Understanding the ins and outs of payroll can be difficult. There’s a lot to get your head around, from formatting to calculating deductions. One of the most important issues concerning the payroll process is tax. We are all familiar with income tax, but often employers overlook the tricky business of payroll tax.
This quick guide covers everything an employer needs to know about payroll deductions and taxes. From what these taxes are, who they apply to and why they matter, to their liabilities and penalties.
This guide will leave no stone unturned…
- What is Payroll Tax
- Payroll Deductions
- Payroll Liabilities & Penalties
- Average Payroll Tax
- Calculating Federal Payroll Taxes
- How to Pay & Report Quarterly Payroll Taxes
- Understanding Payroll Taxes for Small Business
What is Payroll Tax?
First things first. Let’s start by taking a look at exactly what is meant by employer payroll taxes. These are items of tax withheld from an employee’s salary by the employer. You might be wondering “Who pays payroll tax in the USA?”. The tax is split between employer and employee. Deductions from employee wages and taxes are paid by an employer based on the workers’ salaries. Employers pay the withheld amount directly to the Internal Revenue Service (IRS) on the employee’s behalf. Most jurisdictions require these statutory deductions to be reported quarterly and annually.
So, what exactly is this tax based on? The amount of tax an employee will pay depends on how much they’re being paid. The tax is based on the total remuneration, including salary and benefits, paid to all employees. It is paid at a standard rate of 14% (though, under certain circumstances, it can be as low as 4.75%). Employers are allowed to deduct a small percentage of an employee’s pay (around 4%) to help fund this. An employee will be made aware of the taxes deducted from them on their paycheck. There is typically an itemized list stating exactly how much has been deducted for the various taxes that apply to them.
So, what exactly is the difference between payroll and income tax? Whereas the payroll tax cut is used for specific government social insurance programs, federal income tax withholding goes to the government’s general fund. The government social insurance programs referred to here are social security, healthcare, unemployment benefits and workers’ compensation. Furthermore, in some cases, state governments will take a small cut from the wage tax. This is used to contribute to the maintenance and improvement of local infrastructure programs. These could include, road, park and recreation maintenance.
Types of Payroll Deductions
In the United States, there are numerous paycheck taxes and withholdings. Let’s take a look at some of the main paycheck deductions that, as an employer, you need to be aware of.
Federal Insurance Contribution Act (FICA)
This act is at the center of payroll tax. It is divided into two federal programs, funded by social security and medicare taxes. As a rule of thumb, an employee pays 7.65% towards FICA tax.
Social Security
Social security employee tax is paid both by the employee and employer. The money paid into this goes into two different trust funds: Old-Age and Survivors Insurance Trust Fund (OASI) and the Disability Insurance Trust Fund (DI). The first is for retirement and survivor benefits, whereas the latter is for disability benefits. It acts as a safety net for the retired and disabled.
Medicare Insurance
Tax for medical is paid by both the employee and employer. Medicare withholding also goes into two separate trust funds, the Hospital Insurance Trust Fund and Supplementary Medical Insurance Trust Fund. This is primarily used to help with medical fees workers may need to pay throughout their lives.
Unemployment Insurance
The State Unemployment Tax Act (SUTA)
SUTA tax is another federal payroll tax that may also be known in some states as State Unemployment Insurance (SUI) or reemployment tax. This Act was established to offer unemployment benefits to displaced workers. In most states, this is funded by employers only. SUTA rates differ between states. When you register as an employer, your state will tell you what your SUTA tax rate is.
The Federal Unemployment Tax Act (FUTA)
FUTA is the federal withholding tax that provides payments of compensation to workers who have lost their jobs. This is conducted at a federal level, as opposed to the state level of SUTA. Employers pay both federal and state unemployment taxes.
Retirement Programs
Each company may set up its own retirement program with employees which they pay a portion of their salary into overtime. This builds up to form a pension pot that they will have access to once they retire. Rates of deduction vary between companies and individuals.
Local Taxes
Local payroll withholding may be taken by different cities and municipalities. These taxes are paid by both the employee and employer and vary in rates depending on location. They are used to pay for local maintenance and improvements.
Payroll Liabilities & Penalties
Of course, making sure everything is done correctly in the payroll process can be tricky. There is a lot to cover and it can get confusing if you employ a lot of people. Mistakes are common, but it is important to be aware of the main payroll liabilities and penalties associated with these errors.
If small mistakes are made, such as inputting incorrect data, payment posting, or payment schedule, these are not usually penalized. They are usually the result of typos or misreading the information, rather than a willful intent to deceive. In this case, always double-check all information before finalizing payroll, and be quick to correct errors if they are made.
That being said, there are some bigger issues that can mean you are liable to pay fines, penalties or compound interest. Let’s take a look at these below.
Repeatedly paying or filing late
Missing payment deadlines continuously will lead to fines. If there are signs of intent or negligence here, you will be faced with repeat fines and potential investigations. Fines for late payments are as follows:
- 1-5 days — 2% of the amount owed
- 6-15 days — 5% of the amount owed
- After 16 days — 10% of the amount owed
- More than 10 days after you receive the first notice — 15% of the amount owed
Repeatedly making mistakes
We all make mistakes, and that’s OK, if we learn from them! If the tax authorities notice that you are continuing to make the same mistakes then they will get more persistent and hand down fines and penalties.
