As you consider your annual budget and estimate cash flows during the year, you’ll want to take into account how payroll taxes may fluctuate throughout the year. Now is the perfect time to take a look at your tax liability.

Have you ever noticed that payroll taxes are very high in the beginning of the year, but tend to decrease throughout the remainder of the year? It’s all in the math of how payroll taxes work.

Most taxes are based on a fixed percentage of total wages paid to each employee up to a certain amount per year. This is often referred to as a wage cap or limit. For example, Federal Unemployment Tax, also known as 940 or FUTA tax, is calculated at 0.6% of wages up to a $7,000 cap per employee per year. If you have an employee that is paid $45,000 per year then the business would be taxed .06% on the first $7,000 in wages ($42.00 per year). The remaining $38,000 in wages paid to the employee will be Federal Unemployment Tax free. Since the cap is based on wages per employee per year, anytime you hire a new employee the calculation starts from $0 all over again. Consider in the above example another part-time employee that is hired at a $20,000 salary. The first $7,000 in wages will be taxed at .06% and the remaining $13,000 in wages will be Federal Unemployment Tax free.

For many of our clients with a low employee turnover, their federal unemployment liability is very low or even $0 for 3rd and 4th quarter each year. Then in January, the calculation resets to $0 again for all employees – hence why taxes are higher at the beginning of the year.

Federal Unemployment Taxes are only one example. Other taxes that work based off of percentages and wage caps are FICA-Social Security, State Unemployment Taxes, State Disability Taxes, and even various local taxes.

It’s important to seek tips on how to properly plan ahead for cash flow fluctuations. You might cut back on payroll tax expenses by reducing turnover or strategically planning new employment periods. Be sure to reach out to your payroll advisor to get a complete understanding of all of the payroll taxes that apply to your business.

By Christina Walker, Payroll Vault, Oxnard CA