How Does the Payroll Tax Credit Filing Process Work?

In this article:

• What do small business owners need to know about payroll taxes?
• What are payroll tax credits?
• Small business tax credits you should consider
• How to file payroll tax credits

What do small business owners need to know about payroll taxes?

Payroll taxes are tax payments made to the government based on salaries and wages paid to direct employees. No payroll tax is required to be made by businesses for payments made to independent contractors or freelancers. Any business that has at least one paid employee is required to pay taxes on employee compensation. Payroll tax payments can be taken out of the employee’s salary by the employer and then turned over to the government or can be paid directly by the business owner. 

Federal payroll taxes

Payroll taxes paid to the U.S. government are collected, monitored, and enforced by the IRS. There are three types of federal payroll taxes. 

• Federal Income Tax – A percentage of the employee’s pay withheld from their paycheck and paid to the IRS. Withholding amounts are determined by the employee’s salary range and their individual selections made on form W-4.
• Federal Insurance Contributions Act (FICA) Tax – FICA taxes contribute to the federal Medicare and Social Security programs. FICA taxes are sometimes called “shared” taxes because the employee and the employer are each responsible for half of the total liability.
• Federal Unemployment (FUTA) Tax – FUTA taxes are paid by the employer and is calculated on a percentage of the business’s total employee wages.

State payroll taxes

In addition to paying payroll taxes to the IRS, small business owners must also pay payroll taxes to the state taxing authority where their employees reside.

• State income tax – Taxes withheld from the employee’s paycheck. The amount is determined on a state-mandated percentage and the employee’s W-4 selections.
• State Unemployment (SUTA) Tax – SUTA taxes are paid by the employer. The rates are distributed by the state agency every year.

Local taxes

Some businesses may be required to pay income taxes and payroll taxes to their city or county government. Local payroll taxes are used to fund government projects.

What are payroll tax credits?

Since there is no way to avoid paying federal taxes, it’s important to learn about available credits for businesses. Payroll tax credits save business owners money by reducing their total tax liability. The decrease in taxes comes when the employer’s share of social security taxes or Medicare taxes are lowered by the government.

Payroll tax credits are often confused with tax deductions. While deductions reduce the taxable income on a business’s income tax return, tax credits reduce the filer’s tax bill calculated during the return. Payroll tax credits can be nonrefundable, which means that the credit will lower the bill to the total amount owed. Refundable tax credits, on the other hand, will result in a refund to the business owner if the amount of the credit exceeds the business’s liability.

Small business tax credits you should consider

It is important for entrepreneurs to stay informed about what tax credits are available, especially since the federal government is constantly revisiting tax rates and laws. Even if you work with a tax professional, or CPA, to complete your payroll tax returns each year, learning about the latest tax credits can help business owners make more effective business decisions.

Employee Retention Tax Credit

Also called the ERTC  or ERC, the Employee Retention Credit provided small business owners with an opportunity to get a refund for continuing to pay full-time employees during the pandemic. The credits were issued as a part of the Coronavirus Aid, Relief, and Economic Security (CARES Act) and then extended and expanded through the American Rescue Plan Act and the Consolidated Appropriations Act of 2021. The availability of ERTC credits was stopped with the Infrastructure Investment and Jobs Act.

ERTC provides refundable credits which reduce the business owner’s tax bill up to 50% for qualifying employee wages paid between March 12, 2020, and January 20, 2022. Except for self-employed individuals, small businesses are eligible to use ERTC for their 2020 taxes if their business was partially or fully shut down during the pandemic and there was a decrease in gross receipts of at least 50%. To apply ERTC to the 2021 tax year, the business owner must prove that revenues were at least 80% lower than the same time period in 2019. Recovery startup businesses must claim the credit through the end of 2021.

To be eligible for the maximum credits, employers must comply with the ERTC aggregate rules, which resemble the nondiscrimination rules for retirement and savings plans. Qualified wages, as of January 1, 2021, for the Employee Retention Tax Credit include:

• Eligible employers with more than an average of 500 full-time employees during 2019 were being paid, but not providing services because of Coronavirus business disruptions.
• Business owners with less than 500 full-time employees were paying employees during business disruptions by government orders or by a significant decline in sales whether they were providing services or not.
• If a business has fewer than 100 employees, all employees are eligible. If a business has more than 100 employees, only workers who are being paid but not providing services.

Families First Coronavirus Response Act (FFCRA)

The FFCRA, a part of the Tax Relief Act of 2020 created during the COVID-19 pandemic, was created to help small businesses by reimbursing employers for the expenses of wages paid during time off related to Coronavirus. The FFCRA applies to employers that provided paid time off to employees under EPSLA or the Expanded FMLA.

