How to Calculate Payroll Taxes for Small Business [Easy Way]
Bringing a new employee on board is one of the most exciting milestones as a small business owner. It signifies growth and potential, but it also comes with new challenges and responsibilities. Specifically, you’re now responsible for paying payroll taxes to the federal government.
The bottom line is, if you have an employee, you must pay payroll taxes.
Yet, figuring out which ones to pay and how to calculate payroll taxes for small business can be quite a challenge, especially if you have just started growing your team. If you’re a new employer trying to figure out payroll taxes, fear not.
In this article, I’m going to unpack what payroll taxes are, which payroll taxes you’re responsible for, and how to calculate and pay them.
Grab a coffee and let’s dive in! 🤓
Key Takeaways
Payroll taxes are employment taxes deducted from employees’ paychecks to fund social insurance programs, such as Social Security and Medicare.
Even if your business only has one employee, you still need to pay payroll taxes.
There are different types of payroll taxes that business owners need to withhold, including Social Security, unemployment, and Medicare.
Independent contractors and freelancers are not subject to payroll taxes. You only need to pay payroll taxes if you have temporary, part-time, or full-time employees.
Failing to pay payroll taxes accurately and on time can result in serious consequences for your small business. Working with a tax professional can help you stay on track.
What Are Payroll Taxes?
Payroll taxes are taxes that employers withhold from their employees’ wages and contribute on behalf of their employees.
These taxes fund various social programs and benefits, such as Medicare programs, Social Security and unemployment benefits. The key components of payroll taxes in the United States are governed by the Federal Insurance Contributions Act (FICA).
Understanding how payroll taxes work and what payroll tax includes is a critical aspect of your small business operations.
It’s important to accurately calculate and withhold these taxes from employees’ paychecks to stay in compliance with the law. Even if you hire a tax professional, it’s still essential for business owners to understand payroll tax basics.
Types of Small Business Payroll Taxes
“Payroll tax” is an umbrella term for various taxes that an employer must handle in the process of paying their employees. Here are some of the key types of payroll taxes that small business owners typically deal with:
Federal Income Tax Withholding: Employers are required to withhold federal income tax from employees’ paychecks based on the information provided by employees on their W-4 forms. The withholding amount depends on factors such as the employee’s income, filing status, and more.
Social Security Tax: The Social Security tax is part of the Federal Insurance Contributions Act (FICA) and is used to fund Social Security programs. Both the employee and employer contribute 6.2% of the employee’s wages, up to a certain income threshold. Self-employed individuals pay the combined employee and employer share.
Medicare Taxes: Another component of FICA taxes, Medicare taxes fund the Medicare program. Employers and employees each contribute 1.45% of the employee’s wages. High-income earners may need to contribute an additional Medicare tax of 0.9% on earnings above a certain income threshold.
Federal Unemployment Tax (FUTA): This tax is paid solely by the employer to fund unemployment benefits. The FUTA tax is a percentage of the first $7,000 of each employee’s wages.
State Income Tax Withholding: Many states impose income taxes, and employers have to withhold state income tax from the employee’s paycheck based on state regulations. The rates and rules vary by state.
State Unemployment Taxes (SUTA): Like FUTA for the federal payroll taxes, SUTA refers to state unemployment tax that the employer pays to fund unemployment benefits. The tax rate varies by state.
Local taxes: Depending on where your business operates, local taxes may also apply. Your local governments, such as your city or municipality, may impose additional local income taxes or other payroll taxes.
Managing small business payroll taxes requires careful attention to federal, state, and local regulations. Many business owners decide to use payroll software or hire a tax professional to stay on top of employer payroll taxes.
What Payroll Taxes Do Employers Pay?
Employers are responsible for paying various payroll taxes in addition to withholding and remitting taxes on behalf of their employees.
Social Security and Medicare (FICA taxes), Federal Unemployment Tax (FUTA), and State Unemployment Tax (SUTA) are the main payroll taxes that you can expect as a small business owner.
They are used to fund Social Security benefits, Medicare programs, unemployment insurance, and other social insurance programs.
How to Calculate Payroll Taxes for Small Business
Calculating payroll taxes for small businesses involves several steps to ensure accuracy and compliance with federal, state, and local requirements.
