Payroll Taxes 101

March 27, 2020 by First Federal Bank

Stacks of papers on a deskTo help you understand your company’s payroll taxes, check out this brief overview of the factors you should consider before you tackle your taxes.

As a small business owner, you have to manage a lot of responsibilities. Navigating the complex world of tax laws can be challenging. Payroll taxes are among the most complicated to calculate, since they’re comprised of both federal and state-level taxes, and are dictated by rules that vary based on your employees’ duties. To help you understand your company’s payroll taxes, check out this brief overview of the factors you should consider before you tackle your taxes:

Separating contractors from employees

It makes a difference whether you hire independent contractors or employees. You won’t have to worry about payroll taxes for independent contractors — they’re responsible for what they owe to the government. However, if you hire employees, you’re on the hook for payroll taxes. If you’re not sure how to classify your workers, accountant Chizobah Morah recommends you consult the IRS guidelines. First, if you have the right to control how your workers perform labor, they’re employees. Second, if a person has considerable freedom over purchasing supplies and advertises their services to multiple companies, that individual is an independent contractor. Lastly, if a person has been hired for a set time, or to complete a specific project, you have an independent contractor. Employees, however, are continuously employed by your company.

Knowing taxable wage guidelines

Taxable wages include money you pay to your employees in exchange for labor, including gifts and bonuses. However, reimbursements, such as travel expenses and company-paid meals, aren’t taxable — as long as they’re reasonable and necessary for operating your business. To help your paperwork run smoothly during tax time, Morah advises you to make sure your employees hold on to their receipts and expense reports in order to prove  their reimbursements are nontaxable.

Understanding the anatomy of payroll taxes

Payroll taxes are comprised of federal withholdings, calculated from the information in the employee’s W-4 form, as well as Federal Insurance Contributions Act taxes and state-level taxes. The employee will pay half of the FICA tax, while your company will pay the other half. You can calculate your employee’s payroll taxes based on their gross pay. Just deduct an amount based on the employee’s most up-to-date W-4 form, along with FICA taxes. As of 2019, both the employee and company were taxed at 6.2 percent, or 12.4 percent total for Social Security, and at 2.9 percent total for Medicare. If your state has income taxes, you may have to consider taxes for unemployment, disability and worker’s compensation funds. For more nuanced information on tax rates, tax expert Jean Murray recommends consulting the tax tables on the IRS website and the tax section of your state’s website.

Paying your payroll taxes

After you’ve calculated the amount you need to withhold from your employees’ paychecks, put aside the amount your company has to pay for FICA. You’ll also have to submit Form 941 quarterly to report your payroll taxes. According to Murray, based on the size of your payroll, you may have to pay the IRS twice per week or monthly. If you fail to submit them on time, you’ll face fines. For payments that are less than five days late, the penalty starts at 2 percent of the amount you owe. However, this jumps up to 15 percent if you’re more than 10 days late. Further avoidance of payroll taxes can result in a fine of up to $500,000 and jail time.

Payroll taxes are complex, with rules that vary from state to state. If you’re feeling overwhelmed, don’t hesitate to contact a tax expert to help you understand your small business's obligations.