One of the challenges small business owners must contend with is constantly complying with various federal, state, and local tax obligations. Business owners often hire accountants and other tax professionals to deal with these issues, but understanding the basics of taxation can avoid many problems. This is especially true for payroll taxes. Here's what you need to know:
- Payroll taxes typically include federal, state, and local income taxes, FICA taxes (for Medicare and Social Security), and FUTA taxes (for unemployment insurance).
- Some states also impose disability insurance taxes, family leave taxes, and medical leave taxes.
- The first step in calculating payroll taxes is to determine which employees are taxable employees and which, if any, are independent contractors.
- The second step is to determine which wages are taxable.
- The third step is to calculate the amount that will be withheld from your taxable wages.
- Each tax has different deadlines that employers should be aware of to avoid penalties.
What are my payroll tax obligations?
Businesses with employees must withhold payroll taxes from employees' paychecks and pay applicable federal, state, and local taxes. Taxes withheld from employee paychecks typically include FICA (Medicare and Social Security taxes) and, if applicable, federal, state, and local income taxes.
In addition to income taxes, other withholding obligations may include disability insurance taxes in states such as California, Hawaii, New Jersey, New York, and Rhode Island. Paid family and medical leave (PFML) taxes in states such as California, Colorado, Massachusetts, and New York. and FUTA (Federal Unemployment Tax Act) taxes. Failure to pay these taxes or miss the deadline can result in fines and fines, so it is important to correctly calculate the amount owed and pay it on time.
These rules also apply to owners' salaries if the business is unincorporated and has no employees. In this situation, the owner is essentially the only employee of the business. Owners must also pay estimated taxes on their self-employment income each quarter.
Calculating payroll taxes involves three basic steps.
- Identify taxable employees.
- Determine wages that are subject to tax.
- Calculate the withholding tax amount.
Identification of taxable workers
Workers can be employees or independent contractors. Employees are treated as taxable workers subject to payroll taxes, and independent contractors are responsible for paying their own taxes. Workers are generally not considered employees if they have the right to direct and control when they work and how their work is done. However, the line between independent contractors and employees is not always clear-cut. Below is part of the test.
Workers are employees if their employer has the right to direct and control their work. Employers are not required to actually direct or control workers, but they have the right to do so.
This test looks at how much control your employer has over the financial aspects of your job. Having greater control over the consumables used in the work supports the status of workers as independent contractors in some specialized fields.
Another way to differentiate between independent contractors and employees is by the availability of services. An independent contractor is not tied to her one company and can promote her own services or work for other companies. Employees may not do this unless they also work outside the company as an independent contractor for another business.
This test shows how employers and workers perceive their relationship. A worker is an independent contractor if the employer-worker relationship is expected to last until the end of a particular project or only for a specified period of time. If the relationship has no such boundaries, the worker is a taxable employee.
Determination of taxable wages
Taxable wages are compensation for services performed. These may include salaries, bonuses, or gifts. Some forms of compensation, such as reimbursement for travel and meal expenses, do not qualify as taxable wages. Employees should check their receipts or expense reports to see if their expenses are tax-exempt. Expenses must also be normal, necessary, and business-related.
Calculation of withholding tax
Once you know which workers qualify as taxable employees and whether payments to them are taxable wages, the next step is to prepare for federal, state, and local taxes, and for FICA and FUTA purposes. Understand the amount you need to withhold.
federal income tax
All paychecks must have federal income tax withheld for the applicable period. The IRS has two tax tables that employers can use to calculate withholding: the wage bracket table and the percentage table.
It is your responsibility as a business owner to decide which one is right for your business. Although it is generally easier to use a wage bracket table, a percentage table accommodates a larger number of pay periods (from daily to semi-annual) and is more sensitive to employees who earn more than what is reflected in the pay bracket table. Enables calculation of withholding tax.
Federal tax payments must be made online through the Electronic Federal Tax Payment System (EFTPS).
The Federal Insurance Contributions Act (FICA) is a federal law that requires employers to withhold Social Security and Medicare taxes from wages paid to employees. It also requires that the employer and employee each pay half of her FICA taxes. (If you are self-employed, pay half the amount.)
Social Security and Medicare taxes are levied on both employees and employers at a flat rate of 6.2% each for Social Security and 1.45% each for Medicare. This calculates his FICA tax rate of 15.3%, with Social Security at 12.4% and Medicare at 2.9%.
FICA taxes, unlike federal and state taxes, are not affected by the amount of withholding benefits claimed by employees. Simply multiply your employee's gross wage payments by the applicable tax rate to determine the amount you must withhold and the amount you must pay as an employer.
Social Security taxes only apply to the first $160,200 of your 2023 income. That amount increases to $168,600 in 2024. This cap is called the Social Security wage base and is adjusted annually for inflation. Medicare taxes have no income limits.
Federal unemployment tax (FUTA) is paid only by employers. You must pay unemployment tax if any of the following situations apply to you:
- Pay a total of at least $1,500 in wages in any calendar quarter, or
- Assume that you have at least one employee on any day of 20 weeks in a calendar year, regardless of whether the weeks are consecutive. Employees can be full-time, part-time, or temporary.
The FUTA tax rate is 6.0% and is levied on the first $7,000 of each employee's wages. However, you can claim a credit against your total FUTA taxes to reflect the state unemployment taxes you pay. If you pay your state unemployment taxes on time, you can claim a 5.4% credit that effectively reduces your FUTA tax rate to 0.6%.
Failure to remit federal tax withholding on time can result in penalties of up to 15%.
Most states use tables similar to the federal tax tables, which can be found on your state's tax or revenue department website. Jurisdictions that do not tax income (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Wyoming) do not have to withhold state taxes.
What is payroll tax?
Payroll taxes are made up of income taxes (federal, state, and sometimes local taxes) and FICA taxes (Social Security and Medicare taxes). Depending on your state and local jurisdiction, payroll taxes may also include other taxes.
What is the difference between payroll tax and income tax?
Payroll taxes refer to various taxes withheld from an individual's paycheck. This definition often includes income taxes, but the term is sometimes limited to just FICA taxes for Social Security and Medicare.
Do I pay payroll taxes on all my income?
You don't pay payroll taxes on all your income. Payroll taxes include Social Security and Medicare taxes, and Social Security taxes have income limits. The cap hit him at $160,200 in 2023 and increases to $168,600 in 2024. Income above this amount is not taxed for Social Security purposes. However, there is no cap on Medicare taxes.
Employers have a series of tax deadlines throughout the year, and being aware of them and paying on time can help you avoid penalties and late fees. For example, federal income taxes and his FICA taxes must be paid semi-monthly or monthly. The IRS typically sends a notice to business owners at the end of each year indicating which method they must use the following year. FUTA taxes are generally payable quarterly.