Every small business is different, but here are the typical steps to calculate employer payroll taxes:
Determine Gross Wages. Start by determining the gross wages for each of your employees. This includes regular hours worked, overtime, bonuses, and any other taxable compensation.
Withhold Federal Income Tax. By law, the employer withholds federal income taxes using the information the employee provided on their W-4 form. The Internal Revenue Service (IRS) also provides withholding tables to help business owners make accurate calculations.
Calculate Social Security and Medicare Taxes. Both employer and employee contribute 6.2% of the employee's wages in Social Security taxes and 1.45% in Medicare taxes. To calculate Social Security and Medicare, multiply the employee’s gross wages by the appropriate percentage.
Calculate State Tax Withholding. You can use state tax calculators to determine the applicable tax rate.
Calculate SUTA and FUTA taxes. Follow the Federal Unemployment Tax Act FUTA and the State Unemployment Tax Act (SUTA).
Using payroll software or getting tax advice from a professional can help streamline the process and minimize errors in payroll tax calculations.
Example Payroll Tax Calculation
Identifying Taxable Workers
Not every employee falls under the same umbrella when it comes to payroll taxes, and it’s important to identify which employees are subject to payroll tax. While payroll tax applies to most traditional employees, there are certain exemptions.
Independent contractors are responsible for handling their own taxes, including the self-employment tax. You’re not responsible for payroll tax if you outsource to contractors and freelancers. Students and religious workers can also be exempt from payroll tax.
It’s important to properly classify your workers. There are several tests that you can do to determine if your workers are employees or contractors. The IRS has a helpful article on distinguishing between an employee and an independent contractor.
What Is the Difference Between Payroll Tax and Income Tax?
Income taxes and payroll tax are both types of employment taxes. The difference is, income taxes have progressive rates that depend on the total income and can be used to support different types of government initiatives.
Payroll tax has a flat rate and is used to fund specific programs, such as Social Security and Medicare. Some payroll taxes also have a wage base limit, meaning that there’s a maximum amount of an employee’s earnings that can be subject to tax.
How to Pay Payroll Taxes
Begin by calculating the total tax liability, including both employer and employee contributions for Social Security tax and Medicare tax. Deduct the required contributions from your employee’s paycheck and deposit taxes into the appropriate government accounts.
You can use the Electronic Federal Tax Payment System (EFTPS) for federal taxes and similar methods for state and local employer payroll taxes.
What Happens If I Don’t Pay My Small Business Payroll Taxes?
Failure to pay small business payroll tax can have serious consequences, including financial penalties, legal action, loss of business assets, and even criminal charges.
To avoid these consequences, make sure to stay informed and proactive on your payroll tax obligations. Hiring a tax professional helps you easily stay on top of your responsibilities.
The Bottom Line
Payroll tax is a special type of tax that small business owners need to withhold when they have an employee or employees. It includes Social Security taxes, Medicare tax, unemployment taxes, and more. These taxes are used to fund Social Security and social insurance programs.
As an entrepreneur, it’s your responsibility to make sure that these taxes are withheld and pay them to an appropriate government office. Working with a tax professional like Desi Tax can streamline this process.
FAQs
What are the current payroll tax rates?
Payroll taxes are subject to adjustment by tax authorities. As of December 2023, the tax rate for federal payroll taxes is:
Social Security Taxes: 12.4% (employee and employer both contribute 6.2% of the employee’s wages)
Medicare Tax: 2.9% (employer and employee contribute 1.45% of the employee’s wages)
Additional Medicare Tax: 0.9%
Unemployment Taxes: 6%
Make sure to check state and local tax rates with your state and local authorities.
Which employees are taxable?
Employees who receive wages or salary, regardless of whether they’re part-time or full-time employees, are generally subject to payroll taxes.
Independent contractors and self-employed individuals are not subject to payroll tax, including Social Security and Medicare taxes.
How do I pay payroll taxes?
Use the Electronic Federal Tax Payment System (EFTPS) to pay federal employment taxes. Check with your state and local governments what the best payment method is.
Which payroll taxes are paid by employers?
Social security, Medicare, FUTA, and SUTA taxes are paid by employers, but you may be responsible for other taxes as well.
Have any questions? Want to chat it through?
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