Not sending taxes to the tax authorities
If you’re collecting but not paying the payroll tax withholding to the authorities you are breaking the law. Fines will be large, and in extreme cases, the IRS can enforce criminal sentences and close businesses for this offense.
Not collecting payroll taxes at all
Collecting no payroll tax is also against the law and will prevent employees from receiving the benefits from the trust funds. These constitute social security payroll tax and medicare payroll tax. The trust fund recovery penalty is used to penalize those who have not collected or paid into these funds. The penalty is equal to the unpaid balance of the trust fund tax.
Average Payroll Tax
To make sure you’re doing payroll tax deduction correctly, it’s important to familiarize yourself with the tax rates. Tax rates are set by the IRS, Social Security Administration (SSA) and Department of Labor (DOL). The tax rate chart we’ve included offers a general overview of the payroll rates of tax. Let’s take a closer look at those rates below.
Social Security
The employee portion of the social security tax is taxed at a total of 6.2% of the worker’s salary on a maximum salary of $137,700. The employer portion is taxed at the same rate. This figure is split between the OASI, which is taxed at 5.3%, and the DI, at 0.9%.
Medicare
The Medicare deduction from a paycheck is taxed at a rate of 1.45%. The employer must also match this tax at the same rate. There is no maximum salary for this tax. Yet, it must be noted that employees earning over $200,000 pay an additional 0.9%. Employers do not have to contribute more for these employees.
FUTA
FUTA is set at 6.0% with a maximum taxable earnings amount of $7,000. These are payroll taxes paid by the employer only.
Note that SUTA and state and local taxes are taxed at different rates depending on their set laws and regulations.
Calculating Payroll Tax & Federal Payroll Deductions
Now you’ve found out exactly what the rates are, you might be wondering “How do I calculate payroll taxes?” To calculate the FICA withholding and other taxes out of a paycheck, we’ve included a simple step-by-step guide to act as your payroll taxes calculator.
Step 1: Calculate gross pay
Gross pay is the amount an employee earns before any taxes are withheld. Make sure you don’t forget to include any overtime here.
Step 2: Calculate employee tax withholdings
After calculating the gross pay and number of allowances from an employee’s W-4, you will know how much tax to withhold. Withholdings are needed for federal, state and local taxes, as well as FICA in most states. You can simply apply the rates from our rate chart above to work out the percentages needed.
Step 3: Include further deductions
As well as obligatory taxes, employees may also opt-in for other deductions. These pre tax deductions are voluntary and include life or health insurance premiums, 401(k) plans and health savings account contributions.
Step 4: Add on any expense reimbursements
If an employee has paid for any company expenses upfront themselves, they will be expecting these to be paid back. Employers have the possibility to either include this with payroll or pay them back separately. This is done after tax deductions have been made.
Step 5: Add it all together
Once you’ve done these calculations you’re left with net pay and a complete paycheck after taxes.
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Paying & Reporting Quarterly Payroll Taxes
Once you’ve calculated and collected the amount your employees have to pay in taxes, it’s time for payroll tax filing. There are rules and regulations that you, as an employer, must abide by when completing your payroll tax return. For paying and reporting taxes, you must complete the following requirements:
- Federal unemployment tax return (Form 940 or 940EZ) – You must fill out an annual Form 940 which is for your FUTA contributions.
- Employer’s quarterly payroll tax return (Form 941) – Form 941 is used by employers to report quarterly tax withholding amounts for estimated income tax payments, as well as employer payments, and social security and federal medicare tax.
- Annual Return of Withheld Federal Income Tax (Form 945) – Form 945 reports on federal income taxes withheld from non-employees, specifically backup withholding. Payments to non-employees must be reported to the IRS using a version of Form 1099 payroll or Form W-2G.
- Wage and Tax Statements (Form W-2) – Every employer engaged in a business who pays remuneration for services performed by an employee must file a Form W-2 for each employee.
As well, there are local and state payroll tax agencies that require employers to file and report taxes. Check with your local authorities for more information regarding your location.
Payroll tax online
So you’ve gathered all the information together and filled out all the forms. Now you might be wondering how you actually pay the taxes. A simple option is to pay payroll taxes online. This easy method can be done through the Electronic Federal Tax Payment System (EFTPS). This government website is provided free by the U.S. Department of the Treasury. All you have to do is sign up and pay any taxes you owe to the IRS through this online system.
Small Business Payroll Taxes
Many small business owners struggle to keep up with the current information surrounding taxes and payroll. There is a lot of information and if not done correctly, they may be liable for fees and penalties. As such, a lot of small business owners need help with their payroll and tax services. Often, they hire an accountant or tax specialist to take care of any tax-related issues. Yet, that being said, it is important that anyone running a business, whether it be small or large, should have an understanding of how payroll deductions work. There are two ways that might help a small business owner to keep track of payroll. Let’s take a quick look below.
Payroll register
Creating a payroll register is a great solution for keeping track of all payroll information for each of your employees. This will help the payroll and accounting process as you will have all the information you need for the quarter or year at your fingertips.
Yearly tax calendar
A month per month tax calendar for payroll will be advantageous for any small businesses who do their own payroll. It will help keep track of important payroll dates throughout the year for federal, local and state payroll dates.
Conclusions
Payroll tax is a tricky task for any business, small or large. If you want to avoid legal fees and penalties then it’s of the utmost importance that you get up-to-date with all the information at your disposal. If you’d like to dive deeper into understanding payroll, we have a number of resources on our website.
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Contributed by Charlotte Stace
