Small Business Payroll Taxes: A Beginners Guide

Small business owners have many questions. How do I make money? What can I do to grow my business? How are payroll taxes calculated? Paying taxes isn't fun, but it's also a cost of doing business. There are many kinds of taxes you'll face, and some of them might not be familiar to you. Payroll taxes apply when you have employees. Fortunately, there are payroll services in Chicago that can help you manage this part of your business.

What Are Payroll Taxes?

How do payroll taxes work for a small business? Payroll taxes are federal taxes that fund things ranging from Social Security to the Federal Insurance Contributions Act. Calculating payroll taxes tells you how much to withhold and send to the government for legal compliance.

Types of Small Business Payroll Taxes

how are payroll taxes calculated

How much is payroll tax for a small business? First, you have to know all the types of payroll taxes, which are different than income taxes. They might include security and Medicare taxes, and you might have to deal with a state unemployment tax act where you do business. While there are many different kinds of taxes to sift through here, you'll generally face two categories. One is the payroll taxes that you pay as an employer. The other is the payroll taxes that employees pay.

Payroll Taxes Paid by the Employer

As an employer, you are responsible for the following payroll taxes:

  • The employer portion of FICA: The Federal Insurance Contributions Act is a mixed tax handling both Social Security and Medicare. Employees and employers have similar FICA tax rates. It's 12.4% of the gross pay to fund Social Security, while Medicare's share is 2.9%. That means you and your employees each pay 1.45% for Medicare taxes and 6.2% for Social Security.
  • Federal Unemployment Tax Act: FUTA is an employer tax that funds the unemployment systems of individual states.
  • State Unemployment Tax Act: SUTA works like FUTA. It's an employer's responsibility, and it pays directly to your state's government.

Payroll Taxes Paid by Your Employees

Some taxes are paid by your various employees, even though you collect them and then remit them on their behalf:

  • Federal income tax: Your employee will provide information via their W4 form that calculates the federal income taxes you should withhold.
  • The employee portion of FICA: This would be the half of the previously mentioned Medicare and Social Security taxes that your employee is responsible for.
  • State/Local taxes: On top of federal withholding, you might also be required to withhold any applicable state or local taxes from employee paychecks.

How to Calculate Payroll Taxes for Small Businesses

Payroll taxes for small business owners are probably not something you want to face, but you need to know how to calculate them. There is a process you can follow, however.

Step 1. Determine Taxable Workers

Payroll tax and employment taxes are usually only applicable to taxable workers. Wages paid to independent contractors won't count towards payroll tax payments because they pay their own taxes. Having said that, the lines can get blurry between contractors and employees. There are several tests the IRS uses to determine this. One of them is the behavioral test asking whether or not an employer has control over a worker. A financial test considers how much control an employer has over the budget and supplies for a worker. The relationship test looks at whether or not there are no boundaries regarding supervision and labor or if a relationship is only going to last a limited project or duration.

Step 2. Determine Taxable Wages

Taxable Wages

In order to pay payroll taxes, including federal payroll taxes and the Social Security tax, you need to know what an employee's taxable wages are. Paying payroll taxes means knowing the compensation for an employee's services which might include salary, gifts, and bonuses. Certain forms of compensation, however, aren't taxable wages, such as reimbursements for business expenses, including meals and travel. Nontaxable expenses must be reported by employees via expense reports and receipts. They also have to be related to business, necessary, and reasonable.

Step 3: Calculate Withholdings

Certain amounts will need to be withheld from an employee's paycheck. The specific list might vary, but there are four common ones that you might need to watch out for:

  1. Federal Government Taxes: Federal payroll tax applies here, but you might not have to look up any rates. Your employee should have provided a W4 form indicating their withholding preferences that you can follow.
  2. FICA Taxes: These are the combined taxes that pay for Social Security and Medicare. Your employee has to pay half to match the half that you pay into both Social Security and Medicare.
  3. State Taxes: Not all states tax payrolls, but most do. Find out the appropriate rate for where your employee is working so you can make the proper withholdings happen.
  4. Local Taxes: City and county governments at the municipal levels are the least likely to have payroll taxes, but you need to make sure you follow any rules that apply to your location.

