How to Manage Small Business Payroll Taxes

11 minute read

What are payroll taxes?

Payroll taxes refer to taxes that are withheld from an employee's paycheck and paid to the government by the employer. The most common types of payroll taxes include federal income tax, Social Security tax, and Medicare tax. Additionally, many states and localities require employers to withhold state and local taxes from employee paychecks. Other types of payroll taxes include unemployment taxes, workers' compensation taxes, and disability taxes. It is important for small business owners to stay informed about the specific payroll taxes they are responsible for in their state and to ensure they are withholding and remitting the appropriate amounts to the government on behalf of their employees.

What is a taxable employee?

A taxable employee is an individual who is considered an employee according to the Internal Revenue Service (IRS) and is therefore subject to payroll taxes. Taxable employees include full-time, part-time, and temporary workers who receive a salary, wages, or other compensation for their work. Independent contractors, on the other hand, are not considered taxable employees. They are responsible for paying their own taxes, and the company that hires them is not responsible for withholding or remitting taxes on their behalf. It is important for small business owners to understand the difference between employees and independent contractors and to classify them correctly for tax purposes to avoid any penalties or fines from the IRS.

What taxes do employers need to pay?

Employers are responsible for paying a variety of taxes related to their employees, including:

  • Federal Income Tax: Employers must withhold federal income tax from their employees' paychecks and submit it to the IRS.
  • Social Security Tax and Medicare Tax: Employers are responsible for paying a portion of these taxes, and they must also withhold the employee's portion from their paycheck.
  • Federal Unemployment Tax Act (FUTA): Employers must pay this tax on wages paid to their employees.
  • State Unemployment Insurance Tax (SUI): This tax varies by state, and employers must pay this tax to their state government.
  • State and local taxes: Depending on the state, local taxes may also have to be paid by employers, such as disability insurance and workers' compensation taxes. It's important to note that the taxes and their rates vary by state, which is why it's crucial for small business owners to stay informed about the specific taxes they are responsible for in their state and to ensure they are paying the appropriate amounts to the government on behalf of their employees.

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How to Calculate Payroll Taxes for a Small Business

Calculating payroll taxes for a small business can be a complex process, but it is important to ensure that the correct amount of taxes are being withheld and paid to the government on behalf of employees.

Step 1: Determine the employee's gross pay
This is the total amount of money the employee earns before any taxes or deductions are taken out.

Step 2: Calculate federal income tax withholding
This can be done using the IRS Circular E, which provides a tax withholding table, or by using the employee's W-4 form.

Step 3: Calculate Social Security and Medicare taxes
These taxes are a combined total of 7.65% of the employee's gross pay and are split between the employee and employer.

Step 4: Calculate state and local taxes
These taxes will vary depending on the state and the employee's income.

Step 5: Calculate other taxes
Depending on the state, there may be other taxes that need to be calculated such as unemployment insurance or disability taxes.

Applicable Tax Credits
Here are a few tax credits that may reduce your payroll taxes:

Employee Retention Credit
The Employee Retention Credit (ERC) is a tax credit available to eligible employers that retain their employees during the COVID-19 pandemic. The credit is designed to encourage employers to keep their employees on payroll, even if their business has been negatively impacted by the pandemic.

Paid Leave Credit
The Paid Leave Credit can be claimed by employers for two types of leave:

  1. Emergency Paid Sick Leave Act (EPSLA): This credit is available to employers who provide paid leave to employees who are unable to work or telework due to certain COVID-19 related reasons, such as being quarantined or experiencing symptoms of COVID-19.
  2. Emergency Family and Medical Leave Expansion Act (EFMLA): This credit is available to employers who provide paid leave to employees who are unable to work or telework due to certain COVID-19 related reasons, such as caring for a child whose school or place of care is closed due to COVID-19.

Hiring Incentives to Restore Employment (HIRE) Act
This credit is available to employers who hire workers who have been unemployed for at least 60 days

Withholding small business payroll taxes

Withholding payroll taxes is a requirement for small business owners as they are responsible for collecting and depositing federal income taxes, Social Security and Medicare taxes, and any state and local taxes from their employees' wages.

To calculate and withhold payroll taxes, small business owners need to first obtain a Employer Identification Number (EIN) from the IRS. Once they have an EIN, they need to determine the federal income tax withholding amount for each employee by using the IRS's Circular E, Employer's Tax Guide. The small business owner needs to also determine the amount of Social Security and Medicare taxes to be withheld by using the employee's Form W-4.

Employers are also responsible for depositing these taxes with the government on a regular basis. For example, federal income taxes and Social Security and Medicare taxes are generally required to be deposited on a monthly or semi-weekly schedule, depending on the amount of taxes owed.

How to report and pay payroll taxes

Reporting and paying payroll taxes is a crucial responsibility for small business owners. They need to file Form 941, Employer's Quarterly Federal Tax Return, with the IRS to report employee wages and taxes withheld for federal income taxes, Social Security, and Medicare taxes. They also need to report and pay state and local taxes, such as state unemployment taxes.

Small Businesses are also required to deposit the federal taxes withheld from their employees' wages, as well as their portion of the Social Security and Medicare taxes, with the IRS on a regular basis, depending on the amount of taxes owed and the business's size. Finally, they are required to file annual forms such as Form W-2, Wage and Tax Statement, with the Social Security Administration to report employee wages and taxes withheld for the year.

What happens if my payroll taxes are late? Can I go to jail?

If a small business owner fails to pay payroll taxes on time, they may be subject to penalties and interest charges. The specific penalties will depend on the circumstances of the late payment and the amount of taxes owed. For example, if a small business owner fails to deposit payroll taxes on time, they may be subject to a penalty of 2% to 15% of the unpaid taxes. Additionally, interest will accrue on any unpaid taxes.

However, for small business owners who willfully and knowingly fail to pay payroll taxes, the penalties can be more severe. The IRS may take legal action, including fines and even imprisonment. Willful failure to pay payroll taxes can be a criminal offense, punishable by up to five years in prison and a fine of up to $10,000.

Forms Associated with Payroll Taxes

Form W-4

  • This form is used by employees to provide their employer with their personal information and tax withholding information.

Form W-2

  • This form is used by employers to report employee wages and taxes withheld for the year to the Social Security Administration.

Form 940

  • This form is used by employers to report Federal Unemployment Tax Act (FUTA) taxes paid to the IRS.

Form 941

  • This form is used by employers to report employee wages and taxes withheld for federal income taxes, Social Security, and Medicare taxes on a quarterly basis to the IRS.

Conclusion

In conclusion, managing payroll taxes for a small business can be a complex task, but it is an important responsibility for business owners. Understanding the basics of payroll taxes, such as what taxes need to be paid and how to calculate them, can help business owners ensure they are in compliance with tax laws and avoid penalties and interest charges.

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