When thinking about taxes, small business owners focus their attention on federal and state income taxes. However, if you have employees, you have to satisfy the federal employment tax rules and keep up with changing regulations. Easier said than done! Dreadful statistics show that 40% of small businesses pay an average of $845 payroll tax fines each year.
The updated IRS rates for 2021 show that the maximum total penalty can go as high as 47.5% of the tax. Costly fines are not the worst restraining circumstances a small business can face. You can get a real prison sentence for breaking federal payroll tax rules.
The bottom line is clear: negligence with payroll tax calculations and payments can be ruinous! What can you do to keep your business on the safe side? This article will provide you with a detailed guide on dealing with taxes paid by an employer on behalf of employees.
Understanding your payroll tax obligations
The first thing to take care of when you hire your first employee is to get a federal employer identification number (EIN). You may also need to get state and local tax numbers as well. The EIN will be used on your deposits, returns, and other related documents. Now, you are a legal employer complying with federal payroll tax rules! As an employer, you have obligations to the government and the tax agencies, like the IRS (Internal Revenue Service) and SSA (Social Security Administration), as well as to your employees.
By federal law, employers are required to make contributions to fund social programs, such as Social Security, Medicare, Social Insurance and Retirement programs, etc. There may be state and local payroll withholdings too.
All in all, an employer’s tax duties are to make federal payroll tax payments to the government and file the proper reporting and informational returns on time. Employers are also expected to provide employees with appropriate documentation.
To sum things up, small business payroll tax rules require an employer to:
- Withhold federal payroll tax from an employee’s paycheck and deposit the amount withheld. It means employers must pay their share of payroll taxes to the government. In some states, there may be local deposit requirements as well. Make sure to contact the tax agency for precise information.
- File reporting and information returns to the tax agencies, submitting proper payroll filing forms. Which means you must notify the government about taxable payments. You must properly report income, amounts withheld, and amounts paid on behalf of employees and contractors.
- Provide employees and contractors with the IRS assigned forms explaining the compensation paid and amounts withheld.
Things can get complicated, so having the IRS document on the employment tax compliance for 2021 at hand is a good idea. In case a question pops up, you can always refer to the legal files.
What is a payroll tax made of
Payroll tax is money withheld from employees’ payroll. It’s not a single, but a compound tax with a variety of minor taxes summed up.
Briefly, payroll tax consists of federal and state income taxes, FICA taxes (Social Security and Medicare), and FUTA taxes (a contribution to the federal unemployment pool). There are both obligatory and optional payments, which are called statutory and voluntary payroll tax deductions.
As opposed to payroll taxes, the IRS uses a more official term employment taxes to describe an employer’s obligations to the government. People may find this intersection of terms confusing, but they are generally the same, excluding the self-employment tax. Self-employment tax falls into the IRS category of employment taxes, but not in the payroll tax, because as a small business owner, you’re self-employed, and you don’t get paid a salary yourself.
Calculations of payroll tax deductions
Paycheck deductions make the difference between the gross pay and net pay your employees get. It might seem simple on the surface, but payroll calculations require attention to detail and extreme accuracy. Double-check all calculations and monitor earnings statements to make sure all paycheck deductions are correct. If you aren’t using payroll software, you should consider one. There are various payroll solutions on the market for small businesses, so you can find the one that works best for you.
For example, Gusto payroll is perfect for SMB owners who need help with getting records ready for filing returns to the tax agencies. Integrate the payroll software into your accounting system via a third-party app, like Synder, to get the most out of it. Gusto integration with accounting allows you to easily import employee data in the accounting system like QuickBooks or Xero. All your employees’ records will be transferred and securely kept in a couple of clicks. Easy reconciliation and reporting are guaranteed! Accurate and timely compliance will never be a pain again.
But how to make payroll calculations, anyway? Start with determining the pay period. Proceed with calculating the total amount earned by an employee during this pay period. The total amount of money you paid your employee should contain hourly wages, overtime pay, bonuses, profit sharing, gifts to an employee, and all other kinds of compensation. This amount is also known as gross pay. Next, withhold (deduct) percentages from an employee’s paycheck.
Statutory small business payroll tax deductions contain:
- Federal income tax withholdings
- State income tax withholdings, if applicable
- Local tax withholdings, such as city, county, or school district taxes, if applicable
- FICA — Federal Insurance Contributions Act taxes
- Social Security withholding of 6.2% in 2020 and 202, up to the annual maximum taxable earnings or wage base of $137,700 for 2020 and $142,800 for 2021
- Medicare employee tax withholding of 1.45%
- Additional Medicare tax withholding of 0.9% for employees earning over $200,0001
- FUTA — Federal Unemployment Taxes
- SUTA — State Unemployment Taxes, if applicable
After the statutory payroll tax deductions are calculated, you can think of the voluntary ones. They can only be withheld with the employee’s consent and may include:
- Health insurance premiums (like medical, dental, and eye care)
- Life insurance premiums
- Retirement plan contributions (401(k) plan)
- Employee stock purchase plans, such as ESPP and ESOP plans
- Meals, uniforms, union dues, and other job-related expenses
After both legally required and voluntary paycheck deductions are subtracted, the employee receives their net pay. Finally, pay (deposit) the calculated tax deductions to the tax agency.
