What Are Payroll Taxes?
To put it simply, payroll taxes are tax payments paid based upon employee pay. These taxes are either taken out of an employee’s salary by an employee and remitted directly to the government by business owners or paid directly from a business. These taxes fund a number of government programs including Medicare, social security, and unemployment programs.
An important thing to remember is that as a business owner, you are only responsible for the payroll taxes of your direct employees (and yourself). Independent contractors and freelancers that you may hire are responsible for their own payroll taxes.
There’s a lot that goes into IRS Publication 15, the employer’s tax guide. One of the most important things in that document are details about payroll taxes. The Internal Revenue Service (IRS) collects about 70% of total tax revenues from payroll taxes, and thus the enforcement concerning these types of taxes is serious. Despite this, small business owners often leave this tax burden for last when dealing with their accounting. Additionally, taxes can be exceptionally confusing to the untrained or inexperienced eye.
What even are payroll taxes? What is “tax withholding”? To whom do I pay these taxes and how do I do it? The questions are numerous and their answers can get quite confusing as you navigate the legalese of federal, state, and local tax law.
We’ve compiled a guide to payroll taxes including what they are, what paperwork to know about, your responsibilities as a business owner, and some of the best apps and services that you can use to manage these taxes simply and easily.
What Are The Types of Payroll Taxes?
Payroll taxes fall under three buckets: federal taxes, state taxes, and local taxes. Each level of taxation is a bit different and the tax revenues are processed and used in different ways. Below, we’ve outlined the taxes you’ll pay to each level of government and where those taxes go.
Federal payroll taxes are paid to the US government. You will pay and report these taxes to the IRS. There are three types of federal payroll taxes to be aware of including federal income tax withholding, FICA taxes, and unemployment taxes.
Federal Income Tax
These taxes are a type of withholding tax, meaning that you take the amount of the tax out of your employee’s paycheck. The amount that you pay will be a percentage of each employee’s pay, and you transfer that amount to the IRS after withholding.
The amount that you withhold is different from employee to employee and is based on two things:
- The amount of their wage
- An employee’s withholding preferences as stated on their form W-4, filled out by all new employees. This form tells you how much to withhold from an employee’s wages based upon their personal and financial situation and their preferences
Federal Insurance Contributions Act (FICA) Tax
FICA taxes are the portion of payroll taxes that you pay towards Medicare and Social security. It’s called a “shared tax”, meaning that you and your employee will each be responsible for half of its amount.
As of 2020, the Medicare tax rate is 1.45% and the Social Security tax rate is 6.2% of an employee’s taxable wages. This adds up to a total FICA tax rate of 7.65%. There are a few things to keep in mind:
- For wages above $200,000 the Medicare tax rate increases by 0.9%, for a total of 2.35%, and the extra tax is only paid by the employee
- The maximum Social Security tax employees and employers will each pay in 2020 is $8,537.40, and you only pay Social Security taxes on the first $137,700 of an employee’s wage
Federal Unemployment (FUTA) Tax
Federal unemployment taxes, more commonly called FUTA taxes, are paid solely by the employer. The total amount that you pay, as of 2020, is 6% of the sum of all of your employee wages.
Most employers are eligible for a 5.4% credit on their FUTA taxes, reducing the rate to 0.6%. You can find the qualifications for and more details about this tax credit here. Generally, you are entitled to a credit on your FUTA taxes for the amount that you pay towards state unemployment taxes for each of your employees.
State payroll taxes are paid to individual state tax authorities, usually to the state in which your employees live and pay their taxes. Who you end up paying your tax to differs from state to state, but in most states, you will report income and withholding taxes to the state’s Department of Revenue and unemployment taxes to the state’s Department of Labor. The types of taxes are quite similar to that of federal taxes.
State Income Tax
State income taxes, just like that for federal taxes, are a withholding tax that comes right out of your employee’s pay. The percentage that you’ll end up paying will be different from the federal rate, but it’s also based upon the contents of each employee’s W-4 form (their wages and withholding preferences).
State Unemployment (SUTA) Tax
State unemployment taxes are paid solely by the employer. The rate that you end up paying is different from state to state. This rate can sometimes change based upon how long you’ve been an employer and your industry. At the beginning of each year, your state government will let you know your SUTA rate for that year.
After a certain wage threshold, you don’t have to pay any more SUTA taxes. These thresholds are called the wage base and are different from state to state. Make sure that you review this each year so that you properly budget for changes in your tax obligations.
Local cities, towns, and counties often charge their own payroll taxes to fund government projects. These are much more variable in nature and can change wildly depending on where you are located. These taxes can be anything from local income taxes to school board taxes to transit taxes and everything in between.
Most local payroll taxes are withholding taxes paid out of every one of your employee’s wages. Check out this list from The Balance to see if you are subject to local income and payroll taxes.
