Payroll Taxes 101: What Employers Need to Know

Payroll taxes are complex, and failure to pay them accurately and on time can lead to big problems, including fines. Here’s what employers need to know.

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payroll taxes 101

More than a quarter of all employees say they have experienced paycheck errors, according to research by Intuit. Not only can this mess up your bookkeeping and cause additional work for your payroll team, but it also makes for unhappy employees.

Take out too little taxes and you’ll have to fix the mistake and take more out of an employee’s future paycheck. Take out too much and you can cause all sorts of problems for your workers. Two-thirds of employees say they would have trouble meeting their current financial obligations if there were a payroll error or delay, according to Kronos.

If payroll errors happen more than once, it can also cause people to start looking for a new job. Research by Kronos shows that 49% of employees say they will start a job search after just two paycheck issues.

As an employer, you have an obligation to get it right every time and ensure you comply with all regulations concerning payroll taxes. We’ve put together this employer’s tax guide to help.

What are payroll taxes?

Payroll taxes are the taxes paid on wages companies pay to their employees. Both employees and employers share the tax burden. Employers withhold taxes from employee paychecks through payroll deductions, which the company pays to the Internal Revenue Service (IRS) and other state and local agencies. Employers also pay their portion of the taxes owed.

Taxes are based on what constitutes taxable income under IRS regulations. The formal definition of taxable income in terms of the workplace is an employee’s adjusted gross income (AGI) minus any allowable deductions. This includes things like wages, salaries, bonuses, and tips.

Employers withhold taxes from employee paychecks through payroll deductions, which the company pays to the Internal Revenue Service (IRS) and other state and local agencies

Payroll taxes you must collect from employees

As an employer, you are responsible for collecting, reporting, and paying both your share and your employee’s portion of payroll taxes. This includes:

  • Medicare and Social Security taxes (FICA)
  • Federal income taxes
  • State income taxes (if applicable)
  • Local income taxes (if applicable)
  • Unemployment insurance taxes
  • Disability insurance taxes (if applicable)

FICA

Under the Federal Insurance Contributions Act (FICA), the federal government collects taxes to fund Medicare and Social Security.

Social Security taxes

In 2022, the Social Security portion of FICA remains at 6.2% for the employer and 6.2% for the employee for earned income up to $147,000 per year. Employees earning more than $147,000 are not responsible for Social Security taxes on any income above that amount.

The base rate for Social Security taxes of 6.2% has not changed since 1990, but the cap on income changes annually.

Medicare taxes

The Medicare portion of FICA does not have a cap. Both employers and employees pay a flat rate of 1.45% each with no limit based on earnings.

Additional Medicare taxes for high earners

Employees are also subject to an additional 0.9% Medicare tax if classified as a “high earner” by the IRS. This applies only to those with earned income of $200,000 ($250,000 for married couples filing jointly) or more. Employers must collect and pay this tax for their employees, but there is not any employer portion for this tax.

Federal income tax

Employers withhold federal income tax on behalf of employees and pay them quarterly to the federal government. The amount of tax you collect will depend on an employee’s gross pay and how many deductions they claim on their IRS Form W-4.

There are two different methods for calculating the amount of federal income tax to withhold: the wage bracket method and the percentage method. IRS publication 15-T details the two methods and the formulas to use to determine employee withholdings. This can get complex quickly. The worksheet for the percentage method has more than 50 individual calculations to complete. The worksheet for the bracket method has 15 calculations and 14 pages of charts to use.

Most companies use payroll software to calculate this for them.

State income tax

Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming do not have state incomes taxes for earned income reported on W-2s. Outside of these states, companies also have to deduct the right amount of state taxes from paychecks and report it to the IRS and state tax agencies.

State taxes can vary greatly by jurisdiction, not just by the rates but with how they treat taxes to withhold from paychecks and for things like health savings accounts and other deductions. There are flat rates in some states, while others have a sliding scale depending on earning levels.

View the state income tax rates for 2022.

Local income tax

Employees and employers may also be responsible for paying local city or county income taxes as well, even for people who work in one area but live in another. Seventeen states and the District of Columbia allow cities, counties, and municipalities to levy income taxes on top of state taxes, but there’s a wide variation in rates.

Some localities like Aurora, Colorado, charge a flat $2 a month. Most, however, charge a percentage ranging from less than 1% to as high as 3.87%.

View a summary of key city, county, and local income tax rates.

For all the above employee deductions, employers should be aware of any pre-tax deductions employees are having taken out of their checks for benefits. These can include health insurance premiums, HSA or FSA contributions, and retirement plan contributions. Depending on the type of deduction, it may reduce any or all of the above tax obligations for employees.

Payroll taxes you’re responsible for as an employer

As an employer, you are required to deduct the appropriate amount of taxes from your employees’ checks and pay them on their behalf. There are also employer payroll taxes you are solely responsible for:

  • Employer’s share of FICA taxes
  • Federal unemployment tax act (FUTA) taxes
  • State unemployment tax act (SUTA) taxes
  • Workers’ compensation

FICA for employers

As noted, both employees and employers have a tax obligation under FICA. Employers pay 6.2% of an employee’s wages for any income an employee earns up to $147,000. Employers also pay a flat rate of 1.45% of all employee income earned.

FUTA taxes

Employers must also pay taxes under the Federal Unemployment Tax Act (FUTA). FUTA taxes fund state workforce agencies, such as those that collect, manage, and enforce state unemployment taxes.

