Collecting and filing payroll taxes is an essential task in any small business. As a business owner, it’s your responsibility to ensure you’re withholding the proper amount of tax from employee paychecks, compiling data to report to the IRS, and remitting payments promptly. You may pay late fees and penalties if you don’t do these things.
At CMP, we work with small business owners every day to help them with payroll taxes, such as understanding which payroll taxes are paid by employers only. And take advantage of all available tax credits. We recognize how important it is for small business owners to be informed about their responsibilities and to have a strong understanding of how to calculate, withhold, file, and pay their taxes. With that in mind, we have created this guide to help you understand and pay your payroll taxes.
What is Payroll Tax?
Payroll taxes are any taxes that are calculated and paid based on the taxable wages of employees, whether you pay them hourly or they’re on a salary. Since the basis for these taxes is employees’ earnings, they are withheld from the employee’s paycheck and remitted to the appropriate government agencies.
We’ll discuss these in more detail later, but some of the specific taxes that fall under the payroll tax umbrella include federal and state income tax withholding, federal and state unemployment taxes, Social Security taxes, and Medicare taxes.
It’s important to note that the federal payroll tax typically includes the employee’s and employer’s portions. For example, the employer and employee are responsible for part of the Medicare and Social Security taxes deducted from paychecks.
Payroll Taxes Versus Income Taxes
The term payroll tax is most often used to refer to Social Security and Medicare taxes, but it may also apply to any tax that’s withheld from employees’ pay and processed through payroll.
The primary difference between payroll taxes and income taxes is that payroll taxes are split, with both the employer and the employee having financial obligations. By contrast, personal income taxes are paid only by the employee, and they bear the full responsibility for that payment.
While small businesses are not responsible for paying employees’ income taxes, they are responsible for making the right calculations, withholding the proper amount, and remitting the amount to the IRS and state taxing agencies on time. Failure to do these things can cause real problems for your employees, so it’s essential to understand your obligations and take care of them.
Which Payroll Taxes Are Paid by Employees?
Here’s an overview of which taxes are paid by employees and withheld from their paychecks by employers. We’ll go into detail about calculations later in this guide, but keep in mind that withholding is based on the employee’s withholding status as provided on their W-4. It’s essential to note that while the employee pays these taxes, it’s still the employer’s responsibility to withhold the proper amounts and send them to the proper taxing authority.
Federal Income Tax Withholding
As we noted above, federal income taxes for each employee are the employee’s responsibility. Employers are tasked with calculating and withholding taxes based on the employee’s taxable wages and filing status, but the employee pays the entire amount of federal taxes due.
Any State and Local Taxes
State income taxes and any other state or local taxes are also withheld from the employee’s paycheck and are the employee’s responsibility to pay and file. Keep in mind that there are two taxes with shared responsibility, and they’re covered in the next section.
Which Payroll Taxes Are Paid By Employers?
While employees are responsible for many of the taxes withheld from their pay, employer payroll taxes include these two types of unemployment tax. Both are the sole responsibility of the employer.
Federal Unemployment Taxes (FUTA)
The Federal Unemployment Tax Act created a fund to help states pay unemployment when state resources are insufficient. The tax rate as of 2023 is 6%. Employers must pay the tax for any employee who was paid $1,500 or more during any quarter of 2021 or 2022. The tax applies to the first $7,000 of wages, and there may be a different wage base in some states.
State Unemployment Taxes
State unemployment taxes are also the responsibility of the employer, and amounts vary from state to state. We should note here that there are a few states–Alaska, New Jersey, and Pennsylvania–that require employees to contribute to state unemployment tax.
Payroll Taxes Shared Between Employers and Employees
Finally, two taxes require contributions from both employers and employees.
Social Security Tax
The total Social Security tax must be paid is 12.4%. The responsibility for payment is split evenly between employees and employers, with the employee and employer portions equaling 6.2% as of 2023. Keep in mind that the self-employed are responsible for the full 12.4% of the money they earn. The maximum taxable amount is $168,600 for 2024.
Medicare tax is also split between the employer and the employee. The employee share and the employer share are both 1.45% of the employee’s wages for a total of 2.9%. These numbers apply to all earners making up to $200,000 per year.
There’s also a Medicare surtax of 0.9% for single earners making more than $200,000 per year. We should note that the surtax is the sole responsibility of the taxpayer (employee). However, it’s the employer’s responsibility to calculate and withhold any surtax that’s applicable.