What Are Your Responsibilities As A Small Business Owner With Respect to Payroll Taxes?
As an employer, it’s your responsibility to withhold and remit the necessary tax amounts from your employee wages and pay any other taxes, like unemployment taxes, based upon payroll numbers.
How To Pay
The IRS requires that all tax deposits are made through the Electronic Federal Tax Payment System (EFTPS). They’ve made it pretty easy to pay taxes through this service. You can pay through direct deposits for free or through credit cards for an extra fee.
As the employer, it’s your responsibility to pay all payroll taxes to the tax authority, in the correct amount, and at the right time. Small businesses are the most common type of non-compliant taxpayers, and the IRS doesn’t mess around when it comes to tax collection. You should keep a record of all important dates related to all of your tax obligations, including payroll taxes.
When you register your business with the IRS and other tax authorities, they’ll provide you with a schedule that depends on your tax liability and the size of your company. Hang this in your office and make a thousand copies. It’s important that you plan accordingly to make sure that you’re paying your payroll tax obligations on time so that you avoid potential penalties or audits.
Tax professionals will often go the extra mile and recommend that you be depositing payroll taxes on the same day that you issue an employee’s paycheck. By doing this, you’ll never have to worry about falling behind or not having enough to cover your tax obligations when due dates. You can do this for each type of payroll tax, even though some, like FUTA, are due on an annual basis.
As your business grows and your payroll tax liability exceeds $50,000 in the past 12 months, your payroll tax schedule will likely become semi-weekly anyway, so it doesn’t hurt to observe this from the get-go.
Common Tax Forms Concerning Payroll Taxes
Filing taxes in the United States invariably involves sifting through a mountain of paperwork. The number of forms and their similarity can make even the most seasoned tax veteran’s head spin. Below you’ll find all of the tax forms relevant to payroll taxes and links to original IRS documentation for your convenience.
W-4 Form: The W-4 tells you how much income tax to withhold from each employee’s paycheck based on their personal and financial situation and their withholding preferences. Every new hire needs to fill one out, and they can fill out a new one at the beginning of each year to change their withholding amount.
W-9 Form: The W-9 is the W-4 for independent contractors. Every time to hire a new independent worker, whether that be a contractor or a freelancer, have them fill out this form. This will give you their name, address, and social security number (SSN) or employer identification number (EIN).
Form 941: This form details any and all withholding and FICA taxes that you’ve paid to the IRS. You complete and file this quarry and helps you to ensure that you’re keeping up with your payroll tax obligations.
Form 944: If your annual FICA and withholding tax liability is less than $1,000, you’ll file a Form 944 by January 31st instead of the quarterly Form 941.
Form 940: Form 940 reports all of your FUTA taxes. It’s similar to Form 941, but you file this form once per year instead of quarterly.
W-2 Form: A W-2 is completed by employers for each employee and details their income, taxes paid, and deductions for the year. They’re a critical component of an employee’s tax return. These are filed annually for the previous calendar year and must be sent to your employees by January 31st.
W-3 Form: The W-3 is due to the IRS each year on January 31st and details the combined information contained in each W-2 that you’ve issued. It totals all of your federal payroll and withholding taxes paid, and it’ll be filed along with each of your employee’s W-2s.
1099-MISC: The 1099 records all of the payments that you’ve made to an independent worker throughout the year. It’s basically the W-2 for independent contractors and freelancers. If you’ve paid an independent worker over $600 in a year, you have to file a 1099-MISC with the IRS and send a copy to that independent worker by January 31st.
The Best Apps and Payroll Services To Help Manage Your Payroll Taxes
Your payroll system is a critical component of your operations. There are tons of payroll software systems that can help with all aspects of payroll processing, including managing your payroll tax liability. There are also lots of apps out there that make this task as painless as possible. We’ll list off three of our favorites below with a short description of why it’s so great for small business owners.
Square Payroll: Square Payroll offers the full suite of necessary payroll features at a low price. Square Payroll is affordable, keeps track of benefits like retirement plans and healthcare while offering whitelisted policy options, keeps track of pre-tax spending, and is exceptionally automatable. Square does everything you need for calculating payroll taxes outside of reviewing quarterly tax forms. This is a great option for small business owners who want a user-friendly all-in-one option.
QuickBooks Payroll: For current QuickBooks Online users, this product is a great addition. It can be easily integrated into your current QuickBooks system or used as a stand-alone product for a low price. QuickBooks payroll takes care of everything from issuing W-2 forms to literally filing your payroll taxes for you. This is a great option for small business owners who want to be absolutely sure they’re taxes are dealt with correctly with convenience.
Gusto: Gusto, unlike our other choices, is especially good for dealing with local tax obligations. Gusto provides the full suite of services from benefits to deductions to tax filings while also allowing a unique ability to deal with local tax authorities. It also integrates with most accounting software.