- Medicare - provides medical benefits for people aged 65 and above, the disabled, and people with health conditions qualified under the plan.
The social security tax is at a flat rate of 12.4%. This rate is applied to the first $147,000 earned by an employee in 2022 and is split equally between the employer and employee. Thus each will have to pay 6.2% each. Please note that the social security wage base changes every year.
Medicare tax is at 2.9% and is equally divided between the employee and employer (at a rate of 1.45% each). Unlike the social security tax, this one does not depend on any wage base. In addition to the prescribed rate, those employees with a salary above $200,000 have to pay an additional 0.9% towards Medicare, thus making a total contribution of 2.35%.
Federal and state income tax
The employees pay the income tax based on their total wage earned over a determined period. The federal income tax is paid using the W-4 form, while the state and local income taxes are paid according to their respective regulations.
FUTA tax and SUTA tax
Federal unemployment tax Act or the FUTA is the federal tax paid by the employer to provide unemployment benefits to the employees in case they are out of work. The federal unemployment tax ranges from 0.6 to 6%, depending on how much the employer pays for the state unemployment tax.
Similarly, SUTA is the State Unemployment Tax Act that the employer is required to pay towards the state fund. Each state has its own threshold and is subject to change every year. Usually, the employer pays for SUTA, while in some states, such as Alaska, New Jersey, and Pennsylvania, the employees have to pay a share.
Employer Payroll Tax Requirements
Since we have an idea about the various employer payroll taxes, now the question is how it is done and what requirements are needed to pay these taxes. What are the forms one needs to pay attention to? Take a look:
- Form 940: Used to report employer's annual federal unemployment tax
- Form 941: Used to report employer side quarterly tax return and their FICA payment
- Form 944: Used to report employment taxes annually instead of paying quarterly
- Form W-2: Used by employees to report the income earned, taxes withheld from the paycheck, benefits obtained, and other information
- Form W-3: Used by employers to report the wages and tax withheld from employees to the social security administration.
- Form W-4: Filled by the employee for the employer to withhold the correct federal income tax from the salary
Preparing for employer payroll taxes when hiring employees
As soon as a company hires a new employee, the person will be asked to fill out the W-4 form. This is done so the employer can withhold the right federal income tax from their salary. Similarly, the employees need to fill out another form to withhold the state income tax, depending on the regulations followed by the state.
By ensuring the necessary forms are filled out, the employer can ease the process of filing the right amount of income tax for their respective employees.
Payroll taxes for Independent contractors or freelancers
Even though independent contractors and freelancers work for their clients, they are not considered employees. So they do not receive a salary and are responsible for remitting the payroll taxes themselves.
The clients must make the independent contractors and freelancers fill the Form W-9. The labor taxes for these categories have to be filed by using Form - 1099. It acts as a record of income for self-employed people.
Employer Payroll Tax Responsibilities
An employer's responsibility goes beyond just issuing paychecks. As an employer, you are responsible for paying the employer share of payroll taxes, withheld taxes from employee earnings, and the payroll taxes levied on employers exclusively.
However, it's not the same if you employ contractors. Generally, you are not required to withhold or pay any payroll tax on payments made to independent contractors. Learn more about payroll tax employee vs. contractor before getting involved in payroll tax activities.
Here's a list of your employer's payroll tax responsibilities that you need to fulfill.
Paying the employer portion of payroll tax
Employer share of payroll or employer payroll taxes has to be paid by you, the employer, at regular intervals.
For example, your part of the amount contributed to FICA (Social Security and Medicare Taxes), exclusive contribution to Federal Unemployment Tax Act and State Unemployment Tax Act, and the taxes imposed on employers.
Withholding and filing of payroll tax returns
Before filing the payroll tax returns, employers must withhold taxes from employees periodically like federal taxes, state and local income tax, FICA, etc. You are required to withhold the income tax using the W-4 form. The FICA taxes, however, are deducted as a percentage from the gross pay.
After withholding comes filing, employers are required by the law to file payroll tax returns, withheld from employee earnings periodically, with various local and state agencies. Failing to do so might result in a 100% penalty.
Set aside funds
As an employer, you are responsible for setting aside funds for payroll taxes. It includes the employer and employee portion of the Social Security and Medicare taxes. These funds are known as trust fund taxes, meaning they are held in trust until they are paid to the designated agencies.
Depositing withheld taxes from employee's compensation
While as an employer, you are required to pay the employer payroll taxes, you also need to deposit the withheld portions of employee earnings.
For example, FICA tax (Social Security and Medicare Taxes) needs to be paid by employers and employees in equal proportions. Also, income taxes that employers withhold from employee salaries must be deposited.
Reporting employer payroll taxes
Employers must report the taxes owed to the appropriate agency and employees as the law requires. The reports may include Form 940 – Unemployment Tax Report and Form 941 – Employer's Quarterly Wage and Tax Report. Certain other reports are required to be submitted by employers to federal, local, and state agencies.
For example, employers must report all new employees' employment status.
Preparation of reconciliation reports
Employers are also responsible for preparing financial reports, income statements, and balance sheets. So, as you make the expenses related to payroll taxes like salaries/ wage expenses, deductions, etc., you need to record them accurately and report these costs when preparing your business's financial statements.
Preparation of financial reports accounting for payroll tax-related expenses
Employers are also responsible for preparing the financial reports, that is, the income statement and the balance sheet. So, as you make the expenses related to payroll taxes like salaries/ wage expenses, deductions, etc., you need to record them accurately and report these costs when preparing your business's financial statements.
How can employers avoid payroll tax penalties?
Running a business may sometimes be overwhelming for employers as they need to look after the company's management. On top of that, the payroll tax is a heap of work.
While you withhold an employee's share of payroll taxes and pay your portion of the taxes, there's one more thing that employers should be alert of – payroll tax compliance.
Employers withhold the deducted portions of employee compensation and are responsible for depositing the taxes on time.
For example, FICA taxes (Social Security and Medicare) are withheld from employee salaries by the employer until remittance. This indicates that if an employer violates payroll tax compliance, the business may be liable to pay a trust fund recovery penalty.
So, as an employer, you must remember to collect, pay, and account for the payroll taxes amidst all responsibilities. This will save you huge penalties.
Here are a few tips to help you avoid payroll tax penalties:
Tip 1: Keep yourself updated with changes in tax laws
The flat rates of employer payroll taxes and the wage base limits are subject to change by local, state, and federal governments. Hence, keep updating your payroll tax knowledge.
Tip 2: Maintain a correct employee classification
Keep your employee classification accurate. Inserting employees in the list of independent contractors to avoid paying FUTA and FICA taxes is illegal.
Tip 3: Remember to withhold and pay taxes on time
Paying a trade creditor using payroll funds instead of the IRS is considered a willful disregard. Consequently, you might have to pay a trust fund recovery penalty or TFRP. However, if you are forgetful, set reminders to pay taxes on time.
Tip 4: Partnering up with a qualified payroll service provider might help
If you partner with a payroll service provider, handling payroll taxes might get easier. You can automate the FICA calculations, payments, and deductions using payroll software, thereby maintaining accuracy.
Tip 5: Use proper forms while filing tax report
Ensure that you are using the correct forms when filing tax reports. In case of uncertainty, check the list of forms and their usage. Making a mistake or using the wrong forms might result in filing amended returns.
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