Payroll tax deposit rules
Payroll taxes are paid to the IRS either semi-weekly or monthly. Payroll tax deposit due dates depend on how many employees you have and how much payroll taxes you owe:
- Monthly Depositor — deposit during a month by the 15th day of the following month.
- Semi-weekly Depositor — deposit on Wednesday, Thursday, and/or Friday by the following Wednesday; deposit on Saturday, Sunday, Monday, and/or Tuesday by the following Friday.
- FUTA Deposits — Different deposit rules apply to FUTA taxes. Deposits for FUTA Tax are required for the quarter within which the tax due exceeds $500. Pay by the last day of the first month that follows the end of the quarter. If the due date for making your deposit falls on a Saturday, Sunday, or legal holiday, you may make your deposit on the next business day.
Bear in mind that under employer payroll tax deposit rules, you need to make all federal tax deposits through the Electronic Federal Tax Payment System (EFTPS).
Halfway through! The next thing to do is reporting wages, tips, and other compensation paid to an employee. Check the IRS schedule not to miss payroll tax reporting due dates in 2021. Time to move on to the following chapter.
Payroll tax filing forms
The next big thing coming after you calculate deductions and deposit the payroll tax withholdings is reporting tax returns or filing.
Payroll filing is reporting information that you used to calculate employer payroll taxes to the IRS. It is to be done using forms and strictly within a period set by the IRS. Contact local tax agencies to find if you’re required to file state and local reports.
The most common payroll tax filing forms assigned by the IRS are:
- Employer’s Annual Federal Unemployment (FUTA) Tax Return (Form 940)
- Employer’s Quarterly Federal Tax Return (Form 941) This return shows:
- the amount collected for income tax withholding from employees
- the amount collected for FICA withholding (Social Security and Medicare) from employees
- the total amount owed for FICA withholding (including the employer portion of this tax)
- Annual Return of Withheld Federal Income Tax (Form 945)
- Employer’s Annual Federal Tax Return (Form 944)
- for the employers, whose annual liability for Social Security, Medicare, and withheld federal income taxes is $1,000 or less
- Wage and Tax Statements (Forms W-2)
You must also include the amounts you have deposited for your employer payroll taxes. If your deposits are less than the amount owed, you must pay the IRS. Be precise with these reports, since they will allow you to request payroll tax refunds for the overpayment of taxes, in case it happens.
Choose the way to report:
- File manually by completing the payroll tax forms according to instructions provided by the IRS. Mail the form to the IRS, along with any payment you owe.
- Use tax software or service to file it electronically.
- Get professional help from an accountant or tax professional (which is also a great idea if you want to maximize your payroll tax refund).
Common payroll tax mistakes for a small business to avoid
Keeping up with employment regulations may be difficult. There are plenty of places to stumble, but we’d like to warn you about the most common ones that SMB owners repeat. It’s always better to learn from other people’s experiences.
- Filing independent contractors as employees. The amount of money you pay to a contractor is non-employee compensation. Contractors report and pay their payroll taxes. You don’t have to deposit income or FICA tax withholdings from your contractor’s paychecks. But you have to file an annual report for contractors (1099-MISC or 1099-NEC) to the IRS. If you file your employee as a contractor, you will have to pay back taxes for their work along with accrued penalties and interest.
- Calculating overtime wages like regular wages. Overtime wages are not your employee’s regular wages. They are calculated differently. Federal law states that an employee must get not less than 1.5 of their regular pay as overtime wages. States may present different overtime requirements.
- Keeping not enough payroll records. Maintain proper documentation to support the figures you report to the tax agencies. A tax entity may request documentation to back up your payroll tax returns. Record information accurately about hours worked, wages paid, overtime, bonuses, tips, holiday pay, vacation pay, and sick pay of your employees. Solutions like Gusto integration with accounting may be of great help to execute this responsibility.
Meeting small business payroll tax regulations is difficult, and penalties for noncompliance can be severe. We hope this article gave you a clearer view of taxes paid by an employer on behalf of employees.
Be careful to maintain compliance with your state and federal regulatory bodies. Avoid payroll mistakes and reduce your risk of incurring penalties and interest for unpaid or underpaid taxes. Get reliable technical help and free yourself some energy to concentrate on what matters — your business. Because apart from paying taxes, the SMB owner has loads of things to do. You know it better!