• EPSLA – The Emergency Paid Sick Leave Act (EPSLA) reimburses employers with less than 500 employees for paid time off (PTO) relating to their employee’s own health needs or their employees’ family’s health needs for up to 80 hours. Also included in these credits is the business owner’s share of Medicare taxes and their cost of providing health care coverage for the employee on leave.
• Expanded FMLA– The Emergency Family and Medical Leave Expansion Act (Expanded FMLA) made it so an additional 10 weeks of family leave pay could be credited for wages paid to employees that had to stay home with children and other qualified dependents while schools and daycare facilities were closed. The credits also included reimbursements for the business owner for health plan expenses and Medicare taxes.

Vaccine Paid Leave Tax Credit

Funded through the American Rescue Plan, the vaccine paid leave tax credit, provides incentives for companies that allow employees to take paid time off to get vaccinated for Coronavirus. The credit was added to the rescue plan by President Joe Biden to encourage Americans to get vaccinated. The credit provides small businesses with 500 or fewer employees to receive a maximum credit of $511 per day for every vaccinated employee.

Workers Opportunity Tax Credit

The Work Opportunity Tax Credit (WOTC) provides employer credits to small businesses that hire individuals from groups of people that have traditionally faced obstacles finding long-term employment. The goals of the WOTC are to diversify the labor force and create more jobs in underserved communities. Eligibility requirements for this tax credit are that the employee belongs to one of the following categories:

• Qualified IV-A individuals – Any employee with a family member receiving Temporary Assistance for Needy Families (TANF) for any nine-month period during the 18-month period leading up to their hire date.
• Qualified ex-felon – Employees that were hired within twelve months of being convicted of a felony or released from prison.
• Qualified veteran – A veteran that is a member of a family receiving benefits from the Supplemental Nutrition Assistance Program (SNAP), was unemployed for 1-6 months in the twelve months leading up to the hire date, or a disabled veteran hired within a year of being discharged or released from active duty.
• Designated community resident – Employees living in an empowerment zone, enterprise community, or renewal community.
• Vocational rehabilitation referral – Mentally or physically disabled employees who were hired while receiving or after completing vocational rehabilitation.
• Qualified SSI recipient – Employees that were receiving SSI benefits up to 60 days before their hire date.
• Long-term unemployment recipient – Any employee who was unemployed for at least 27 weeks prior to being hired.

How to file payroll tax credits

Each business tax credit has specific instructions on how to claim the credit, but most are reported along with the payroll tax return. Taxpayers wishing to receive a tax credit for periods they’ve already filed and paid taxes for can file an amended return. To file or amend payroll taxes:

1. Complete and submit the Employer’s Quarterly Federal Tax Return (IRS Form 941-X) by the due date for that calendar quarter (April 30, July 31, October 31, and January 31).
2. Complete and submit the Federal Unemployment Tax Act (FUTA) tax return (IRS Form 940) due annually by January 31.
3. Register for the Electronic Federal Tax Payment System (EFTPS)
4. Submit tax payments online for employee income tax, Social Security tax, Medicare taxes, and unemployment taxes.

When claiming payroll tax credits, the taxpayer can choose to reduce employment tax deposits or request an advance payment of the refund. The ERTC, Vaccine paid leave tax credit, and FFCRA credits are all reported on IRS Form 941, which is already used for filing payroll tax returns. To take the WOTC, employers must file Form 8850 with a state agency within 28 days of hiring the eligible employee.

Payroll tax credit FAQs

Is my business eligible for payroll if it is not structured as a corporation? Yes. Although the eligibility requirements vary for each tax credit, businesses organized as limited liability companies (LLC), Partnerships, S-corporations, and C-corporations can take advantage of payroll tax credits.

Can I use a paper check to pay my payroll taxes? No, the IRS requires employers to use their Electronic Federal Tax Payment System to file and pay payroll taxes. However, many payroll providers or CPAs take care of this on behalf of their clients.

If I have taken out a PPP loan, can I still take the ERTC for my business? Originally, under the CARES Act, business owners that had been approved for a refundable Paycheck Protection Program (PPP) loan were not eligible for ERTC. However, the amendment made by the Consolidated Appropriations Act made it possible for entrepreneurs to still receive the tax credits under ERTC.

I run a tax-exempt nonprofit organization with 113 employees on my payroll. Am I eligible for payroll tax credits? Yes. Nonprofits categorized as 501(c) organizations by the Internal Revenue Code are eligible for the Employee Retention Credit if they are otherwise eligible.

Final Thoughts

Making payroll tax payments is an essential part of managing a small business. Every business owner should stay informed about the current payroll tax credits so that they can reduce their tax liability as much as possible. Many of the most recent tax credits were implemented to help small businesses stay afloat as the country navigated unprecedented times during the pandemic. If you believe your business missed out on filing for some tax credits, it’s not too late to amend those returns or even receive an advance or business loan based on those future credits. Some entrepreneurs, like Mike Gavigan, were even able to receive cash upfront by taking out an ERTC loan with Biz2Credit.