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Small Business Payroll Taxes Explained



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Payroll Taxes Defined

Payroll taxes encompass the various taxes withheld from an employee's earnings and remitted to the government by the employer. Common payroll taxes include federal income tax, Social Security tax, and Medicare tax. Moreover, many states and local jurisdictions mandate employers to withhold state and local taxes from workers' paychecks. Additional payroll taxes encompass unemployment taxes, workers' compensation taxes, and disability taxes. It's crucial for small business owners to remain updated on the specific payroll taxes applicable in their state, ensuring they accurately withhold and submit the required amounts to the government on behalf of their employees.

Taxable Employees

A taxable employee refers to an individual who, according to the Internal Revenue Service (IRS), is classified as an employee and therefore subject to payroll taxes. This category includes full-time, part-time, and temporary workers who earn a salary, wages, or other forms of compensation for their services. In contrast, independent contractors are not deemed taxable employees. They bear the responsibility of handling their own taxes, while the hiring company is not obliged to withhold or submit taxes on their behalf. Small business owners must be vigilant in differentiating between employees and independent contractors, ensuring accurate classification for tax purposes to circumvent any penalties or fines imposed by the IRS.

Employer Tax Responsibilities

Employers bear the responsibility of paying a range of taxes connected to their employees, such as:

  1. Federal Income Tax: Employers are required to withhold federal income tax from employees' paychecks and remit it to the IRS.


  1. Social Security Tax and Medicare Tax: Employers must pay a share of these taxes while also withholding the employee's portion from their paycheck.



  1. Federal Unemployment Tax Act (FUTA): This tax applies to wages paid to employees and must be paid by employers.


  1. State Unemployment Insurance Tax (SUI): This tax rate varies across states, and employers need to submit payments to their respective state governments.


  1. State and local taxes: Some states mandate additional taxes for employers, such as disability insurance and workers' compensation taxes. It's crucial to remember that taxes and their rates differ from state to state. As a result, small business owners must stay up to date on the specific taxes applicable in their location and ensure they pay the correct amounts to the government on behalf of their employees.

Payroll Tax Calculations for Small Businesses

Accurately calculating payroll taxes for a small business can be a daunting task, but it's crucial to ensure the appropriate taxes are withheld and remitted to the government on behalf of employees. Here's a step-by-step guide:

Step 1: Determine the employee's gross pay – the total earnings before any taxes or deductions.

Step 2: Calculate federal income tax withholding using the IRS Circular E tax withholding table or the employee's W-4 form.

Step 3: Calculate Social Security and Medicare taxes, which together amount to 7.65% of the employee's gross pay, shared between the employee and employer.

Step 4: Calculate state and local taxes, which vary by location and income.

Step 5: Account for other taxes like unemployment insurance or disability taxes, depending on the state.

Tax Credits

Employee Retention Credit (ERC): This credit encourages eligible employers to retain employees during the COVID-19 pandemic, even if their business has been adversely affected. Paid Leave Credit: Claimable by employers for two types of leave:

  • Emergency Paid Sick Leave Act (EPSLA): For employers providing paid leave to employees unable to work or telework due to COVID-19 related reasons, such as quarantine or experiencing symptoms.


  • Emergency Family and Medical Leave Expansion Act (EFMLA): For employers providing paid leave to employees unable to work or telework due to COVID-19 related reasons, such as caring for a child whose school or place of care is closed.


Hiring Incentives to Restore Employment (HIRE) Act: Available to employers hiring workers who have been unemployed for at least 60 days.

Small Business Payroll Tax Withholding

Small business owners must withhold payroll taxes as they are responsible for collecting and depositing federal income taxes, Social Security and Medicare taxes, and any applicable state and local taxes from employees' wages.

To accurately calculate and withhold payroll taxes, small business owners need to follow these steps:

  1. Obtain an Employer Identification Number (EIN): First, secure an EIN from the IRS.


  1. Determine federal income tax withholding: Utilize the IRS's Circular E, Employer's Tax Guide, to determine the appropriate withholding amount for each employee.


  1. Calculate Social Security and Medicare taxes: Use each employee's Form W-4 to establish the correct amount of Social Security and Medicare taxes to withhold.

Additionally, employers must deposit these taxes with the government on a regular basis. For instance, federal income taxes and Social Security and Medicare taxes typically need to be deposited monthly or semi-weekly, depending on the total taxes owed.

Reporting and Paying Payroll Taxes Small business owners have a critical responsibility to report and pay payroll taxes. To ensure compliance, follow these steps:

  1. File Form 941, Employer's Quarterly Federal Tax Return: Submit this form to the IRS to report employee wages and taxes withheld for federal income taxes, Social Security, and Medicare taxes.



  1. Report and pay state and local taxes: This includes taxes such as state unemployment taxes.


  1. Deposit federal taxes: Regularly deposit the federal taxes withheld from employees' wages and the employer's share of Social Security and Medicare taxes with the IRS, depending on the amount of taxes owed and the size of the business.


  1. File annual forms: Submit Form W-2, Wage and Tax Statement, to the Social Security Administration to report employee wages and taxes withheld for the year.

By adhering to these guidelines, small business owners can ensure they fulfill their obligations and maintain compliance with payroll tax regulations.

The Implications of Late Payroll Taxes for Small Business Owners

When small business owners fail to pay payroll taxes punctually, they may face penalties and interest charges. The specific consequences will vary based on the circumstances surrounding the late payment and the amount of taxes owed. For instance, if a small business owner does not deposit payroll taxes in a timely manner, they could be subject to a penalty ranging from 2% to 15% of the unpaid taxes. Moreover, interest will accumulate on any unpaid taxes.

In more extreme cases where small business owners deliberately and knowingly neglect to pay payroll taxes, the repercussions can be severe. The IRS may pursue legal action, including imposing fines and even incarceration. Intentionally failing to pay payroll taxes is considered a criminal offense and can result in up to five years in prison and a fine of up to $10,000.

Payroll Tax Forms

Form W-4: Employees complete this form to provide their employer with personal and tax withholding information.

Form W-2: Employers use this form to report employee wages and taxes withheld for the year to the Social Security Administration.

Form 940: Employers submit this form to report Federal Unemployment Tax Act (FUTA) taxes paid to the IRS.

Form 941: Employers file this form on a quarterly basis to report employee wages and taxes withheld for federal income taxes, Social Security, and Medicare taxes to the IRS.

Understanding these forms is essential for small business owners to ensure accurate payroll tax reporting and compliance.

Wrapping Up

In summary, navigating the complexities of payroll taxes is a vital responsibility for small business owners. By grasping the fundamentals of payroll taxes, including which taxes must be paid and how to calculate them, business owners can ensure they comply with tax regulations and steer clear of penalties and interest charges.


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The material discussed on this page is meant for general illustration and/or informational purposes only and is not to be construed as investment, tax, or legal advice. You must exercise your own independent professional judgment, recognizing that advice should not be based on unreasonable factual or legal assumptions or unreasonably rely upon representations of the client or others. Further, any advice you provide in connection with tax return preparation must comply in full with the requirements of IRS Circular 230.




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