How Payroll Taxes Are Calculated
Now, let’s go into detail about how employers calculate employee and employer payroll taxes. The calculations may be simple or complex depending on the tax and the employee’s earnings.
Tax Bracket Method
The tax bracket calculation method is the simplest method for calculating payroll tax withholdings. Most companies that handle payroll internally use it, which uses the federal tax brackets as a framework. Employers can instruct their payroll department or accountant to use this method.
Simply stated, withholdings using this method are calculated based on the employee’s federal tax bracket. Since the brackets don’t change within a tax year or from employee to employee, it’s possible to program the brackets and avoid doing any calculations when it’s time to run your payroll.
As a reminder, employees pay a percentage of their wages as taxes. Federal income taxes are bracketed, with individuals paying a higher percentage as their wages increase. For example, the tax rate for earnings up to $10,275 is just 10%. As the percentages increase, taxes are calculated only on the earnings in each new bracket.
It’s important to remember that this method works with up to 10 allowances, including dependents, tax credits, and additional employment, as specified on the employee's W-4 form.
The percentage method is far more complicated than the tax bracket method and requires complex calculations that are best handled by a professional payroll service. This method uses the employee’s tax status and allowances as claimed on their W-4 form to calculate tax withholding accurately.
Unlike the tax bracket method, the percentage method allows for the calculation of withholdings for employees with more than ten allowances on their W-4. The easiest way to calculate using the percentage method is to use IRS Publication 15-T, which includes a percentage calculation table and form.
It’s important to note here that it’s the employee’s responsibility to make accurate allowance claims on their W-4. If you use the percentage method based on their claims and they end up owing more tax than you withheld, that’s their responsibility and not yours.
Common Payroll Tax Pitfalls
Payroll and tax withholding pitfalls and mistakes are easy to avoid if you know what they are and understand your responsibilities. Here are some of the most common pitfalls, with some tips on how to sidestep them.
1. Employee Misclassification
Classifying employees properly is a must if you want to avoid mistakes with your payroll taxes. For example, you’ll need to double-check their employment status to be sure you’re properly classifying them as exempt or non-exempt and paying overtime when it’s due.
You’ll also need to be careful about classifications of contract workers and freelancers since there’s no withholding requirement for them. If you were to classify an employee as a contractor or not pay overtime to someone who’s earned it, you’d be in violation of the Fair Labor Standards Act (FLSA) and may be fined.
2. Failing to Report Every Taxable Form of Compensation
In addition to regular salaries and wages, there are other forms of employee compensation that may be subject to federal income tax withholding. These may include things like:
- Stock options
- Employee discounts
- Achievement travel
Report these benefits to avoid penalties down the road. Working with a tax professional and a payroll service will ensure that you report all taxable earnings and withhold what’s necessary to avoid tax penalties.
3. Keeping Incomplete Records
A common payroll error for companies that handle payroll internally is failing to keep complete payroll records for the required time. The FLSA requires employers to maintain three years’ worth of payroll records, including payment rates, hours worked, and payroll dates.
Keep in mind that some states require more stringent record-keeping than the federal government. While you may never need to provide these records to the IRS or your state taxing agency, not having them on hand can complicate your financial and legal situation. So, your best bet is to keep meticulous records of everything related to your payroll and payroll taxes.
4. Missing Deposit and Filing Deadlines
Meeting federal and state tax filing and deposit deadlines is essential to your tax compliance as an employer. You must report your taxes and pay any taxes you have withheld from employees’ paychecks on time to avoid late fees and penalties.
This is another area where working with a professional accountant and payroll service may be beneficial. Any service you use will have processes in place to make sure deposits are made on time and that you have the information you need to file quarterly taxes and your annual tax return.
5. Incorrect Wage Garnishments
Wage garnishments may require employers to withhold employees’ taxable income to pay back taxes, penalties, or child support. It’s essential for garnishments to be calculated and withheld accurately.
Mistakes in this area may negatively impact employees. For example, if wages are withheld improperly or above what’s owed, employees may have difficulty getting their money back. They may end up facing additional penalties if you don’t withhold enough.
Navigating Payroll Tax Complexity with CMP's Team of Tax Professionals
Every employer is responsible for withholding, filing, and paying payroll taxes, and it’s essential to do it correctly. This guide will help you navigate payroll taxes and avoid some of the employers' most common mistakes.