Employers are required to pay FUTA taxes on wages paid to employees that are not household or agricultural employees and meet one of these two tests:

  • Paid wages of $1,5000 or more to employees during any quarter
  • Had one or more employees during any part of a day in 20 or more different weeks. This includes full-time, part-time, or temporary employees.

The FUTA tax rate is 6% on the first $7,000 an employer pays to each employee annually. However, employers may be eligible for a credit if they also pay state unemployment taxes. In some cases, this credit can offset as much as 5.4% of FUTA taxable wages.

State unemployment taxes

The State Unemployment Tax Act (SUTA) authorizes states to collect unemployment taxes, too. Depending on the state, the employer may have to pay all of the state unemployment taxes or it is a split between employers and employees.

Workers’ compensation insurance

Workers’ compensation pays for benefits in case an employee files a claim under worker’s comp due to a work-related illness or on-the-job injury. In some states, you can buy coverage through a private insurance company, but in most states, you must pay worker’s comp taxes through the state.

Technically, this is not a tax but a legally required commercial insurance policy. How much you pay will also vary depending on how risky your industry is. It gets complicated fast as employers must take into account such items as class code rate, the Experience Modification Rate (EMR or X-Mod), and payroll rates.

What’s the process for collecting and remitting payroll taxes?

Employers have the responsibility to collect payroll taxes from employees, file regular payroll tax reports, and pay both the employee and employer portion of their taxes.

To collect taxes, employers withhold the appropriate amounts from an employee’s paychecks during each payroll period.

Federal payroll taxes

Employers must file federal taxes with the IRS quarterly using IRS Form 941 along with an annual income tax return. With Form 941, employers also report FICA taxes due.

Payroll taxes aren’t paid annually like personal income taxes. In most cases, you are responsible for paying federal payroll taxes either monthly or semiweekly depending on the amount of taxes you pay.

  • If federal income taxes and FICA amount withheld from employees is $50,000 or less annually, employers can pay monthly. Tax deposits will be due on the 15th day of the following month.
  • If federal income taxes and FICA amounts withheld from employees total more than $50,000 annually, employers must deposit funds semiweekly in the week following the payroll period.
  • Businesses that are less than a year old should follow the monthly deposit schedule.
  • Employers must file IRS Form 940 annually and pay any FUTA balance of $500 or more each quarter (by the last day of the month following the end of the quarter.

View due dates for federal employment taxes.

The IRS requires businesses to make their tax payments through the Electronic Federal Tax Payment System (EFTPS). Many states also have similar electronic payment portals to handle state taxes.

State payroll taxes

Most states follow the same guidelines as federal taxes and require businesses to file their tax taxes quarterly. Businesses typically can remit tax payments monthly or quarterly depending on the amount of the tax liability and state rules.

Most states require employers to pay SUTA every quarter.

For both state income taxes and SUTA, businesses should check with their state’s tax authority to make sure.

Workers’ compensation

Payment of worker’s comp will vary depending on state regulations and whether you pay through the state or use a private insurance carrier.

Local income taxes

Check with your local tax jurisdiction to determine when local income taxes are due, although most jurisdictions require the same quarterly payment schedule as federal income taxes.

Other tax reporting and payment obligations

Other tax reporting and payment obligations include:

  • IRS Form 943: The annual payroll tax return for agricultural employees
  • IRS Form 944: Some small employers are eligible to file and pay employment taxes annually rather than monthly or semimonthly. If so, they would use form 944 to do so.
  • IRS Form 945: Reporting of nonpayroll disbursements, such as pension distributions.
  • Social Security Administration Form W-3: Summarizes all W-2s from employees and includes copies of all W-2 forms.
  • IRS Form 1096: The Annual Summary and Transmittal of U.S. Information Returns is a summary used to report nonemployee compensation. These are payments to independent contractors or individuals that are not employees. Employers are not required to withhold or pay taxes on these payments. However, they must report any amount of $600 or more paid to any contractor during the calendar year.

Consider a payroll company

Payroll taxes are a crucial part of running a business. If you make a mistake, you can face significant payroll tax penalties — even if the mistakes are unintentional. The biggest fines go to companies that are intentionally violating the rules. According to the IRS, the most common schemes to avoid paying employer payroll taxes include:

  • Paying employees in cash to avoid tax payments
  • Filing false tax returns
  • Understating the amount of taxes owed
  • Not reporting or paying for taxes withheld from employee paychecks

Willful behavior to avoid paying taxes is a felony and can lead to significant fines and even jail time.

Because of the complexity of calculating taxes and managing compliance, many companies choose to engage a payroll service provider to handle their payroll for them. A payroll company can assist with certain aspects of tax collection and payment or handle all of your payroll processing and taxes for you.

Most payroll companies will manage:

  • Automatic payroll processing
  • Tax withholding and wage garnishments
  • Preparation and filing of payroll taxes
  • Payroll reporting
  • Self-service options for employees to review pay statements or update withholding

Payroll companies also stay on top of changing regulations. This ensures companies remain in compliance to accurately pay their taxes and avoid any fines for noncompliance.

In most cases, payroll service providers can integrate with business financial systems and help you figure out how to do payroll efficiently.

Payroll taxes are complex

As you can see, an employer’s payroll tax responsibilities are complex and vary greatly depending on your location, industry, and payroll size. To make sure you are accurately calculating, withholding, paying, and filing your payroll taxes, make sure you have trained and dedicated payroll administrators on staff, work with a tax and accounting professional, or use a payroll service provider.

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