The Employer's Guide to Payroll Taxes
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Last Updated: 05/05/2023
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Withholding, filing, and remitting payroll taxes can be complicated tasks, but they are ones that you as a business owner must get right.
Let's review some payroll tax basics.
Employers are required to deposit employment taxes and report these taxes on a quarterly basis in most cases. Employment taxes include withholding from employees' paychecks to cover income taxes - federal, and where applicable, state and local - as well as the employees' share of Social Security and Medicare taxes (FICA). They also include the employers' share of FICA as well as federal and state unemployment taxes. The failure to properly withhold and deposit taxes may result in significant penalties for employers.
What Is Payroll Tax?
Payroll taxes are federal and state taxes related to an employee's taxable compensation. They include:
- Income tax withholding based on information provided by employees on Form W-4. This tax is paid exclusively by employees.
- FICA, Social Security and Medicare taxes, is paid equally by employers and employees. The Social Security portion is referred to as Old Age, Survivors, and Disability Insurance, or OASDI, and provides benefits to retirees, spouses, and former spouses, dependent children in some cases, and disabled individuals under retirement age. The Medicare portion allows those age 65 and older (and certain other individuals) to qualify for Part A Medicare coverage with no additional cost, plus coverage through Parts B, C, and D for an additional premium.
- FUTA, which is a federal unemployment tax, paid exclusively by employers.
- State unemployment tax paid by employers, although a few states require some employee contributions.
What Is the Purpose of Payroll Taxes?
Payroll taxes help the government pay for social programs like Social Security and Medicare, which assist the retired or disabled. FUTA, a federal tax, helps pay for those who have lost their jobs. The amount of money taken out of each paycheck depends on what the employee indicated on their W-4 form when they were hired. This form explains how much money should be withheld from each paycheck to cover federal income taxes.
How To Calculate Payroll Tax Withholdings
Calculating paycheck amounts for tax withholding involves looking at the employee's W-4 form and other information like salary and deductions. After considering these factors, the HR manager or owner can determine how much money should be taken from the paycheck for payroll taxes. For example, if an employee has an annual salary of $40,000 and indicated on their W-4 form that they are in the 10 percent tax bracket, then $400 would be taken from each paycheck for payroll taxes.
What Should Employers Know About Payroll Tax Responsibilities?
Employers have several mandatory tasks in handling payroll taxes:
- Calculate income tax withholding and other employment taxes.
- Deposit all payroll taxes according to a set deposit schedule (with an exception for a very small employer).
- File quarterly reporting about all employment taxes withheld, including income tax withholding and FICA (with an annual report for a small employer), and report annually to employees and the Social Security Administration about all employees' tax payments.
- Complete any additional required reporting, including state-level reporting and annual FUTA reporting.
Note: An employer may also be required to withhold other amounts from employees' paychecks, such as salary elective deferral amounts for employee contributions to 401(k) plans and flexible spending accounts or for garnishment to cover child support. These additional withholding amounts do not figure into payroll taxes; they are merely an additional employer responsibility.
Mandatory Employer Payroll Taxes List
Employers have responsibilities when it comes to payroll taxes, and the company may be penalized if these responsibilities are not done properly. There are a variety of payroll taxes, some paid by employers, some by employees, and some by both. But in all cases, it's up to employers to calculate, withhold, and deposit them.
When employers do not properly deduct payroll taxes from employee wages, they may face a variety of consequences. Depending on the extent of the violation, they may be subject to fines and penalties, including civil monetary penalties, criminal prosecution, and even jail time. Additionally, employers are legally liable for any unpaid taxes due. They may also have to pay interest on any unpaid taxes and the associated penalties if the errors are not corrected within a reasonable time frame.
Federal Income Tax
Income tax withholding from employees' paychecks is designed to cover what they will owe in federal income tax for the year. This includes amounts for employees' federal income taxes as well as Social Security and Medicare taxes. For certain employees, it also includes an additional Medicare tax (explained below under "Additional Medicare Tax").
