Employment Taxes 101: An Owner's Guide to Payroll Taxes
The Internal Revenue Service requires most businesses with employees to withhold and deposit federal payroll, social security, and Medicare taxes. Withholding, filing, and remitting payroll taxes can be complicated, but they are tasks that you as a business owner must get right. Failure to make proper tax withholdings or deposits can result in significant fines and penalties for a business.
To help you understand the basics, here are answers to some common questions regarding employment taxes:
What is included in mandatory federal payroll taxes?
While the withholding percentage may vary from employee to employee, all employees are subject to a minimum of federal payroll taxes. These taxes are specified in the Federal Insurance Contributions Act (FICA) and include federal income, Social Security, federal unemployment, and Medicare taxes. These tax-withholding rules apply regardless of whether employees are part-time, seasonal, or full time.
In addition to the minimum required federal payroll taxes, different states may require specific withholdings as well. Here are some additional details on federal and state payroll taxes:
- Federal income tax and state income tax (where applicable) are withheld by the employer from all employees' wages, based on the information provided by employees on their Form W-4.
- Social Security tax (FICA) is calculated on a percent tax for both Social Security and Medicare on all wages. Both of these taxes are split equally between employees and employers so that each pays 6.2 percent for Social Security and 1.45 percent for Medicare. Since 2013, employers have also had to withhold an additional 0.9 percent Medicare tax for annual wages paid to an employee in excess of $200,000 ($250,000 for employees who are married and file taxes jointly).
- Federal Unemployment Tax Act (FUTA) is collected to help fund the nation's unemployment insurance system.
- State unemployment tax rates vary by state. Except for a few states, state unemployment taxes are not deducted from employee wages. Consult your tax advisor on the specifics for your location.
What forms are required when calculating and submitting payroll taxes?
If your business has at least one employee, it is important to know which forms apply at various stages throughout the employee life cycle. Failure to submit the proper paperwork within the federal guidelines can result in significant fines for your business.
Before you can legally employ anyone in the U.S., you are required to register your company with the federal government and obtain an Employer Identification Number (EIN). This number is like a Social Security Number for your business and is used to help track all your employees' tax payments. Once that paperwork is complete, your business may also need the following forms:
- Form I-9 (Employment Eligibility Verification) must be filled out for every person hired – this form verifies the person is eligible to work in the United States.
- Form W-2 (Wage and Tax Statement) must be filled out annually for any employee who worked during the preceding tax year.
- Form W-4 (Employee's Withholding Allowance Certificate) is completed by the employee and provides the information needed to calculate how much federal income tax should be withheld from each paycheck.
- Form 941 is the federal tax return for employers that is filed quarterly with the IRS.
- Form 940 is the Federal Unemployment Tax Act (FUTA) return, which is filed annually with the IRS.
- Applicable state and local required tax forms.
How often do I have to file taxes?
Employee-paid and employer-paid taxes must be deposited by or on behalf of a business owner on a schedule determined by relevant federal, state, or local tax agencies. These deposits may be due daily, twice per week, monthly, or quarterly, depending on the tax liability sums involved.
While deposit schedules can vary based on the amount of payroll tax paid in previous periods, new employers are generally classified as a monthly depositor — especially if they are in their first year of business. For a discussion on the different deposit schedules, see IRS Publication 15 (also called Circular E).
Being a monthly depositor means that payroll taxes during any particular month are generally deposited by the 15th day of the following month. The deposit should consist of taxes withheld from the employees' pay, as well as the employer's share of certain payroll taxes. As the tax year draws to a close, the IRS alerts employers of the frequency of federal deposits for the year ahead.
How much should I withhold?
Before you can make a payroll tax deposit, you must first calculate the amount of payroll taxes to withhold from your employees' pay. To calculate your payroll tax withholding manually, you can use the withholding tables in Circular E to calculate the federal income tax to be withheld. Next, use IRS topic 751 to calculate the social security and Medicare taxes. The current rate for social security taxes is 6.2 percent for the employer and 6.2 percent for the employee, for a total of 12.4 percent of the employee's social security taxable wages. Medicare taxes are 1.45 percent for the employer and 1.45 percent for the employee, for a total of 2.9 percent of the employee's Medicare taxable wages, with an additional 0.9 percent liability for employees earning over $200,000 a year.
After you know how much should be withheld from your employees' paychecks, you can then calculate the amount you'll need to deposit. Simply add up all federal income, social security, and Medicare taxes withheld from all employees during the month. The resulting amount is the required tax deposit.
How do I handle independent contractors or self-employed individuals?
Self-employed individuals do not pay FICA taxes because their income is classified differently from that of an employee. Instead, the self-employment (SE) tax was created to enable self-employed individuals to build up Social Security and Medicare credits. The SE tax is a combination of the employer and employee share of FICA, applying to net earnings from self-employment tax. The Self Employed Individuals Tax Center is a comprehensive resource provided by the IRS.
When working with independent contractors, employers should not withhold any taxes from those workers' wages. Contractors pay their taxes directly to applicable federal, state, and local government agencies, and employers do not have to match any of their Social Security or Medicare taxes, as they do with employees. No unemployment tax is owed for these workers.
- Form W-9 provides an independent contractor's taxpayer identification number to companies that will pay them income during the tax year.
- Form 1099-MISC is completed by the company to state how much was paid over the course of the year. The contractor uses that income statement to determine how much in various taxes is owed to the federal government at tax time.
Once I've calculated my business employment taxes, how do I submit them?
After the deposit amount is computed, you will need to make the actual deposit. The IRS now requires employers to make their payroll tax deposits through EFTPS, or the Electronic Federal Tax Payment System. On the EFTPS website, register with your business and banking information. After you're registered, you'll be able to log in to the site and make your payroll deposits through electronic fund transfer.
When it comes to paying your employees, doing it yourself may seem like a savvy way to save on the expense of a payroll service, but the numbers may not always add up. Between the time required to process your payroll, the complexity of payroll tax laws, and the potential fines for tax errors, it's worth considering the benefits of outsourcing this vital task.