Like everything in life, there are great things about running a business, and others that you wish that you didn’t have to worry about. Payroll taxes fall into the latter category for many new business owners.
Taxes can be daunting, confusing, and stressful. Understanding them—and what your personal tax obligations are—helps to alleviate all of those negative feelings. Let’s break down the topic of payroll taxes so that you can confidently manage this part of your business.
Payroll Taxes 101: What are they?
Payroll tax is a specific amount of money that employees and employers pay to the government for each paycheck earned from salaries, wages, or tips.
Think of payroll taxes as a part of each paycheck that goes to the government to fund a specific public benefit. They’re not just one tax, but a collection of specific line items that are deducted to fund programs at the local, state, and federal levels.
Both you (the employer) and the employee contribute to payroll taxes. As an employer, you’re responsible for withholding a part of the employee’s paychecks to cover their share, and need to file and pay your share directly to the government.
Setting up a payroll tax system is a critical step for all new businesses that employ workers. Not only is it a legal obligation for employers, it’s also critical to ensuring that your employees are paid the right amount of money for each pay cycle.
Do I need to pay payroll tax?
If your business has employees, then you need to pay payroll taxes. It’s really that simple.
Any business that staffs full- or part-time employees is responsible for deducting payroll taxes from their paychecks, and paying an employer’s share to the government. Paying these taxes isn’t optional’ it’s a legal requirement to operate your business in the United States, and avoid penalties.
We’ll also re-iterate that payroll taxes exist at the federal, state, and local levels. Make sure that you’re aware of your tax obligations for each geographic area in which you operate. If you’re not sure about what you need to deduct and pay, we recommend consulting a professional accountant, or using a payroll software.
Which of my employees is considered a “taxable worker”?
Taxable worker is a non-formal term that’s used to describe any employee from whom you need to withhold taxes (and for whom you need to pay employer payroll taxes).
As mentioned above, any employees that are formally under an employment contract—whether full-time or part-time—are considered to be taxable workers. That means you need to deduct income tax and pay your share.
Non-taxable workers include independent contracts, unpaid interns and co-op students, or interns and co-op students receiving stipends. You don’t have to withhold any payroll taxes for these folks. They’ll need to report any money received under these terms as part of their personal income, and are responsible for paying their own share of taxes.
Don’t forget! Payroll taxes also apply to any cash bonuses you give to your employees. This is considered supplemental income, and is also subject to federal income tax. Depending on where you operate, there might also be state and local tax implications to account fot.
What are the specific payroll taxes I need to know about?
We know. There’s a lot to digest when you’re setting up payroll taxes for the first time. Don’t worry: there are tools and resources available to help make this process easier. We’ll get to those later in the article.
If you’re feeling unsure about what taxes you need to cover, it helps to break things down by each level of government. Here’s a list of state, local, and federal taxes you may have to pay.
State and local payroll taxes
Every state has different types of payroll taxes with differing rates. Take a look at the U.S. Small Business Administration website for resources about your specific local and state tax obligations.
In general, these are the state and local payroll taxes you need to know:
- State income tax: Many states require withholding of state income tax from employees’ wages, similar to federal income tax withholding. Rates and regulations vary by state.
- State unemployment insurance (SUI): Employers pay SUI taxes to fund state unemployment benefits. Rates can differ based on the employer’s unemployment claim history and the state’s unemployment insurance fund status. Check out the U.S. Department of Labor website for more information.
- State disability insurance (SDI): In some states, employers must contribute to a disability insurance program that provides short-term benefits to eligible workers who are unable to work due to non-work-related illness or injury.
- Local taxes: Some localities impose additional payroll taxes on employers, which can fund local services or benefits. These taxes can vary widely by city or county. Consult with your local government, business association, and chamber of commerce.
Depending on the state, there may be additional taxes related to worker’s compensation, paid family leave, or health care. Always check with official sources online, or consult with an expert tax account.
Federal payroll tax
The IRS also imposed federal payroll tax on all businesses operating in the United States. Here’s a roundup of the four main types of federal payroll taxes.
- Federal income tax: Employers must withhold federal income tax from employees’ wages based on information provided by employees on their Form W-4.
- Social security tax: Part of the Federal Insurance Contributions Act (FICA), this tax is paid by both employees and employers. It’s 6.2% of wages up to a certain limit set by the IRS each year.
- Medicare tax: Also under FICA, both employees and employers pay a Medicare tax of 1.45% on all wages, with an additional 0.9% Medicare surtax for wages exceeding a certain threshold for high earners.
- Federal Unemployment Tax Act (FUTA) tax: Employers pay this tax without deducting it from employee wages. The FUTA tax rate is 6% on the first $7,000 of each employee’s earnings per year, but tax credits for state unemployment taxes paid can reduce the effective rate to 0.6%.
