An Employer's Guide to Payroll Taxes
Once a business grows large enough to hire employees, it must start withholding and remitting payroll taxes. These include federal, state and local income taxes, Social Security and Medicare taxes, and unemployment taxes.
How do employers manage these payroll taxes? Which must be paid by employers and which must employers pay? And what if an employer takes on independent contractors or freelancers?
While you should consult a professional tax advisor on payroll and tax-related matters, here are some basic concepts you should know:
All employers must have an Employer Identification Number (EIN), which can be applied for online. This number is used by the government to help track an employer's tax payments. For every person hired, the employee must fill out a Form I-9, which verifies the person is eligible to work in the United States. An employer must also collect every employee's Social Security number to enter on that employee's annual Form W-2 wage and tax statement and obtain a signed Form W-4 that provides the information needed to calculate how much federal income tax should be withheld from each paycheck. Certain forms need to go to the Internal Revenue Service and the Social Security Administration, such as the quarterly federal tax return for employers (Form 941) or the annual Federal Unemployment (FUTA) Tax Return (Form 940).
Employers generally have to withhold federal and state income tax from all employees' wages, based on what employees enter on their Form W-4. Income taxes are paid solely by the employees through these withholdings. Currently, the federal government levies a 12.4 percent tax for Social Security on up to $118,500 (increasing to $127,200 for 2017) of an employee's pay and a 2.9 percent tax for 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). However, there is no employer match required for the additional Medicare tax.
Beyond these taxes, employers are also solely responsible for paying the federal unemployment tax (FUTA) to help fund the nation's unemployment insurance system. There is also the state unemployment tax that subject employers must pay. With the exception of a few states, state unemployment taxes are not deducted from an employees' wages.
Generally, employees — regardless of whether they are part-time, seasonal or full time — are subject to the same tax withholding rules, according to the IRS.
When working with independent contractors, employers should not withhold any taxes from those workers' wages. Contractors pay their taxes directly to the federal government 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 those workers.
In fact, companies can get in trouble if they treat their contractors as actual employees and withhold taxes.
If a contractor is paid more than $600 in a year, he or she simply needs to provide a Form W-9. The employer then provides that contractor with a Form 1099-MISC that states 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.
It's important to know the rules around collecting and paying payroll taxes before you start hiring employees, as any errors will likely have to be reported to the IRS and can be timely and costly to fix. If you have any questions, be sure to consult with a payroll or tax professional.