Payroll taxes are a fact of life for every U.S business. Employers and employees are responsible for paying payroll taxes based on each employee's wage or salary.
Both parties must pay some of these taxes, and the cost is split evenly between the company and employee. In some cases, the employer pays all of the taxes, and in others, the employee does.
If you couldn’t tell by now, the U.S. payroll tax system is anything but simple. There are local and federal payroll taxes, and these are often very different. So, what you pay in one state may be completely different in another. That’s why it’s best to consult a licensed tax professional or payroll specialist familiar with the state’s rules to ensure your small business’s compliance. Or, if the idea of processing tax payments and tax rates seems overwhelming and time-consuming, outsource this job through a professional employer organization (PEO) or payroll service provider.
Here is a general breakdown of payroll taxes.
What are employment taxes, a.k.a. payroll taxes?
Before we dig into the details about the various types of employment taxes, let’s first explain what they are and what they do. Employment or payroll taxes are taxes levied on wages or salaries used to finance social insurance programs, such as Social Security, disability insurance, and Medicare. The Internal Revenue Service (IRS) not only expects business owners and self-employed persons to pay their share of payroll taxes they’re also expected to withhold the right amount of taxes. Not doing so is a big deal that could result in big fines. More on that later.
Payroll taxes are different from income taxes which are taxes on employees' wages by the federal government, many state governments, and some local governments to fund their programs.
What are the basic state and federal payroll taxes?
Both federal and state taxes are part of payroll taxes. Here is a rundown of what each tax is and who pays for it.
FICA Tax
Employers and employees both pay FICA tax, with each party paying the same amount. FICA taxes, or Federal Insurance Contributions Act taxes, are made up of Social Security taxes and Medicare contributions.
The Social Security tax rate for 2022 is 6.2% of gross wages per party for a total of 12.4% up to individual earnings of $147,000. After an employee earns $147,000 in a year, no more Social Security taxes will be deducted from their paycheck or charged to the employer.
The Medicare tax rate is 1.45% of an employee’s entire salary for most employees and employers, for a total of 2.9%. Employees exceeding the specified income threshold are also responsible for paying an additional 0.9% Medicare tax. While the employee is the sole contributor for this additional amount, the employer must also withhold this sum for the employee. The threshold requiring this added Medicare tax is $250,000 for joint filers, $200,000 for singles, and $125,000 for married people who file separately.
FUTA (Federal Unemployment Tax Act)
FUTA pays in part for federal unemployment benefits. Employers pay this tax in full. All employers must pay 6% FUTA up to $7,000 in wages. After an employee earns $7,000, the federal government does not collect FUTA. FUTA does not apply to contractors, yet it applies equally to full and part-time employees. For FUTA purposes, an employee is anyone the company fills out a W-2 for who makes more than $1,500 per calendar quarter or works at least one day in 20 different weeks in the same year.
SUTA (State Unemployment Tax Act)
This tax goes hand-in-hand with FUTA, raising money for each state’s unemployment benefits. Labor laws and state unemployment benefits vary widely, so this SUTA tax contribution also varies by state. Consult a local tax pro in your area when in doubt.
Additionally, employers paying in for SUTA may be eligible for up to a 5.4% break on FUTA taxes. This also varies by state.
Federal Income Tax (Withholding)
Employees opt into the percentage of tax withholding they want to pay in each pay period, with a goal of withholding enough taxes to pay for FICA and their federal income taxes each year. Employers, their payroll system, or their PEO withhold this money from each paycheck.
State Income Tax
Most states charge a state income tax on earnings, paid for by the employees and withheld by their employers. The exceptions with no state income tax are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. New Hampshire and Tennessee do not charge state income taxes on wages, yet these two states do charge a state tax on income from interest and dividends.
In addition, a number of cities, counties, or municipalities charge income tax on earnings. There are seventeen states and the District of Columbia that allow smaller government entities to collect income taxes, so know your local labor laws when setting up a business.
Here’s a list of some of the areas with local income taxes. Like federal and state income taxes, these local taxes are withheld from the employee’s paycheck. Businesses may be responsible for other employer payroll taxes for short-term disability insurance, unemployment insurance, family medical leave, and other similar assistance programs.
What payroll taxes for contractors and freelancers?
You don't have to withhold employment taxes if you hire a contractor or self-employed professional. However, you are required to obtain a Form W-9 from the worker and then submit Form 1099-NEC to the worker and the IRS if the reported income exceeds $600 or more.
What happens if a business pays late?
Ooof, you definitely do not want to go there! If a business is late in paying its employees’ payroll taxes, the IRS will take notice and will charge a penalty. This penalty amount continues to go up the longer the company does not pay. This could break a small business, so we can’t stress the importance of getting payroll taxes right. If the IRS believes a business is intentionally negligent in paying these taxes, it could sue the business in civil or criminal court.
Help! This is a lot!
Don’t panic if the thought of payroll taxes makes you nervous. It’s a big job and one of the areas most likely to lead to legal woes if not handled properly. The good news is that there are options for small businesses to get help with all payroll matters. Of course, any good payroll company or PEO (Professional Employer Organization) worth its salt will be able to do the heavy lifting.
Paying for these services upfront through a PEO or payroll service provider can save a small business oodles of time, headaches, and legal troubles. They figure out the payroll tax rate, when taxes are due, and how much money to withhold, and they will file on your behalf (payroll service) or as a co-employer (PEO). In fact, a PEO like Decent also shares in the legal liability with their small business partners. Due to this additional legal responsibility, PEOs are expert advisors on payroll, tax laws, and all matters of compliance.
Of course, a PEO does all that and so much more, including providing HR services and health insurance plans for their small business partners.
Wondering if a PEO is the right move for your company? Click here to learn more about why more small businesses are turning to PEOs. We're also happy to talk it over with you and help you decide! Contact a Decent team member at hello@decent.com. Our pricing is transparent because we want to make it easy to understand and easy to work with. Check out our pricing page and request a custom quote here.