These are all of the taxes you need to be aware of. Now let’s talk about forms (we know: you’re excited).
Forms. There are always forms. Which payroll forms do I need to know?
Governments love their tax forms. Unsurprisingly, you probably don’t (and neither do we). But it’s still important to have a general idea of which forms you need for each type of payroll tax so that you keep on the government’s good side.
We’ll keep this section brief because, well, forms are boring.
- Form W-4 (Employee’s Withholding Certificate): Used by employees to determine the amount of federal income tax to withhold from their paychecks. Employers may also provide this form to new hires during the onboarding process.
- Form W-2 (Wage and Tax Statement): Issued annually by employers to report wages paid and taxes withheld for each employee to the IRS and the employee. Copies are sent to employees and the Social Security Administration by January 31st of each year.
- Form 941 (Employer’s Quarterly Federal Tax Return): Used to report income taxes, Social Security tax, and Medicare tax withheld from employees’ paychecks, as well as the employer’s portion of Social Security and Medicare taxes.
- Form 940 (Employer’s Annual Federal Unemployment (FUTA) Tax Return): Filed annually to report the amount of FUTA tax the employer has paid on behalf of their employees.
- Form W-9 (Request for Taxpayer Identification Number and Certification): Used to request the taxpayer identification number (TIN) of a contractor or other payee, which is needed for reporting purposes. These forms are often provided by freelancers or contractors to the employer before starting work.
- Form 1099-NEC (Nonemployee Compensation): Used to report payments of $600 or more to independent contractors or other non-employees for services performed.
- State-Specific Forms: Depending on the state, there may be additional forms required for state income tax withholding and state unemployment insurance contributions. Employers can contact the state agency directly for forms and filing instructions.
Each of these forms can be accessed using the links above. Sure, employers can fill these out and submit them manually, but we’d recommend the use of payroll software to automate this process.
How do I calculate payroll taxes?
Once you’ve identified the different types of payroll taxes you have to deduct and pay, the final steps are calculating those deductions and sending that money to the government.
Let’s say you’re based in California and need to calculate payroll taxes for an employee making $55,000 per year. Here’s the process.
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- Determine gross pay: This is the total amount your employee earns before any deductions. In this example, $55,000 is the gross pay.
- Calculate federal income tax: Use the IRS withholding tables and the employee’s W-4 form to find out how much federal income tax to withhold. The amount varies based on the employee’s income, tax filing status, and any additional withholdings they request.
- Calculate social security and Medicare taxes (FICA):
- Social security tax: 6.2% of gross pay up to the wage base limit ($168,600 in 2024). For $55,000, it’s 6.2% of $55,000 = $3,410.
- Medicare tax: 1.45% of all gross pay. For $55,000, it’s 1.45% of $55,000 = $797.50.
- Calculate federal unemployment tax (FUTA):
- FUTA is 6% of the first $7,000 of each employee’s earnings but can be reduced to 0.6% with credits. For one employee, it’s 0.6% of $7,000 = $42 per year.
- Calculate state taxes: This includes state income tax and State Unemployment Insurance (SUI). Rates vary by state. In California, the state income tax rate ranges from 1% to 12.3% depending on the income bracket. For simplification, let’s assume a mid-range rate of 6% for our example: 6% of $55,000 = $3,300 for state income tax.
- Calculate any local taxes: Some locations have local payroll taxes, but we’ll skip this for our example as it varies widely.
- Add up total withholdings: Add federal income tax, FICA taxes, and state taxes to get total withholdings. Employers don’t withhold FUTA from employees’ wages.
Here’s the math for this example:
Gross pay: $55,000
Federal income tax: Variable based on W-4 (let’s say $5,000 for this example)
Social security tax: $3,410
Medicare tax: $797.50
State income tax (estimated at 6%): $3,300
Total withholdings (excluding FUTA, which is employer-paid): $12,507.50
Once you’ve figured out that calculation, you then need to send the tax withholdings to the appropriate tax agencies. Typically, these deductions are split evenly between each of an employee’s paychecks.
My brain hurts. I need some help!
Our brains hurt, too. (We did include ‘ugh’ in the title.) But don’t reach for the Advil yet though—we have a secret weapon up our sleeves.
Payroll software, like the one we offer at Homebase, can automate every step that we’ve outlined in this article. That’s right. It can identify which taxes you need to pay, how much you need to deduct, fill out all of those forms, and submit them to the proper tax agencies.
Here’s how it works. When you run payroll, Homebase calculates taxes and paychecks, sends direct deposits to your team, and automatically pays and files your payroll taxes. All you have to do is set up the software (we can help with that), add your employees to payroll, and get them working.
Ready to ease some of that brain ache? Get started with Homebase now.
Remember: This is not legal advice. If you have questions about your particular situation, please consult a lawyer, CPA, or other appropriate professional advisor or agency.
