There’s so much to consider when starting a small business. One of the most complicated is handling taxes. As the owner of a startup, it’s up to you to pay some taxes on behalf of your employees or withhold others from their paychecks.
This guide aims to give you a basic understanding of the payroll taxes you’ll have to deal with and how you can handle them yourself or with the help of a payroll service. Learning the ins and outs of different payroll taxes will help you stay in compliance and avoid things like Internal Revenue Service (IRS) fines.
What are payroll taxes, and who must pay them?
Payroll taxes are taken out of employee wages or salaries. The money from payroll taxes is used to pay for government programs, like Social Security, Medicare, and unemployment benefits.
Some employment taxes are paid directly by an employer, while others are withheld from an employee’s paycheck by their employer and submitted to the IRS. (Self-employed people and most LLC members pay Self-Employment Tax instead of payroll tax since they are not employees and do not receive a paycheck.)
What kinds of payroll taxes are there?
Payroll taxes can be paid completely by an employer, completely by an employee, or split between the employee and employer. The IRS designates who’ll be responsible for paying different types of taxes. The four types of payroll taxes are:
- Federal income tax: These are taxes on an employee’s gross income and taken out of an employee’s paycheck.
- Federal Insurance Contributions Act (FICA): These taxes go toward Social Security and Medicare taxes and are split by employees and employers.
- Federal Unemployment Tax Act (FUTA): This tax goes toward a federal fund that loans money to states during hard financial periods.
- State taxes: There are several state taxes, which vary from state to state. Some are paid out of an employee’s salary, and others are paid by an employer.
Payroll Taxes Collected From Each Employee’s Paycheck
These taxes are only taken out of an employee’s paycheck. The employer must withhold these taxes from their employees’ paychecks to be sent to the IRS.
Federal Income Tax
Federal income taxes go to the federal government and pay for things like roads, bridges, schools, and any other resources offered to the general public. Federal income tax is a progressive tax. That means that different amounts of income are charged differently. The percentage rate the federal government charges on a specific amount of income is called a bracket. Here are the 2021 federal tax brackets in the United States:
- 10% for income up to $9,950 ($19,900 for married filing couples filing jointly)
- 12% for income over $9,950 (over $19,900 for married filing couples filing jointly)
- 22% for incomes over $40,525 (over $81,050 for married couples filing jointly)
- 24% for incomes over $86,375 (over $172,750 for married couples filing jointly)
- 32% for incomes over $164,925 (over $329,850 for married couples filing jointly)
- 35% for incomes over $209,425 (over $418,850 for married couples filing jointly)
- 37% for incomes greater than $523,600 (over $628,300 for married couples filing jointly)
State Income Tax
This tax will differ depending on which state you reside in. Some states have a progressive tax structure that mirrors federal income tax withholding practices, while others impose a flat tax on income. Some states, like Florida and Texas, don’t even have a state income tax.
For example, if you live in California, you could pay a state income tax as high as 12.3%. If you live in North Dakota, the maximum state income tax is 2.9%.
Payroll Taxes Paid by the Business Owner and Collected From an Employee’s Paycheck
These taxes are split between the business owner and the employee. The employer withholds part of these taxes from their employees’ paychecks and remits the rest themselves.
FICA taxes are split into two categories. Social Security taxes are used to offer retirement benefits for older people, and Medicare taxes provide health benefits to people who are older, disabled, or have certain medical conditions.
Half of an employee’s FICA taxes will be taken directly from their paycheck, and the other half will be paid by their employer.
Social Security Tax
The Social Security tax equals 12.4% of an employee’s income, where 6.2% is taken from the employee’s check, while the other 6.2% is paid by the employer. There’s also a wage base for the Social Security tax. This is the maximum amount of income the government can take the Social Security tax from. The current wage base for an employee is $142,800.
The Medicare tax rate stands at 2.9% of an employee’s income and is much smaller than the Social Security portion. At this rate, 1.45% is taken from an employee’s paycheck, and the employer pays the other 1.45%.
However, Medicare doesn’t have a wage base, and people with higher incomes pay more. High earners will pay an additional 0.9% of Medicare tax on income past a certain amount. The employer doesn’t have to match this extra charge. This amount will vary based on an employee’s filing status.
- $250,000 a year if filing jointly and married
- $125,000 a year if filing separately and married
- $200,000 a year if single
Payroll Taxes Paid by the Business Owner
Only employers pay these taxes. Nothing is withheld from an employee’s paycheck.
Federal Unemployment Tax Act (FUTA)
This tax is only charged on the first $7,000 of a worker’s gross income at a rate of 6%. There is a FUTA credit of 5.4%. Business owners who qualify only have to pay 0.6% of an employee’s income in FUTA.
