Understanding payroll taxes: A guide for small business owners

If your company employs people, it is your responsibility to collect and pay payroll taxes levied basis their wages. If not, payroll taxes apply to your personal paychecks from the business you run. Additionally, you need to ensure that payroll taxes are calculated accurately and paid in a timely manner.

Below is a guide to simplify payroll taxes and help you avoid unnecessary penalties from the IRS.

What are payroll taxes?

Payroll taxes include federal, state and local income taxes as well as FICA taxes (Medicare and Social Security taxes). These taxes are among the mandatory withholdings that must be made from an employee’s paycheck as part of the payroll tax system.

Others include Federal Unemployment Tax Act (FUTA) and disability insurance taxes applicable in states like California, New York and Rhode Island to name a few.

Businesses of all sizes are required to pay these taxes, which means business owners should be aware of payroll tax compliance and what it entails. This means calculating their employees’ tax withholdings depending on their income and deductions in an accurate way.

What is the importance of accounting for payroll taxes?

Accounting for payroll taxes in an efficient manner and having a well-organized system in place can positively impact your small business’s overall financial health. Along with protecting cash flow, it also contributes to upholding a favorable reputation with both employees and government organizations. Eventually, boosting stakeholder trust in your business, which is essential for sustained growth and success.

What are the different types of small business payroll taxes?

U.S. federal payroll taxes are classified into numerous types, and each type necessitates different calculations and withholdings. In addition, some states and local municipalities need to collect additional payroll taxes depending on the location of the business. Below is a more comprehensive look:

Federal Income tax

Employers are required to withhold federal income tax from their employees’ wages. In order to determine how much tax to withhold, they need to use the employee’s Form W-4, Employee’s Withholding Certificate, and the relevant Federal Income tax withholding methods as applicable.

Social Security and Medicare taxes

Employers must generally withhold and pay the employer part of Social Security and Medicare taxes from their employees’ paychecks.

The rates of the Social Security and Medicare taxes differ, however, only the Social Security tax has a wage base restriction. The wage base limit is the maximum taxable wage for the year. Employers need to multiply each payment by the employee tax rate to calculate the amount of withholding for Social Security and Medicare taxes.

For 2023, the Social Security tax rate is 6.2% and the Medicare tax rate is 1.45% for both the employer and the employee.

Additional Medicare tax

Employers must withhold the 0.9% Additional Medicare tax on an employee’s wages and compensation that exceed $200,000 in a calendar year in addition to the applicable Medicare tax. Start withholding this tax in the pay period in which you pay wages to an employee in excess of $200,000 and continue to withhold it until the end of the calendar year. This tax has no employer match. 

FUTA

Employers must record and pay FUTA tax in addition to Federal Income tax, Social Security tax, and Medicare tax. FUTA tax needs to be paid from your own funds. Employees are not required to pay this tax or have it deducted from their wages. For 2023, the FUTA tax rate is 6% for the employer on the first $7,000 paid to the employee.

Self-Employment tax

The Self-Employment Tax is a Social Security and Medicare tax levied mostly on self-employed individuals. It is quite similar to the Social Security and Medicare taxes withheld from the employees’ paychecks.

State taxes

The state payroll tax varies by state. Some jurisdictions do not collect taxes on wages but levy taxes on other types of income like investment dividends. State payroll taxes are applicable to businesses basis the location of their employees.

Besides, a few states withhold additional payroll taxes for state disability funds, state worker’s compensation funds, and state unemployment tax funds. State Unemployment Tax Act (SUTA) is the most common state payroll tax is to be fully covered by the employer.

Local taxes

Depending on your business’s location (zip code, county or municipality), you may be required to pay additional payroll taxes. These taxes can be used to fund local initiatives and projects like transportation that can support commerce and production. They could be taxes that you, the employer, are liable for, taxes that the employee is liable for, or both.

FAQs on payroll taxes

What are the payroll tax penalties for missed or late payments?

In case, you forget to make your payroll tax deposits accurately, on time, or in the right way, the IRS can levy a Failure to Deposit Penalty on you. This penalty is calculated as a percentage of the unpaid taxes as illustrated below:

• One to five calendar days: 2% of the unpaid tax deposit
• Six to 15 calendar days: 5% of the unpaid tax deposit
• More than 15 calendar days: 10% of the unpaid taxes.
• More than 10 days after your first notice: 15% of the unpaid taxes.

How should I report and file my payroll taxes?

You can report the payroll taxes by filing Forms 941, 943, 944, 945, and 940 on paper or through e-file. For any additional information, you can explore the Employment Tax Forms page of the IRS.

How can I ensure payroll tax compliance?

With numerous regulations and deadlines to meet, managing payroll taxes can be a daunting task, especially for small businesses. An ideal option for you can be partnering with an outsourced payroll service provider. Alongside ensuring compliance, these experts can also assist you in making accurate and timely tax payments and avoiding costly penalties.

Want more? Escalon has helped over 5,000 companies across a range of industries to optimize routine business functions, like taxes, accounting, insurance HR and payroll, and operate more efficiently. Talk to an expert today.