You hired a payroll vendor to take care of your payroll and taxes. But what about your responsibility to pay taxes as an employer? Which payroll taxes are the employee's responsibility? How do you calculate payroll taxes?
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Taxes differ in responsibility for both employers and employees. We’ll break down the basics for you here.
1. What is payroll tax?
If your business has employees, you’re required to withhold payroll taxes from employees’ paychecks and pay any applicable federal, state, and local taxes.
Federal taxes include the following:
- Federal Insurance Contributions Act (FICA) - Half is paid by the employer, half is paid by the employee.
- Federal Unemployment Tax Act (FUTA) - Paid for completely by the employer.
- Federal income tax - Paid for by the employee.
On the state level, State Unemployment taxes are paid by the employer. For some states though, such as Alaska, New Jersey, and Pennsylvania, State Unemployment Insurance (SUI) taxes are paid by both the employer and employee.
Always check your local regulations as there are certain payroll taxes that are as specific as which municipality or township you operate within.
2. Which workers are taxable?
Before you even get to all these calculations, you must determine the types of workers you employ. That might seem like an obvious step, but it could be easy to overlook the tax responsibilities of an employee versus an independent contractor. Employees are subject to payroll taxes while independent contractors are responsible for paying their own taxes.
The IRS has a comprehensive guide for determining the difference, but here’s a quick set of questions to ask that can help.
- Does the company control or have the right to control what the worker does and how he or she does the job?
- Are the business aspects of the job controlled by the payer? (Ex. Are expenses reimbursed?)
- Are there written contracts or employee-type benefits? (Ex. Vacation pay or insurance). Will the relationship continue and is the work a key aspect of the business?
For more information on classifying your employees, read here.
3. What are taxable wages?
At its most basic level, taxable wages are compensation for services performed. This would include salary, bonuses or gifts. Other forms of compensation that you might provide such as business expense reimbursement do not qualify as taxable wages. For the expenses to be nontaxable, they must be necessary, reasonable, and business-related, and employees have to verify them through receipts or expense reports.
Do you offer benefits that are funded through payroll deductions? Some are made on a pre-tax basis, thus reducing the amount of pay that is subject to tax.
Examples of these types of deductions that need to be factored in are:
- Contributions to certain types of retirement plans.
- If you are a nonprofit, your employees may participate in a 403(b) plan.
- A health flexible spending account (FSA) or a health savings account (HSA).
4. Withholding – What are the responsibilities for both the employee & employer?
Upon hiring, each employee is required to fill out a Form W-4. The amount of federal tax withheld is based upon an employee's W-4. As a reminder, federal withholding tax is paid only by the employee.
FICA is comprised of Social Security and Medicare taxes, paid in equal amounts by both the employer and employee.
When it comes to calculating a paycheck, let’s say John gets paid $580 bi-weekly. He participates in his company’s 401(k) retirement plan at a rate of 6%. John is also enrolled in his company’s cafeteria plan; his pre-tax medical deduction is $10 per paycheck.
Here’s how to calculate a paycheck that contains pre-tax deductions:
- Compute 401(k) contribution. (John’s example: $580 x 0.06 = $34.8)
- Calculate the amount of pay subject to federal income tax by subtracting both the 401(k) contributions plus cafeteria plan deductions. (John’s example: $580 - ($34.8 + $10) = $535.2)
- To calculate the amount of pay subject to Social Security and Medicare taxes, you must understand that 401(k) plans are not exempt from Social Security and Medicare taxes. To calculate, re-add in the 401(k) contribution amount. (John’s example: $535.2 + $34.8 = $570)
In order to calculate your payroll tax, you must know the current rates. Keep in mind that the information the employee puts on their Form W-4 would impact federal withholding.
In addition to federal withholding, the Social Security tax rate for employees is 6.2 percent. The Social Security taxable wage base is $147,000. The Medicare tax rate is 1.45 percent of the employee’s gross pay.
The FUTA tax rate is 6.0 percent of the first $7,000 you pay in wages to an employee. This tax is paid by the employer. You are required to pay this tax if either of the following applies:
- You pay wages totaling at least $1,500 per quarter.
- You have at least one employee on any day for 20 weeks in a calendar year (regardless of if these weeks are consecutive).
For state-withholding purposes, each state varies. Check our Quick Wage & Tax Guide to understand your state's specific tax rates. We update this resource every year.
6. Where can I go for resources?
This breakdown only scratches the surface of how to calculate payroll taxes. As you can tell, it can be very complicated. If you would like to do some of your own calculations, visit our resources tab on PrimePay.com and choose calculators. Here you’ll find options such as salary paycheck, FICA tip credit, gross-up calculators, and much more. These calculators are beneficial for both you and your employees.
Still seeking additional help? Click here to get your business started with the right payroll solution for you.
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Editor's Note: This post was originally published on Sept. 29, 2017, October 24, 2018, and February 2020, and has been updated for freshness, accuracy, and comprehensiveness.