Navigating the requirements of payroll expense tax can be daunting for a small business owner. Learn more about what it is and what’s required as an employer.
On the simplest level, payroll taxes are different from income taxes, with the main distinction being that payroll taxes are paid by both employer and employee, while income taxes are only paid by the employee. However, it is the employer’s responsibility to withhold both when making payroll.
Under federal law, most employers, regardless of the size of your business, are required to withhold federal taxes from employees’ paychecks based on their wages. They also need to include an employer contribution component, so both the employer and employee owe taxes on an employee’s wages. If you don’t have employees but operate as an incorporated entity, your own paychecks are also subject to payroll taxes. As the business owner, it is your responsibility to properly calculate the taxes owed and pay them on time so as not to incur any penalties. Even if you work with a payroll service, it is important to have at least a working knowledge of the basics behind payroll taxes.
TYPES OF PAYROLL TAXES
There are two main types of federal payroll expense taxes, which are mandated by the Federal Insurance Contributions Act (FICA). The first is Social Security (or Old Age) Survivor and Disability Insurance (OASDI) which fund Social Security benefits. The second is Medicare tax or Medicare Hospital Insurance (HI) fund the hospital component of Medicare benefits. Employers need to withhold FICA taxes from employees’ wages and deposit those taxes along with an employer matching share.
Beyond those, there is unemployment insurance, which operates on both federal and state levels. The Federal Unemployment Tax Act (FUTA) pays toward the federal-state unemployment system, and only the first $7,000 of an employee’s wages are calculated toward this tax. FUTA taxes are paid by businesses, separately from other taxes, and employees do not have it withheld from their pay.
The State Unemployment Tax Act (SUTA) provides state benefits to qualified workers who lose their jobs through no fault of their own. The SUTA is also funded by the Employer based on its State requirements.
Five states, currently, (California, New Jersey, New York, Rhode Island, Hawaii) and Puerto Rico also require employers to provide short-term disability insurance for non-work-related illness or injury that may prevent a worker from performing his or her job. Some states only charge this tax to the workers while others charge the employer, so it is essential for you to familiarize yourself with your state’s requirements. (More states are adding this benefit every year, so make sure to check.)
MANAGING PAYROLL EXPENSE TAX
Federal payroll tax returns are filed separately from payments. Generally, employers pay employment taxes by making federal tax deposits through the Electronic Federal Tax Payment System (EFTPS) on a monthly or bi-weekly basis, and payroll tax returns are filed on a yearly or quarterly basis, depending on the size of your business’s payroll.
Employers report wages and compensation paid to employees by filing the required forms with the IRS. At the end of the year, the employer must provide employees with Form W-2 to report wages, tips, and any other compensation or reportable benefits. Small businesses must file Forms W-2 and W-3 with the Social Security Administration and, if required, state or local tax departments.
COMPLIANCE IS KEY
Payroll expense taxes are considered a special category of taxes because the employee’s share belongs wholly to them, and it may be contributing toward their Social Security account for which they will earn benefits for the future. The federal government does not take kindly to businesses that misallocate these funds, even accidentally. The IRS can withdraw owed funds directly, put a tax lien on property, or, in extreme cases, threaten business owners with prison time.
Even the most well-intentioned business owner can make a mistake and face unwelcome consequences. By partnering with a payroll service provider that specializes in small business solutions, you can rest easier knowing that your company’s tax compliance and ongoing success is in the hands of experts.
LET PAYROLL VAULT DO THE WORK
The highly trained specialists at Payroll Vault make it our job to help you stay informed and up to date about tax deductions, year-end documentation, and compliance standards so you can get back to focusing on running and growing your business. Our client-focused approach means that you will receive personalized assistance as we help you establish a more efficient payroll processing system.
To learn more about how Payroll Vault can work for your business, request a quote from Payroll Vault.