States that owe money in unemployment benefits loans from the federal government don’t qualify for the full amount of FUTA tax credits. Their credit is reduced until they’ve paid back what they owe. These states are called credit reduction states. As of November 2020, the only credit reduction state was the Virgin Islands.
State Unemployment Tax Act (SUTA)
Unemployment taxes are decided by each state. Some states, like North Carolina, have a SUTA tax rate of as low as 1%, while other states, like California, have rates as high as 3.4%. It’s also important to note that while most states require the employer to pay all tax amounts of SUTA, a few, like Alaska, do charge employees a portion, as well.
How do I submit payroll taxes?
After you’ve distributed paychecks to your employees, it’s time to send your payroll taxes to the IRS. There are a few tax forms you’ll need and deposit schedules you’ll have to follow. Here are some instructions on tax filing with the IRS.
Federal Tax Deposits
As a business owner, you’ll need to make tax deposits for your employees’ share of income and FICA taxes on a semiweekly or monthly basis. You’ll have to decide your deposit schedule before the beginning of a tax year. When depositing, you’ll include income taxes and FICA taxes. Business owners can e-file tax deposits through an electronic funds transfer via the Electronic Federal Tax Payment System (EFTPS).
Quarterly FUTA Tax Deposits
The timeline for filing FUTA taxes is different than for filing income and FICA taxes. These taxes need to be filed on a quarterly basis, but only if your business’s FUTA tax liability is over $500. If not, you don’t have to make a deposit until you owe at least $500. You must also pay these taxes electronically. The IRS has several guidelines for paying FUTA taxes.
Quarterly Form 941
Every quarter, your business is required to file Form 941 with the IRS. The document notifies the IRS of the total payroll tax liability for your employees from the previous quarter. The filing form lets you report the amount of income and FICA taxes you’ve withheld (and paid to the IRS) from your employees’ paychecks. It also lets you pay your employer portion of FICA taxes.
Where you’ll mail your quarterly return without your tax payments will depend on the state where you reside. You can also file it electronically and make employer tax deposits on the IRS website.
Annual Form 940
You’ll use Form 940 to report your company’s unemployment tax liability and the quarterly FUTA tax payments you’ve made during the year. Form 940 only needs to be filed with the IRS annually. You can submit this form by mail. The address will vary depending on which state you’re in. However, the IRS recommends you file it electronically.
State Tax Reports
Depending on where you do business, you’ll have to collect state income and unemployment taxes throughout the year. Unfortunately, there’s no universal way that states handle these. Different states have different schedules for when taxes are due and different processes for reporting them.
Take a look at your state’s website to see the regulations. Some states don’t even require you to report state income taxes. If you live in one of these states, you can skip filing income taxes:
- New Hampshire
- South Dakota
It’s important to note that New Hampshire and Tennessee still charge taxes on investment income (like dividends and interest), but both states have taken steps toward eliminating those taxes, as well.
Don’t get dragged down by payroll taxes
Dealing with payroll taxes is one of the most cumbersome parts of running a company. Still, if you want to avoid hefty fines and penalties from the IRS, it’s vital to understand your tax obligations. Even if you have a good grasp on taxes, it’s easy to make mistakes. It might be wise to enlist the help of a certified public accountant (CPA) or another tax professional to help you do everything correctly.
Starting a business is an exciting adventure, but it has many challenges. Luckily, you don’t have to go at it alone. ZenBusiness has the resources you need to stay in compliance and successfully grow your business.
Payroll Tax FAQs
- What if I have out-of-state employees?
Usually, you’ll withhold taxes for the state where they work. However, some states have reciprocal tax agreements, which allow workers to be charged tax rates based on the state where they live. The employee will have to give you a form requesting reciprocal tax treatment.
- What are the payroll tax due dates for this coming year?
April 30, July 31, Oct. 31, and Jan. 31 are the due dates for quarterly tax returns (Form 941). FUTA tax returns (Form 940) are due on Jan. 31, but you have until Feb. 10 if you’ve paid your unemployment taxes on time. Also, if a due date happens to fall on a weekend or a holiday, you have until the next business day to submit your return.
- What will a payroll tax cut do?
It would decrease the amount of total taxes employees and employers have to pay, but it would also lower the amount of money the government could put into programs like Social Security and Medicare. Even so, it could give temporary aid to taxpayers impacted by the coronavirus pandemic.
- What was the payroll tax cut holiday?
The payroll tax holiday was a COVID-19 pandemic relief program that allowed employers to choose to defer the collection and payment of Social Security taxes on employee wages from Sept.1, 2020 through Dec. 31, 2020. However, employers had to pay at least half of those taxes back by January 3, 2022. The remainder of the deferred payments must be remitted by Dec. 31, 2022 to avoid penalties and interest charges.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.