While the phrases "income tax" and "payroll tax" are often used interchangeably, there is a distinct difference. Payroll taxes include amounts paid by both the employee and the employer to cover any federal taxes due, while income taxes specifically refer to the amount owed by the employee to cover their individual federal income taxes owed. Payroll taxes also include contributions to Social Security and Medicare for both the employee and employer, as well as federal unemployment tax (FUTA) and state unemployment tax.
In addition to federal income tax, payroll taxes may also include withholdings for any state income taxes due. All states - other than Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming which have no income tax, and New Hampshire and Tennessee which do not tax wages - require employers to withhold state income tax from employees' paychecks. Some cities, including New York City and Philadelphia, also have local income taxes, which can result in additional wage withholdings.
In a handful of locations, other payroll tax withholdings are required to cover:
- Short-term disability
- Paid family leave
- Unemployment benefits
Social Security Tax (FICA)
Social Security and Medicare taxes, which make up FICA, are imposed on both employers and employees to pay for Social Security benefits and Medicare benefits. Employees and employers each pay 6.2 percent of compensation up to an annual wage base limit ($160,200 in 2023) for the Social Security portion, plus 1.45 percent of all compensation for the Medicare portion.
Federal Unemployment Tax Act (FUTA)
The federal government doesn't pay unemployment benefits, but it does help states pay them to employees who've been involuntarily terminated from their jobs. To fund this assistance program, employers must contribute to FUTA, which is a tax created by the Federal Unemployment Tax Act. The tax applies only to the first $7,000 of wages of each employee. The basic FUTA rate is 6 percent, but employers can receive a credit for state unemployment tax of up to 5.4 percent, bringing the net federal rate down to 0.6 percent, or a maximum FUTA payment of $42 per employee.
However, the credit is reduced if a state borrows from the federal government to cover its unemployment benefits liability and hasn't repaid the funds. Such a state then becomes a "credit reduction state" and the credit reduction (listed on Schedule A of Form 940) means the employer pays more FUTA than usual.
State Unemployment Tax
States have to pay unemployment benefits to eligible workers who are involuntarily terminated (for any reason other than gross misconduct or furlough). To fund this liability, states impose unemployment tax on employers. The tax is calculated similarly to insurance in that the rate employers pay is based on their previous claims experience. The more claims made by former employees, the higher the tax rate on such employers. Each year, the state informs an employer of its tax rate, which can never be below a minimum amount.
Additional Medicare Tax
When an employee's compensation from an employer exceeds $200,000, the employer must withhold an additional amount for the additional Medicare tax. This tax is 0.9 percent of earned income over a threshold amount ($250,000 for joint filers, $125,000 for married persons filing separately, and $200,000 for all other filers). This tax is paid solely by the employee; the employer merely has the responsibility of calculating and withholding it. The $200,000 withholding threshold applies regardless of the employee's marital or tax filing status.
Understanding Payroll Tax Responsibilities
Employers' payroll tax responsibilities are extensive. They include figuring income tax withholding (federal and where applicable state and local), depositing payroll taxes, and filing various returns to report payroll activities.
How To Calculate Employer Payroll Taxes
Payroll taxes are figured according to an employee's reported deductions on Form W-4. This form tells the employer the employee's marital status and whether additional withholding should be made to cover certain personal taxes or whether an employee may be entitled to deductions that reduce his or her income taxes. If no W-4 is provided, then an employer withholds as if the employee were single with no other adjustments.
Employers relying on outside payroll service providers, like Paychex, can leave the calculations to the service provider. Some employers who do payroll in-house use software or rely on tables provided by the IRS in Circular E to calculate payroll taxes.
What Forms Are Required When Calculating and Submitting Payroll Taxes?
There are no special forms used to calculate payroll taxes, and no special forms are needed when depositing payroll taxes. However, there are required forms that report withholding activities to the appropriate federal, state, and local tax authorities.
Overview of Tax Returns and Deposits
Employers need to file employment-related tax returns and deposit employment taxes according to set deadlines. If they fail to do so, they may be subject to failure to file and failure to pay penalties. Additionally, "responsible persons" in the company who fail to deposit trust fund taxes—amounts withheld from employees' paychecks—may incur a 100 percent personal liability. This trust fund recovery penalty is triggered when a person with the authority to make payment decisions willfully fails to deposit the taxes. The possibility of these penalties means employers must get things right.
