What are payroll taxes and who pays them?
Both employers and employees pay payroll taxes, which are based on the wages that employees earn. The main types of payroll taxes are federal income tax, state income tax, Social Security tax, Medicare tax, federal unemployment, and state unemployment. Social Security tax and Medicare tax are generally known together as Federal Insurance Contributions Act (FICA) taxes.
For their employees, employers pay half of the Social Security tax and half of the Medicare tax. Employers also pay the federal unemployment tax. In most states, the employer pays state unemployment tax, too. However, some states require the employee to pay it as well.
Employees generally pay federal and state taxes through tax withholdings. The employee is also responsible for paying the other half of the Social Security tax and Medicare tax. Employees do not make these payments directly to the government. Instead, the employer withholds the employee's part of the payroll taxes from the employee's pay. The employer then sends both the employee's part and their own part of the payroll taxes to the right taxing agency.
Federal unemployment taxes (FUTA) are paid only by the employer. In most states, the employer also pays state unemployment taxes (SUTA). However, a few states, such as Alaska and Pennsylvania, may also require employees to pay into SUTA. Depending on the state, these taxes may not be called SUTA, but rather SUI tax, reemployment tax, or state unemployment insurance.
The employer pays half the FICA taxes, and the employee pays the other half. Generally, the employee pays the rest of the payroll taxes.
How do employers calculate withholdings from employee paychecks?
For 2023, Social Security taxes are equal to 12.4% of the employee's first $160,200 of pay. The employer and the employee each pay one-half of the Social Security taxes. The amount of pay that counts for Social Security taxes is based on the cost of living in the U.S. and typically increases each year. In much the same way, Medicare tax is 2.9% of all of the employee's pay. Again, this tax bill is split equally between the employer and the employee. There is also an extra Medicare tax of 0.9% on pay of more than $200,000. Only the employee pays the extra Medicare tax.
Employers must pay FUTA tax at a rate of 6% on the first $7,000 of each employee's pay. Most employers are also required to pay SUTA, but the amount differs from state to state. Some states may also charge the employee a SUTA tax. Although the FUTA tax appears to be simple, most employers get a tax credit to lower their FUTA cost based on the amount of SUTA they pay on their employee's earnings. This can make it hard to calculate the amount of FUTA.
To calculate your employee's withholding, you will need the employee's Form W-4, the employee's gross pay for the pay period, and the IRS income tax withholding tables and tax calculator. The income tax withholding tables will help you figure out the withholding for each employee based on their Form W-4 and gross pay. Gross pay is the amount an employee earns before any taxes are taken out. You can do a similar calculation to find your state withholdings.
Withholding mistakes can be rather costly. Until a business owner is confident that they can complete withholding calculations correctly on their own, new employers may want to reach out to a tax professional for help.
What happens if I make a mistake calculating withholdings?
Mistakes can easily happen when calculating payroll tax withholdings. If you withheld too much from an employee's paycheck, you are usually required to refund the employee. You can do so by giving the employee a check for the extra amount you withheld. Another option is to withhold less from the employee's future checks until the issue is corrected.
If you withheld too little from an employee's paycheck, you can withhold more from their future paychecks until you have withheld the proper amount. The other option is that your business could pay the missing amount.
Once you have corrected the payroll tax withholding amount, you may need to change the payroll tax return documents. Depending on the type of error and the tax documents you filed before discovering it, you may need to file a Form 941-X, Form W-2c, or other IRS forms. If the error is big, you may want to ask a lawyer for help to decide on how to fix it. Fines and interest may be charged if you did not pay the right amount of payroll taxes on time.
What do employers do with employee tax withholdings and deductions?
The law usually requires you, the small business owner, to send or deposit federal and state income tax withheld from your employee's wages to the proper government agency. This may include FUTA, SUTA, and the employer's and employee's portions of Social Security and Medicare taxes. Federal payroll taxes must be paid through the Electronic Federal Tax Payment System (EFTPS). You will likely need to sign up with the EFTPS before sending in federal payroll taxes. Your business will also generally be required to register with each state where you have employees. Your SUTA payments and state income tax withholdings will be paid directly to that state. Also, your business will probably be required to file a variety of payroll tax returns. Form 941, Employer's Quarterly Federal tax return, and Form 940, Employer's Annual Federal Unemployment (FUTA) tax return, are two of the most commonly required payroll tax return forms.
There are various filing deadlines for the different types of payroll taxes. The filing dates may also depend on the size of your business or the state you have employees in.
Employers are generally required to deposit federal employment taxes either monthly or every two weeks. The IRS publishes an Employer's Tax Guide that can tell you which of these is best for you. FUTA is typically paid every three months. SUTA and state income tax withholding vary by state. Most states have guides available online that explain how and when to turn in payroll taxes. For example, if you are in California, consult the 2023 California Employer's Guide.
Finding out the right timing for your payroll tax payments can be complicated. Asking a tax professional to help you develop a payroll tax deposit schedule can simplify the process.
What do I need to know about paying small business taxes for the first time?
You might be confused while trying to pay your business taxes for the first time. However, proper tax planning at the time you are forming your small business can save you headaches down the road. How and when you file your small business taxes usually depends on the type of business you run. It is important to remember that you may have to file taxes for your business even if it was not running during the tax year.
If you own a sole proprietorship or a disregarded LLC, you will probably file your business taxes on a Schedule C. The Schedule C is a form that is attached to your personal income tax return and has the same due date, usually April 15. If you run a C-corporation, partnership, or S-corporation, your business will likely file a tax return separate from your personal one.
C-corporation tax returns are typically due on April 15. Partnership and S-corporation tax returns are typically due on March 15.
Whether you file your small business taxes on your own or use the services of a tax professional, it is important to have accurate financial records for your business. You will generally need a Profit and Loss statement and a balance sheet to prepare your business tax return. If you are not familiar with bookkeeping, you may want to hire an accountant who can set up your business's accounting system.
If you have a legal question about payroll or small business taxes, reach out to a Rocket Lawyer network attorney for affordable legal advice. Want to leave figuring out complicated tax credits and deductions to the pros? Get matched with a tax pro via Rocket Tax™ to save time and money filing your tax returns.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.