As a small business owner, it is crucial that you know and understand payroll taxes and whether you owe any payroll taxes or not. You will become responsible for payroll tax the day you hire your first employee. Note that understanding the tax system for small businesses is important to people who have the ultimate responsibility of meeting all tax obligations.
Payroll is one of the things most small business owners hate as they think it is complex. However, it is worth mentioning that if you have just a few employees, you can do it yourself instead of hiring a third party for this purpose.
The good news is that small business taxes, such as payroll taxes, are not as complicated or difficult as they may seem. All you have to do is understand the different kinds of payroll taxes for small businesses, who’s responsible for paying them, and the payment and filing deadlines. Despite its name, payroll tax isn’t a single tax; rather, it is a blanket term that refers to all taxes you pay on the wages of your employees.
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What are Payroll Taxes?
Payroll taxes are various taxes that both employees and employers have to pay based on the amount employees earn. Keep in mind that payroll taxes are used for financing social insurance programs, like Social Security and Medicare. Also, keep in mind that there are some differences between payroll taxes and income taxes. Also, both the employer and the employee owe payroll taxes on an employee’s wages.
Small Business Payroll Tax - What’s included?
There are two main categories of payroll taxes.
1. Federal payroll taxes
2. State payroll taxes
Federal Payroll Taxes
There are three main federal payroll taxes. Two are mandated by FICA (Federal Insurance Contributions Act).
Social Security
Note that Social Security taxes are also called OASDI taxes, which stands for Old Age, Survivor and Disability Insurance. As you can imagine, these payroll taxes are used to fund Social Security benefits.
Medicare
The Medicare tax, also called the Medicare Hospital Insurance (HI) tax, funds the hospital insurance part of employees’ Medicare benefits.
These two taxes are known as FICA taxes. Employers have to withhold FICA taxes from their employee’s paycheck and also report the withheld amounts to the IRS.
The third federal payroll tax is:
Unemployment Insurance:
Note that the Federal Unemployment Tax Act (also known as FUTA) helps in paying for the country’s federal-state unemployment insurance system. FUTA taxes finance unemployment compensation benefits which people receive when they lose their job. Keep in mind that only the first $7,000 of your employee’s wages are used for calculating this tax.
State Payroll Taxes
Just like the federal government, the state government also has payroll taxes, such as state income tax and state unemployment taxes (SUTA).
Unemployment Insurance:
The first state payroll tax is the State Unemployment Tax Act (SUTA). It provides state unemployment benefits to all eligible employees who lose their jobs without any fault of their own.
Disability Insurance:
Five US states, including California, New Jersey, Hawaii, New York, Rhode Island, and Puerto Rico, also require business employers to provide disability insurance (short-term) for non-work related sickness and injuries that prevent employees from working.
Calculating Federal W-4 Withholding
Note that as an employer, you have to withhold tax on behalf of your employees. You also have to remit those taxes on a quarterly basis to federal, state, as well as local tax authorities in the country.
For calculating how much of the employee’s income you need to withhold, you will need a copy of your employee’s Form W-4, and the payroll period (such as monthly, weekly or semi-monthly), and your employee’s gross pay. The next step in the process is to determine the method you would like to use in order to calculate the withholding tax. You have two options, which are the percentage method and wage bracket method. It is worth mentioning that the wage bracket method is considered the more straightforward way of calculating payroll tax.
Calculating FICA
When it comes to calculating and funding FICA, an employee pays half from the paycheck while the employer, you, will pay half out of your revenue. For social security, the total percentage that is sent to the Internal Revenue Service is 12.4%; however, it is split between you and the employees. You will withhold 6.2% of the employees’ paychecks.
In 2019, the maximum amount of employee income that could be taxed for Social Security is $132,900. On the other hand, there is a flat rate of 2.9% for the Medicare tax. And like the Social Security tax, both you and your workers have an obligation to pay it. You have to take 1.45% out of the employees’ wages and pay the other 1.45%. There is no cap, unlike the Social Security tax, on the amount of income that is taxed.
Processing Small Business Payroll Taxes
Take the following steps:
1. Prepare an employee’s paycheck by calculating the gross pay. And then subtract the Social Security, federal income tax withholding, and Medicare deductions.
2. Clearly itemize these on your workers’ paystub so it is simple and quick to understand before you can distribute them.
3. Now calculate the amount that you owe for your portion of FICA taxes and set the amount aside with your employee part of the taxes.
4. Depending on the size of your small business, make payroll tax deposits either monthly or semi-weekly.
5. You have the option to make your payroll tax deposit payments using the IRS EFTPS.
6. If you do not want or know how to use EFTPS, you may also arrange for your financial institution, tax professional, payroll service, or any other reliable third party to make electronic payment deposits.
7. You also have to submit your annual and quarterly tax reporting. You can submit your quarterly report on form 941 to the IRS showing the amount of your payroll tax liability as well as the amounts you’ve paid on the liability in the previous quarter.
8. Also, submit your yearly unemployment tax report to the IRS on Form 944, showing both the amount of the unemployment tax liability and the amount you have paid.