Employers must file a variety of tax returns related to employment taxes. On the federal level, they include:
- Form 940, an employer's annual FUTA tax return.
- Form 941, an employer's quarterly tax return reporting withholding and the employer's share of FICA.
- Form 943, the employer's annual return for agricultural employees.
- Form 944, used for small employers eligible to pay employment taxes annually rather than depositing them according to a schedule.
- Form 945, a federal income tax return used to report non-payroll payments, including pension distributions.
Employers must also report withholding to employees and the Social Security Administration annually. For this purpose, they must file:
- Form W-2 with employees.
- Form W-3 with the Social Security Administration. This is a transmittal form that summarizes all W-2s; copies of all W-2s are included with the W-3.
Employer Tax Deposits
All payroll taxes must be deposited with the government in a timely manner. The Internal Revenue Service (IRS) sets the tax deposit deadline for employers. These deadlines depend on the amount of the deposits:
- Semi-weekly schedules are for the largest employers.
- Monthly schedules are used by the majority of employers.
Some payments may be made with either Form 941 or Form 944, depending on certain criteria. Refer to pages 26 -27, Depositing Taxes in IRS Publication 15, for further details.
Filing Employer Tax Returns
Employers must file returns by set deadlines (explained below). Usually, employer tax returns are filed electronically through an authorized e-file Provider or software purchased specifically for this purpose.
How Often Do I Have To File Taxes?
Most employers' returns are filed annually. However, the employer's federal return (Form 941) is filed quarterly.
States have their own filing schedules for their returns. Check with your state tax/revenue/finance department.
How Much Should I Withhold?
It's up to the employer to calculate the correct amount of withholding based on an employee's submitted Form W-4. A revised Form W-4 went into effect in 2020, but existing employees are not required to submit new forms; employers can calculate withholding based on any previous versions on file. However, if an employee's tax status changes and they would like to adjust the amount of their claimed deductions (and associated tax withholdings), they must submit an updated Form W-4.
Upon hire, all employees are required to complete a Form W-4, Employee's Withholding Certificate to provide the employer with the information needed to properly compute withholding.
For new employees, employers must require them to complete Form I-9 to verify they are legally eligible to work in the U.S. It's also advisable for employers to have employees complete Form 8850, which is a form employers must submit to the state workforce agency to determine whether the new employee falls within a targeted group that entitles the employer to a work opportunity tax credit.
Once I've Calculated My Business Employment Taxes, How Do I Submit Them?
Payroll taxes must be deposited electronically through the Electronic Federal Tax Payment System, or EFTPS. Small employers, who are permitted to pay their employment tax when filing their annual employer tax return, can opt to use EFTPS.
For state employment taxes, check with your state to determine how to deposit employment taxes.
How Do I Handle Independent Contractors or Self-Employed Individuals?
Independent contractors and self-employed individuals are not employees. However, businesses should review the status of the worker to ensure that the individual is properly classified as an independent contractor. Businesses that engage them are not responsible for any employment taxes on payments made to them. These workers pay self-employment (SE) tax on their net earnings from self-employment (their profits from their business activities), which is essentially the employee and employer share of FICA. If a self-employed person also has wages from a job, the wages are coordinated with the SE tax so that the wage-base ceiling can be properly applied.
If total payments to an independent contractor in the year are $600 or more, the business must file an annual information return—Form 1099-NEC—to report the payments to the worker and to the IRS.
Staying Updated on Payroll Taxes Is Critical
Employer payroll responsibilities may often seem overwhelming. The rules keep changing, as evidenced by a Form W-4 update in 2020, a higher wage base limit for Social Security taxes, mandatory payments of certain benefits offset by employment taxes, and a deposit deferral option.
The consequences of improperly processing payroll taxes can be significant. To ensure that you do things correctly, consider outsourcing payroll to a payroll service provider.