In 2017, the IRS collected $2.39 trillion (yes, that’s with a ‘T’) in payroll taxes. That amount represented 70% of all federal tax revenue collected for the year.
When employers neglect to withhold and transmit payroll taxes, it can add up to a massive federal tax deficit, accounting for $72 billion of the tax gap. Nearly one-third of business owners are penalized for payroll tax errors.
Stay out of trouble and follow our employer’s guide to payroll taxes.
The Basics of Payroll and Taxes
Payroll tax withholding goes by other names such as employment taxes or trust fund taxes (because the employer holds them in trust). Here is the breakdown:
- Gross wages - An employee’s wages before all withholding
- Net wages - An employee’s wages after withhold, also known as Take-Home Pay
- Bonuses, commissions, back pay, overtime pay, and accumulated sick pay are all subject to payroll tax withholding for federal, state, and (if applicable) local taxes
The most common item of payroll withholding is FICA (Federal Insurance Contributions Ac), which funds Social Security, Medicare, and other social insurance benefits. It sets the specific rates and thresholds for Social Security and Medicare withholding.
Federal taxes also pay for defense and security. If your state has a state payroll tax, the withholding goes toward education, healthcare, corrections, the state police, parks and recreation, and transportation.
Every year, the IRS and state tax agencies publish tax tables to help determine how much to withhold from each paycheck. Withholding takes into account:
- Gross wage amount
- Employee filing status
- Number of withholding allowances, commonly called exemptions
- Pay frequency (biweekly, monthly, etc.)
About that last bullet point - the more often you pay your employees, the more often you must calculate and withhold payroll taxes. Using the appropriate business or tax software relieves that burden.
Always check with your state and local tax authorities, and pay attention to the passage of new laws governing business and taxes. At the time of this post, the following states do not have an income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Furthermore, while New Hampshire and Tennessee don’t tax wages, they do tax some individuals as well as interest income.
Some Taxes Are Shared
Social Security and Medicare are shared equally between employer and employee. In 2019, for example, the employee and employer each paid the following:
- The Social Security Tax Rate was 6.2% on the first $132,900 of wages paid, capped at $132,900 in earnings. The maximum amount paid for the year was $8,239.80.
- The Medicare Tax Rate was 1.45% on the first $200,000 of wages. There is no cap.
- Medicare adds 0.9% for wages over $200,000
Some Taxes Are Not Shared
Employees pay their full share of Federal and state income taxes. As an employer, you are responsible for Federal and State Unemployment Taxes.
The Federal Unemployment Tax (FUTA) is calculated using the same information as FICA. The IRS publishes an annual update called Publication 15 (Circular E) - The Employer’s Tax Guide. For 2019, FUTA was calculated as 6% of your payroll, capped at maximum taxable earnings of $7,000 per employee.
Many states also require you to pay State Unemployment Taxes (SUTA). The state tax agency releases an updated table each year. SUTA provides employers with a bit of a perk. If you pay it on time, you can deduct up to 5.4% on your FUTA withholding, taking FUTA down to a level of 0.6%.
What Should You Do With the Withheld Money?
Once you withhold taxes, you must remit, or pay, the funds to the appropriate taxing authority:
- Federal payroll taxes go to the IRS.
- State payroll taxes go to the relevant tax authority, such as the Department of Revenue and the Department of Labor (for unemployment taxes).
- Local taxes go to the appropriate authorities, depending on the type of taxes paid.
When you remit taxes is set by a schedule released by the IRS and other taxing agencies. You should have received a schedule when you registered your business. Keep an eye out for notifications of changes.
The typical Federal schedule for Federal Income Tax and FICA is monthly or semi-weekly. In some cases, you may pay annually. The schedule is based on a four-quarter IRS look-back period.
FUTA deposits are due quarterly. Contact your state to determine when to remit the amounts.
Besides remitting tax withholdings, employers must report on the income taxes, Medicare, Social Security, and tipped wages according to Form 941 - Employer’s Quarterly Federal Tax Return.
Report FUTA annually on Form 940, Employer’s Annual Federal Unemployment (FUTA)Tax Return. Local reporting is set by local agencies.
At the end of every year, you are required to send each employee and to the Federal and State government a W-2 by January 31.
Penalties for Failing to Withhold or Remit Payroll Taxes
You face severe penalties plus interest if you don't pay, pay late, or pay but don't follow the guidelines. The Failure to Deposit (FTD) penalty is a percentage rate that depends on the number of calendar days the deposit is late or whether there is a direct payment.
Everything is laid out in IRC6656(b)(1):
- 2% penalty on deposits 1-5 days late
- 5% penalty on deposits 6 -15 days late
- 10% penalty for deposits more than 15 days late
- 10% for deposits not paid by Electronic Funds Transfer (EFT)
- 15% for all amounts still unpaid for more than 10 days after the date of the first notice requesting payment of tax due or the day on which you receive the notice of demand for immediate payment, whichever is earlier.
But wait, there’s more!
- If you fall behind on reporting, the fine is 5% of the amount owed, up to 25%.
- If you fail to pay the fines and penalties, add another 0.5% per month plus 1% after the notice up to 25%.
- All fines are subject to quarterly interest ranging from 3-6%.
- Interest continues to accrue until you pay the full amount.
If you leave things long enough, the IRS can place a tax lien against your personal or business property, seize assets, or close your business.
Tips for Payroll Taxes
Every time you pay your employees, withhold the payroll taxes and contribute your employer amounts. Set it aside. In fact, create a separate account for these taxes and do not borrow from it. Set up another account for cash reserves; don't mix the two.
If you make an administrative mistake and don’t indicate willful deception, the IRS sees it as a minor issue that can be easily fixed. However, repeatedly missing deadlines, underreporting liabilities, misclassifying employees and contractors, or not withholding taxes at all are significant issues. These can get you in trouble with the IRS.
Payroll tax withholding can get complicated. Make sure you follow the guidelines, remit on time and in full. Use payroll software to streamline the process, and if you need help, call Top Tax Defenders. We are happy to talk.