To keep a small business running smoothly, you need a tax professional. They not only make sure you remain compliant with all tax regulations, but they are also a valuable resource when business owners become entangled with problems.
When operating a small business, payroll is one of the largest operating costs and one of the biggest administrative burdens. Approximately 1/3 of small businesses spend more than six hours a month on payroll duties.
Payroll errors can cost small businesses huge penalties. In 2019 the IRS levied just under $5 million in payroll tax penalties, rendering an additional $13.7 billion in revenue for the country. Misclassifying workers is a common error, with 10% to 20% of employers making the mistake of classifying employees as independent contractors.
If you find figuring payroll taxes/withholding taxes confusing, you are not alone. To learn about your obligations – keep reading! We are going to share some tips to help you understand how to properly calculate employer payroll taxes.
1. Payroll Tax Obligations
Every small business owner with employees has an obligation to withhold payroll taxes. To properly withhold taxes, deductions from every paycheck must include FICA (Medicare and Social Security), federal income tax, state income tax, and any local income tax.
To calculate the proper payroll taxes, you need to determine who your taxable workers are and what the taxable wage amount is. You then need to calculate the withholding amount at the proper payroll tax rate.
2. What Is a Taxable Worker?
Many business owners are unsure about whether a worker is an employee or an independent contractor. Employees are taxable workers subject to payroll taxes. This is a person you direct and control regarding the manner in which they perform their duties.
You pay an independent contractor for the work they do. You take no payroll tax deductions from their payment. This person performs a service for you under a contract or sales agreement. You do not control the manner in which they perform their work. An independent worker is responsible for paying their own taxes to the government.
The IRS realizes that business owners have difficulty classifying workers. The relationship tests help determine how to classify a person as an employer vs contractor.
- Behavioral Test – the employer/business owner has the right to direct and control the person performing work
- Financial Test – an independent contractor has control over the supplies they use and is not tied to one company but can advertise and perform services for anyone they choose
- Relationship Test – if the period in which the person is performing work is open-ended, they are an employee, if the relationship is for a specific project only, the person is an independent contractor
3. Calculating Federal Income Tax Withholding
You must withhold federal income tax from every paycheck you issue to a taxable worker. You can calculate this tax using tax tables from the IRS.
The wage bracket tables are set up to determine withholding using the length of the payroll period—monthly, semi-monthly, bi-weekly, weekly, or daily. You select the appropriate pay period and wage bracket for the employee and read across the table to the appropriate column for that person’s filing status.
Percentage tables are set up for the same five payroll periods with a further division for filing status. You reduce the employee’s wages by the value of the exemptions they claim, then use the table to locate the withholding amount for their wage bracket.
You will need to determine which table is most accurate for your business. The percentage tables are more inclusive and will work better if you have employees paid at different payroll periods.
4. Calculating State Taxes
The payroll tax rate for state income tax varies depending on state law. There are eight states that do not have any income tax taken from payroll: Wyoming, Washington, Texas, Tennessee, South Dakota, Nevada, New Hampshire, Florida, and Alaska. The state of New Hampshire collects income tax on investment income and interest, but that is being phased out completely by 2027.
The state of Pennsylvania bases state taxes on a fixed percentage of gross wages. In Arizona state taxes are a fixed percentage of the federal tax.
Kansas, along with more than half the states in the country, has a variable tax rate. For 2021 it began at 3.10% for incomes up to $15,000 if single or $30,000 for married couples filing jointly. The highest level is 5.70% for incomes of $30,001 if single and $60,001 if married filing jointly.
In Oklahoma, the state income tax rate varies depending on the amount of taxable income. For 2021 the highest rate of 5.00% was collected on incomes over $7,200.
For the 2022 tax year, all individual income tax rates in Oklahoma are reduced by 0.25%, which lowers the highest level to 4.75%. Residents enjoy having the 9th lowest income tax rate in the country.
Calculating payroll taxes correctly is important. If you have any questions don’t guess. Contact a professional tax service like Polston Tax to get the answers you need.
5. Calculating FICA
The Federal Insurance Contributions Act (FICA) requires employers to take payroll withholding for Social Security and Medicare. The employer and employee share the FICA tax on a 50/50 basis.
The combined FICA rate is 15.3%, with 12.4% going for Social Security and 2.9% to Medicare. Both employee and employer each pay 1.45% on Medicare and 6.2% on Social Security. If you are self-employed, you must pay the entire 15.3% yourself.
Social Security tax is only payable up to the first $142,800 of income in 2021 and the first $147,000 in 2022. Medicare does not have an income limit.
6. Additional Medicare Tax
There is an additional Medicare tax paid by the employee only if their wages exceed $200,000. The tax is withheld for wages over $125,000 on married employees filing separately, $200,000 for singles, and $250,000 for married filing jointly.
Your business does not have a business tax obligation on the additional tax. You do have an obligation to withhold it from your employee’s wages.
7. Federal Unemployment Tax
Employer payroll taxes obligations include the Federal Unemployment Tax Act (FUTA) of 1939. This law requires businesses with employees to pay this tax either annually or quarterly as part of their payroll taxes if either of the following applies:
- You pay wages of at least $1,500 during a quarter
- You have at least one employee working for a total of 20 consecutive or non-consecutive weeks during a calendar year
As of 2021, the FUTA tax rate is 6% on the first $7,000 in wages you pay each employee each year. If you also pay state unemployment insurance your business may receive a federal tax credit of up to 5.4%. This lowers your FUTA rate to 0.6%.
The revenue funds unemployment benefits and job service programs in all states. The tax is based on employee wages, benefits workers who lose their jobs, but is paid only by the business. You do not deduct this payroll tax from your employee’s wages.
