Taxes can be complicated, whether you’re filing your own personal taxes or business taxes. When you’re a business owner, it’s essential to get your payroll taxes correct, or there could be consequences with the government ranging from fines to audits. Learn as much as you can about payroll taxes so that you can be confident that they’re run correctly every time.
What Are Payroll Taxes?
Payroll taxes are any federal or state taxes that are based on an employee’s compensation. Every business will owe federal income taxes, but what is required at the state level may vary depending on the location of the business. Payroll taxes are divided into several categories.
Income Tax Withholdings
Income tax withholdings are taxes based on an employee’s income that are withheld from their paychecks throughout the year. While the business owner isn’t responsible for paying this particular tax, they are for calculating the amount to be withheld and making sure that it is withheld from the paychecks of W-4 employees.
The FICA tax is a federal income tax that stands for Federal Insurance Contributions Act. This particular payroll tax is paid by both employees and employers. The employee contribution is included in their income tax withholdings. FICA taxes cover two different types of tax, which are subject to all forms of taxable compensation, including:
- Taxable fringe benefits
- Salary reduction contributions to a 401(k) or similar plan
- The contributions themselves may not be taxable
Social Security Taxes
The Social Security tax is also called the OASDI, which stands for Old Age, Survivors, and Disability Insurance. It consists of 6.2% of all taxable compensation and is used to provide benefits to those who are retired or disabled or who are their spouses, former spouses, or dependent children.
The other half of FICA taxes is Medicare taxes, which make up 1.45% of taxable compensation. By paying this tax, employees can later qualify for Part A Medicare when they’re eligible. There’s no additional cost for Parts B, C, or D.
FUCA stands for Federal Unemployment Tax Act and is the federal unemployment tax. This payroll tax is paid exclusively by employers and applies only to the first non-exempt $7,000 (as of 2023) paid to each employee.
State Unemployment Taxes
Some states may also charge an unemployment tax to employers. In some cases, employees may also be required to pay a portion of this tax.
What Are a Business Owner’s Payroll Tax Responsibilities?
When it comes to payroll taxes, there are certain responsibilities that a business owner must handle.
Calculating Income Tax Withholdings
It may be the employee who is paying the income tax, but it is the employer who is responsible for calculating what is owed. Doing this manually can be very time-consuming and prone to errors, especially if there are employees who are paid at different rates and live in different areas of the country.
How to Calculate Tax Withholdings
What percentage of an employee’s pay is withheld for income tax purposes depends on their rate of pay. For example, someone making less than a certain amount may not be required to pay payroll taxes at all. For those who do, the percentage of taxes withheld increases as income rises above certain thresholds. Only the income that is above that threshold actually gets taxes at the new amount, however, rather than a higher tax rate applying to all of the income.
Note that the IRS may change the tax rates and the income brackets for those different rates. It’s therefore essential to double-check the current tax rates and brackets each year.
Income Tax Brackets
As of 2023, the income tax brackets are:
|Tax Rate||Filing Singly||Filing Jointly||Filing as a Head of Household|
|10%||$0 – $11,000||$0 – $22,000||$0 – $15,700|
|12%||$11,001 – $44,725||$22,001 – $89,450||$15,701 – $59,850|
|22%||$44,726 – $95,375||$89,451 – $190,750||$59,851 – $95,350|
|24%||$95,376 – $182,100||$190,751 – $364,200||$95,351 – $182,100|
|32%||$182,101 – $231,250||$364,201 – $462,500||$182,101 – $231,250|
|35%||$231,251 – $578,125||$462,501 – $693,750||$231,251 – $578,100|
Tip: Use Payroll Software
The best way to accurately calculate income tax withholdings and stay up-to-date on any changes to the federal tax brackets or state income tax rates is to use payroll software. Not only does this save you time by handling all of the complex calculations for you but it may also file taxes for you and help to ensure greater accuracy.
Withhold Income Taxes
Once the appropriate amount of income taxes has been calculated, that amount has to be withheld from each paycheck paid to employees. Business owners may also have to withhold other amounts, such as:
- 401(k) contributions
- Wage garnishments
- FSA contributions
Even though these are not payroll taxes, these withholdings are still the responsibility of the business owner.
Deposit Withheld Taxes
It’s also the employer’s responsibility to deposit the taxes that are withheld from employee paychecks unless you’re the owner of a very small business. As of 2023, the limit is a tax liability of $2,500. Small businesses that owe less than that in taxes don’t have to make deposits but can instead send in withheld income tax with their tax returns.
