If you have employees, you have endless administrative work to do, or so it seems. Payroll taxes are part of the package. But do you know what you need to know about withholdings, deposits, and the attendance paperwork?
Because tax law changes frequently, it's always good to have a refresher.
What Are Payroll Taxes?
Also called employment taxes, payroll taxes are withheld from an employee’s paycheck by the employer. The employer then submits that payment to the appropriate taxing agencies on behalf of the employee.
Payroll taxes go to support social programs and public expenses for American citizens. The programs include everything from Social Security and Medicare to public employee salaries and education. Withholding is part of the formula for calculating net pay.
In case you get mixed up, here is how it works:
- Gross Pay = Pay Rate X Hours Worked
- Net Pay = Gross Pay - Payroll Tax Deductions - Voluntary Payroll Deductions
As an employer, you are also responsible for withholding state or local payroll taxes required by your state and city.
Be aware that withholding rates change according to current tax legislation.
The federal government sets specific rates for withholding Social Security and Medicare taxes from employee wages. As of 2021, the rates are as follows:
- Social Security - the employee and the employer each contribute 6.2% of the employee’s gross wages. The total withholding per employee is then 12.4%. If the taxable amount goes over $137,700, no additional tax is withheld.
- Medicare - the employer and the employee each contribute 1.45% of the employee’s gross wages. The total withholding per employee is 2.9%.
- Total Social Security and Medicare, including the employee and employer contribution, adds up to 15.3%.
Social Security is the only payroll tax with a wage base limit. The maximum wage base subject to Social Security tax for 2021 is $142,800. There is no wage base for Medicare — all covered wages are subject to Medicare tax.
As the employer, you are required to match the employee withholding for each employee according to the individual gross wage amounts.
You can see already how this gets tricky.
If an employee’s gross wages are over a certain amount, you are required to withhold an additional 0.9% from that individual’s paycheck. However, you are not required to match it as the employer. Withholding continues for each pay period through the end of the calendar year. Withholding proceeds according to the employee’s tax filing status. The additional 0.9% comes out for:
- Wages over $200,000 and the employee files as single
- Wages over $250,000 and the employee files jointly
- Wages over $125,000 and the employee files married filing separately
What if you’re self-employed? You still need to remit payroll taxes for yourself if you have a business but no employees. You effectively pay Social Security and Medicare for yourself because you must remit both the employee and employer contributions.
In the case of a self-employed individual, the rate is 15.3% of net business income instead of wages.
Calculating Federal Withholding
While there are two methods for calculating withholding, most businesses use the Wage Bracket Method.
IRS Publication 15-A contains tables entitled Wage Bracket Percentage Method tables. Use the table corresponding to the employee’s pay period. Consult the employee’s W-4 form to determine if they file as married or single and how many allowances they claim.
- Step 1: Find your employee’s gross wage per pay period in Columns A and B. The wage selected should be more than the amount found in Column A and less than in Column B.
- Step 2: After identifying the correct line according to Columns A and B, subtract the amount shown in Column C from gross wages.
- Step 3: Multiply the result by the percentage found in Column D.
- Step 4: Consult the employee’s W-4 for additional tax withheld and add that to the result from Step 3.
- Step 5: The result from steps 1-4 is the amount to withhold from the employee’s paycheck for that pay period.
Once you determine federal withholding, calculate any state and local withholding plus any voluntary withholding for insurance, retirement plan contributions, union dues, or other deductions the employee has requested.
The second method for calculating federal withholding is the Percentage Method. However, it is more complicated than the Wage Bracket Method. It is not a recommended method if you are doing payroll taxes on your own. See IRS Publication 15-A if you need to know more.
FICA and FUTA
FICA, the Federal Insurance Contributions Act, is the law covering Social Security and Medicare. You report and pay it quarterly using IRS Form 941 Employer’s Quarterly Federal Tax Return.
Employee and employer contributions to FICA combined total 15.3% of gross employee wages up to $137,700.
FUTA is the Federal Unemployment Tax Act. It covers federal unemployment insurance paid by the federal government to state unemployment agencies.
FUTA is an employer-paid payroll tax reported and paid annually using IRS Form 940 Employer’s Annual Federal Unemployment Tax Return. You calculate FUTA at 6% on the first $7,000 of wages paid to the employee in a calendar year. It isn’t withheld from the employee’s paycheck — you as the employer pay it.
Because each state receives a credit to cover 5.4% of FUTA payments, employers effectively pay only 0.6% annually into FUTA.
As an employer, you are required to:
- Calculate and withhold income tax and other payroll taxes.
- Deposit all payroll taxes according to a set deposit schedule unless you are a very small employer*.
- Submit payroll taxes electronically through the Federal Electronic Tax Payment System (EFTPS).
- Report FICA quarterly to the IRS and annually to employees and the Social Security Administration.
- Report FUTA annually.
- Follow state-level reporting requirements.
*If you are a very small employer, you can pay when filing the annual employer tax return and can opt to use the EFTPS.
If you hire independent contractors or self-employed (freelance) individuals, you do not need to withhold payroll taxes from the amount paid for services. However, you should review the status of each worker to determine if they are correctly classified as an independent contractor.
If you paid more than $600 to an independent contractor during a tax year, you are required to report those payments annually to the IRS and the contractor using Form 1099-NEC.
Taxes are constantly changing, and payroll taxes can be an administrative burden on a smaller employer. Manually calculating, withholding, and submitting payroll taxes can be overwhelming.
Help is available for any size employer who needs assistance with payroll taxes. Contact Top Tax Defenders to learn more.