8. Small Business Owners With No Employees or Self-Employed
If you are incorporated, even if you do not have outside employees, the above rules regarding taxes apply to your own paychecks. This is because you are the sole employee of the corporation.
If you are not incorporated and have no employees, you will need to pay estimated taxes against your self-employment income every quarter.
As a business owner, whether a partner, shareholder, or sole proprietor, you must make estimated tax payments on the business ownership earnings. This is mandatory if your total tax on investment credit recapture tax, built-in gains, and excess net passive income tax is $1,000 or more. A corporation must pay estimated taxes when anticipating a tax liability of $500 or more.
When self-employed you need to estimate the amount of tax you need to pay for the year based on your income. Your estimated tax is then paid on a quarterly basis to the IRS. This rule also applies to freelance workers and independent contractors who do not have taxes being taken from a paycheck.
At the end of the year, you file your normal tax return and pay any remaining tax due or request a refund. If your estimated taxes paid are not equal to at least 90% of your actual tax liability, the IRS will assess interest and penalties against the delinquent amount.
9. Employees Receiving Tips
If you have employees who receive tips of $20 or more per month, they must report their total tips to you. This report must be in writing by the 10th day of the following month. An excellent record-keeping method is to use the Employee’s Daily Record of Tips, Form 4070A, and the Employee’s Report of Tips to Employer, Form 4070 to ensure accuracy.
Tips include anything the employee receives. This includes tips directly from a consumer, added to a credit card charge, or as part of a tip-sharing program. Tips must be reported as income when the employee files their tax return.
Service charges you add to a bill your customers must pay, even if later given to the employee, are not tips. As a business owner, you cannot use non-tip wages when computing employer credit under IRS Code 45B. The service charges are non-tip wages subject to federal income tax and FICA.
Examples of non-tip wages, also called auto-gratuities, include:
- Large party charges—restaurants
- Bottle service charges—nightclubs and restaurants
- Room service charge—hotels and resorts
- Luggage assistance charge—hotels and resorts
- Mandated delivery charge—pizza or other retail delivery companies
You use the tip report from your employee to determine the amount of FICA and income tax you need to withhold. This information is combined with hourly wages to determine proper withholding. You must also pay the employer’s portion of the FICA.
Because of numerous regulations regarding tip reporting and taxes, you may wish to refer to Publication 15 (Circular E), Employers Tax Guide. To make sure you are in compliance with all rules and regulations, the best move you could make is to consult a tax law professional.
10. Pay on Time
In order to avoid costly penalties and late fees, it is imperative to make payroll tax payments on time. You may pay your federal taxes online using the Electronic Federal Tax Payment System (EFTPS).
You pay FUTA quarterly and the FICA and income taxes on a monthly or semi-monthly basis. The payment frequency is directed by the IRS, who will notify you at the end of each year of your payment requirements.
The determination of a payment being on time is its arrival date. If you can prove a payment was mailed at least two days before the due date, it will be considered on time.
11. Liability of Responsible Persons
As the employer, you have a responsibility to deposit the taxes you withhold according to the deadlines. You must also file all employment-related tax returns. Failure to follow these steps leaves you subject to penalties.
The employees who are responsible for depositing trust fund taxes are subject to 100% personal liability if they fail to make the deposits. Trust fund deposits are the money that is withheld from your employees’ paychecks.
If anyone with authority to make payment decisions willfully fails to deposit funds for taxes, the Trust Fund Recovery Penalty is triggered.
12. Tax Returns Regarding Employment Payroll Taxes
Business owners have an obligation to file federal tax returns regarding payroll taxes. These include:
- Form 940—annual FUTA tax return
- Form 941—employer’s quarterly tax return for withholding and employer’s share of FICA, also for credit to cover payments of mandatory sick leave during COVID-19
- Form 943—employer’s annual return for agricultural employees
- Form 944—For employers eligible to make an annual payment of employment taxes rather than on a schedule
- Form 945—federal income tax return for reporting non-payroll payments and pension distributions
- Form 7200—only if necessary to obtain advance credit of employment taxes
In addition to the federal requirements, you need to check on any state requirements where your business operates.
13. Required Reporting to Employees
As an employer, you have an obligation to report withholding to your employees. This is done using Form W-2.
You must also report withholding to the Social Security Administration using Form W-3. This form is transmittal, summarizing and including copies of all W-2s.
14. IRS Payroll Tax Deferral
Part of the 2020 COVID relief to employers and self-employed people is a delay in paying the employer’s share of Social Security tax liability. This is normally 6.2% of the employee’s wages.
Employers taking this option were sent reminders that half of the deferral amount came with a due date of January 3, 2022. The remaining half of the deferral is due January 3, 2023.
Deferral payments are made using the Electronic Federal Tax Payment System. To make sure you receive proper credit for the payment you must submit it separately from other tax payments.
15. Hire a Pro
When operating a business, make sure you are following all areas of law correctly and tax records are in order. This prevents sending up red flags with the IRS and is beneficial if you become the target of an audit.
When seeking out a tax professional, look for a company with a large team of that provides a variety of services. Your business will benefit from a group that can assist you with bookkeeping, tax planning, financial and accounting services, tax return preparation, and more.
When reviewing their website look for case results. You want a successful company that can show you how to calculate employer payroll taxes.
Ease Tax Responsibilities
You may be feeling overwhelmed about the payroll tax responsibilities business owners have. At Polston Tax, our experienced team of over 100 attorneys, CPAs, accountants, financial analysts, and case managers, can put your mind at ease.
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