Step 4: Subtract Any Payroll Deductions

You need to deduct any other deductions due to come out of your employee paychecks. This can be an important part of when you pay taxes, but there might not be a federal tax that applies here. State unemployment tax is accounted for in another step, and state payroll taxes vary from one state to the next.

Step 5: Add Any Reimbursements

Do you reimburse your employees for any expenses? If so, then you need to add it back to their gross pay. This needs to happen after you subtract any payroll deductions but before you calculate their final paycheck.

Step 6: Calculate Paycheck

At this point as a small business owner, you are ready to calculate your employee's paycheck. There's no tax credit for doing this, but it means your employee gets paid, and you stay in compliance with government laws. You already did the withholding taxes, but unemployment taxes are in the following steps.

Step 7: Calculate FUTA

small business payroll taxes

Once you calculate all the withholding taxes, you also need to compute the Federal Unemployment Tax Act (FUTA tax) for a particular payroll period. The FUTA tax rate applies to the first $7,000 of employee wages at 6%, although you might get a credit of as much as 5.4% when you file Form 940. The Federal Unemployment Tax Act is important to help out those who might be out of work for reasons beyond their control.

Step 8: Calculate SUTA

State unemployment taxes aren't always the same as unemployment insurance taxes, but SUTA will apply to nearly every state you might be doing business in. However, the rate will vary from one state to the next. This differs from federal taxes, such as Social Security or FICA taxes that are set in stone and apply the same across the country.

How to Report and Pay Payroll Taxes?

As a business owner, you want to claim tax credits when you can, but you might also pay federal and state income tax when you have to. Payroll taxes provide many things for employees, such as unemployment benefits in some cases. Reporting payroll tax is different than paying it, and you might have to do it quarterly or annually with various forms, such as 941, 944, 943, or 940.

Payroll Tax Payment Schedule

Small business owners have tax obligations they must adhere to. Both the employee and business owner benefit when all this is paid on time. You'll pay federal payroll taxes on one of two schedules based on how much you usually owe to the IRS.

If your federal payroll taxes are $50,000 or lower through a 12-month span of time, you can do monthly deposits for your taxes. However, if your taxes exceed $50,000, then you will deposit your taxes two times each week. If you wind up paying annual payroll taxes under $1,000 a year, you can request to skip semi-weekly payments and just pay once per year.

Federal tax deposits can be made electronically via the Electronic Federal Tax Payment System. However, if you owe payroll taxes under $2,500 per quarter, then you can still mail paper checks in. Local taxes vary by municipality or state.

What Happens If Payroll Tax Payments Are Late or Unpaid?

Tax Payments Are Late

Whether your employees' paychecks are paid monthly or more frequently, you need to make sure that payroll tax payments are also made on time. Keep in mind that this is unlikely to apply if you use contractors as payments to contractors are handled much differently.

The federal government operates with the assumption that payroll taxes are a unique category where the employee's share actually belongs to that employee instead of their employer. For instance, these taxes might be funding future benefits, such as Social Security. If a small business gets tempted to use that money for purposes other than what the government lays out, it can be punished with serious penalties. Late payments also accrue interest and penalties which add up quickly. The IRS might put a tax lien on property you own, take the money you owe them straight out of a bank account, or even imprison you.

Interest penalties on late fees vary based on how late the payments are. A few days late might put you at just a few percentage points, but after a month or so, you might face 15% fees plus hundreds of dollars in fines. Falling behind just a few weeks can start eating into your revenue and profits. The IRS won't care if you're making enough money to afford it. This has caused many small and medium business owners serious headaches, so don't let this stall your small business growth.

How Can S. Lewis CPA Help Your Small Business with Payroll Taxes?

Calculating payroll taxes correctly is crucial to pay for things like Medicare benefits and other programs reliant on employee contributions. If you need payroll services in the Chicago area, then get expert help with state and local taxes that might apply to employee earnings. Contact us right away to see how we can help you ensure that it's done right the first time around.

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