File Quarterly Reports
Business owners also have to file quarterly reports regarding all taxes withheld from employees, including both income tax and FICA taxes. Smaller businesses may only have to file these reports annually.
File Annual Reports
Business owners also have to report to both employees and the IRS all employee tax payments that were made. If you pay FUTA taxes, then you’ll also need to make reports regarding the amount paid. For smaller businesses, annual reports may take the place of quarterly reports regarding income taxes and FICA taxes that were withheld.
File State Reports
Depending on your state, there may be additional quarterly or annual reports that you need to file.
What Are the Payroll Tax Forms?
There are different forms for each type of payroll tax that an employer must file. These forms include:
- Form 940 – this is the FUTA tax return form
- Form 941 – this is the employer’s quarterly tax return form
- Form 943 – this is the employer’s annual tax return form (for business owners with agricultural employees)
- Form 944 – this is the employer’s annual tax return form (for small businesses that can file annually instead of quarterly)
- Form 945 – this is the employer’s annual tax return form (for reporting non-payroll payments)
- Form W-2 – this is the employee’s annual withholdings and income report form
- Form W-3 – this is the Social Security Administration’s summary of all W-2s
- Form W-4 – this is the employee’s withholding form, filled out by employees and submitted to the employer
- Form I-9 – this is the employment eligibility form for all new employees
How to File Payroll Taxes
Once you have calculated how much your business will owe in payroll taxes, how much you’re withholding from employees, and whether you need to file quarterly or annual returns, it’s time to actuall submit the tax payment. You can do this at EFTPS, which is the Electronic Federal Tax Payment System® service for tax payments provided for free to individuals and business owners alike by the federal government. For state taxes, there may be a similar portal or another method preferred by that state for tax filing purposes.
What Are Some Common Payroll Tax Mistakes?
Payroll taxes can be complicated. This is why it’s recommended to use payroll software so that errors can be reduced. The following are some common payroll tax errors that business owners can make.
Failing to Withhold Income Taxes
One common error is to forget to actually withhold taxes or other amounts from an employee’s paycheck. If this occurs when it shouldn’t, in the best-case scenario an employee will contact you to get it corrected. In the worst case, you might have the IRS thinking you’re purposefully misclassifying employees as contractors to avoid paying your share of FICA taxes. Payroll software could help to avoid this error via its automatic payroll deduction tools.
Calculating the Taxable Wages Incorrectly
Another common error is to incorrectly calculate an employee’s taxable wages, which would then result in the withheld taxes also being incorrect. This mistake could be easy to make in a situation where an employee’s rate of pay was different than usual, for example, because of overtime. Payroll software could calculate these changes automatically.
Not Calculating Fringe Benefits into Taxable Income
Employee taxable income isn’t just their actual salary. Health care plans, gym memberships, commuter packages, and more can all be considered compensation and may be taxable. If you don’t include all taxable income in your calculations for withholdings, then the amount will be incorrect. Payroll software could help ensure that all taxable income is included.
Using the Incorrect Tax Rate
One of the things that make payroll taxes so complicated for a business owner is the different tax rates that apply to different levels of income. If an employee’s taxable income is in a higher tax bracket, then there would be multiple rates that would apply to different portions of their income. Applying the wrong tax rate to an employee’s withholdings could see you withhold too much or too little. Payroll software can automatically calculate this for you.
Classifying Employees Incorrectly
From a business owner’s perspective, there are some financial perks to having contractors instead of employees. Not offering benefits is one. Not being responsible for any FICA payments is another. However, it’s important to make sure that contractors are only classified as contractors if they’re actually working like contractors rather than as employees. Misclassifying employees as contractors could see you in hot water with the IRS and you’d still be liable for those taxes anyway.
What Is the Difference Between a Contractor and an Employee?
Contractors set their own schedules and can complete projects their own way. They also provide their own equipment and materials and are considered owners of their own small businesses, providing benefits for themselves. Employees, on the other hand, have set schedules and receive training and equipment from their employers. They also receive benefits like health care plans and 401(k) contributions.
Not Correcting Tax Errors Immediately
Don’t wait for an employee or the IRS to alert you to a possible payroll tax error. It’s important to check regularly that everything is correct and if you notice an error, address it immediately. It’s easier to fix the error sooner rather than later.
Invest in Payroll Software
The best thing you can do to ensure greater accuracy in filing payroll taxes and calculating withholdings is to invest in payroll software. Using a payroll system can not only make the process faster but also reduce the risk of errors in the calculating and filing process. Any changes that occur to tax rates and brackets can be automatically taken into account. To find the right payroll software for your needs, use an online software match tool like Matchr.com’s.