An Owner’s Guide to Employment Taxes
Employment Taxes. Yes, even as you read the words, your shoulders slump, and your eyes glaze over. We get it. It’s a common phenomenon. It’s probably the same expression your new employee has when you ask them to complete a W-4.
If I asked you to list the top 10 things you love about running a small business, I doubt employment taxes would make the cut. Employment taxes can be overwhelming, but a basic understanding can help an employer avoid significant penalties and late fees. So save the “glaze” for the donuts and let’s look at some of the basics every small business owner needs to know.
What are employment taxes?
In general, employment taxes refer to the withholdings from employees’ paychecks for federal, and when applicable, state and local income taxes, along with the employees’ portion of Social Security and Medicare taxes (FICA). Employment taxes also include the employer’s portion of FICA and federal and state unemployment taxes. Employers are responsible for withholding, depositing, and reporting these taxes for both the employer and employee portions, usually on a quarterly basis (although some state and local schedules may differ).
A closer look…
Federal Income Tax
Federal income taxes are based upon an employee’s taxable compensation and are paid toward their anticipated federal tax liability. The amount of the withholding is determined by the information provided on the Employee’s Withholding Certificate, Form W-4. All employees are required to provide the employer with a completed W-4 so appropriate tax withholdings can be calculated.
Federal Insurance Contributions Act (FICA)
Taxes under FICA include Social Security and Medicare taxes. The current tax rate for Social Security is 6.2% for the employee and 6.2% for the employer. For 2022, the wage base limit for Social Security is $147,000, so wages earned in excess of $147,000 are not subject to the social security tax for that year.
The current tax rate for Medicare is 1.45% for the employee and 1.45% for the employer. As Medicare has no wage base limit, all covered wages are subject to the Medicare tax for both the employee and employer.
There is an Additional Medicare tax of 0.9% for wages exceeding a threshold (based on the taxpayer’s filing status), but this only impacts the employee. In other words, the employer need not match this amount. For 2022, the threshold is $200,000 for single filers. While the tax is paid by the employee, the employer is required to withhold, deposit, and report the tax on behalf of the employee.
State and Local Income Tax
Employers are required to withhold state income tax from employees’ paychecks in all states except Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming (2022). In addition, some cities require employers to withhold a local income tax from employees’ wages based on the city, county, and school district.
Federal Unemployment Tax Act (FUTA)
The FUTA tax helps to fund state unemployment systems by providing unemployment compensation for workers who have lost their jobs. The FUTA tax rate is 6% for the first $7,000 an employee earns per year after subtracting any payments exempt from FUTA tax. Only the employer pays the FUTA tax; there is no deduction from the employee’s wages. In some states, employers may qualify for a federal tax credit of up to 5.4%, which can lower their FUTA rate as low as 0.6%.
A state that has borrowed from the federal government to cover unemployment benefits and has not repaid the funds is referred to as a “credit reduction state”. Employers in these states will have a reduced credit resulting in a higher FUTA tax if they paid their unemployment taxes in a timely manner.
State Unemployment Tax (SUTA)
SUTA, also referred to as state unemployment insurance (SUI), is for the purpose of funding unemployment benefits for workers who have lost their jobs. SUTA tax rates vary by state and may change each year. Employers pay SUTA tax based on their state’s wage base limit—the maximum threshold for which SUTA taxes can be withheld. Generally, this tax is paid by the employer only, however some states also require employee contribution. The SUTA tax rate is based on the employer’s claims experience and the employer receives notice of their SUTA rate quarterly or annually (depending on the state).
What is required of the employer?
If you are still reading this, take a deep breath, pat yourself on the back, and shake off the sleep! Now that we have a general overview of employment taxes, we will look at what this means for the employer. Employers are required to calculate withholdings, deposit the taxes, and file accurate and timely returns. Getting this right means avoiding penalties and late fees.
As stated earlier, withholdings are calculated based on the employee’s Form W-4 or employee’s state withholding certificate. In the absence of a W-4, an employer should withhold as though the employee is single with no adjustments. The IRS provides tax tables in the Publication 15 (Circular E), Employer’s Tax Guide. If you are handling your payroll in-house, there are many software options that will calculate these taxes based on the current IRS tables. If your payroll is outsourced to a payroll provider, they will calculate the withholdings for you. Hint Hint, one of those options sounds better than the others!
Filing Tax Returns and Depositing Withholdings
Calculating the withholdings is just the first step. The employer is also required to file tax returns reporting the withholdings and deposit the taxes according to set deadlines. The list below is not intended to be comprehensive, but rather a brief overview of some of the most common reports required for small business owners.
Form 941 is the Employer’s Quarterly Federal Tax Return reporting the employee’s federal income tax withholding, Social Security and Medicare Tax withholdings, and the employer’s share of the Social Security and Medicare taxes.
Form 944 is the Employer’s Annual Federal Tax Return for small employers whose annual liability for Social Security, Medicare, and federal income tax withholdings is $1,000 or less. This form allows them to file and pay these taxes once a year instead of every quarter.
Form 940 is the Employer’s Annual Federal Unemployment (FUTA) Tax Return.
In addition to these reports, employers are required to report withholdings to employees and to the Social Security Administration annually. Those reports are made using Form W-2 and Form W-3.
State income tax and SUTA reporting requirements and deadlines vary by state. Contact your local taxing authority (department of revenue or finance) for this information.
Employment taxes are deposited with the government based on a schedule determined by the IRS. The frequency with which employers are required to deposit is dependent on their annual taxes. Some employers are required to deposit on a monthly schedule, while others deposit on a semi-weekly schedule.
Federal deposits are made electronically through the Electronic Federal Tax Payment System, EFTPS. State and local entities have their own deposit requirements. Contact your local taxing authority for payment deadlines and options.
Still have questions? Let’s talk about outsourcing
Are you still with me? Have you flatlined? Yes, there’s a lot to take in when it comes to employment taxes. It is easy to get overwhelmed and feel lost in the weeds. Whether you are handling payroll yourself or outsourcing it, it is important to understand the basic requirements. No one wants to lose money to penalties and late fees!
So what are the benefits of outsourcing to a payroll provider like Whirks? The answer is simple: they do the work for you! A payroll provider keeps up with the ever-changing regulations and ensures the tax withholdings are calculated correctly, reported accurately, and deposited in a timely manner. They can also respond to tax notices on your behalf, freeing you up to spend more time growing your business. Looking for a reliable payroll provider?