As a small business owner, you have a long, exhaustive list of responsibilities. And while certain obligations can be shoved to the backburner at times, others must be addressed in a proactive manner. Financial tasks, such as accounting and taxes, fall into this latter category.
If you’re a new small business owner and you’ve just recently hired your first employees, you need to make sure you have a firm grasp on the concept of payroll taxes and what responsibilities you have.
What Are Payroll Taxes?
Payroll taxes are essentially federal taxes that the government requires employers and employees to pay in order to fund government programs like Medicare, Social Security, and unemployment compensation. As an employer, you’re required to withhold these taxes from your employees’ paychecks and send the funds to the IRS on their behalf.
There are a few different types of payroll taxes small business owners need to be aware of:
- Federal income tax: These are taxes that you withhold from employees based on their salary, filing status, dependents, and other information they fill out on their W-2 tax forms. Federal income tax withholdings generally range between 10 percent and 37 percent of gross earnings.
- FICA taxes: FICA taxes, which stands for Federal Insurance Contributions Act, is comprised of three different taxes bundled into one. The first type is Social Security Tax, which comes in at 12.4 percent. You, the employer, are responsible for exactly half of that amount (6.2 percent). Medicare Tax is 2.9 percent, with employers owing 1.45 percent per employee. And if an employee’s income exceeds a certain threshold, there may be an additional 0.9 percent Medicare Tax.
- FUTA taxes: This program helps fund and oversee state unemployment insurance programs. As an employer, you’re required to contribute. The standard FUTA tax rate is 6 percent on the first $7,000 paid to each employee per year. In other words, it’s roughly $420 per year per employee making at least $7,000.
As a small business owner, the IRS requires you to calculate and withhold payroll taxes with each paycheck you distribute to an employee. Make sure you familiarize yourself with the details.
Calculating Payroll Taxes
At first glance, it’s easy to feel overwhelmed by payroll taxes, percentages, income thresholds, W-2 statements, filing statuses, etc. – but just breathe! It’s not as complex as it seems.
To calculate payroll taxes, you begin by determining how much federal income and FICA taxes must be paid. Once you have these figures, you figure out what percentage of the FICA taxes you’re responsible for. And depending on how many employees you have on the payroll, you’ll be required to make IRS payments monthly or bi-weekly.
The easiest way to calculate your payroll taxes is to hire a bookkeeper or accountant to manage your books on your behalf. You can also use a payroll tax calculator or software program to run some basic numbers. (Though you shouldn’t rely on a free tool to make your tax payment decisions. These figures should be used as a general rule of thumb.)
What About Employees’ Tips?
For those with employees earning tips – like in a restaurant, bar, or valet service – there are certain obligations.
Generally speaking, an employee’s tips aren’t taxable unless they make at least $20 in tips per calendar month. If they make more than this, you’re required to withhold income and FICA taxes on all reported tips. (You’re supposed to require your employees to report their tip amount to you by the 10th of the following month.)
If your employee doesn’t report their tips to you, you can only be held liable for your portion of the FICA. Issues arise, however, if the IRS makes a written notice demanding payment.
Penalties for Not Paying Payroll Taxes
Employers fail to make payroll tax payments for a variety of reasons, including:
- Forgetting to withhold
- Forgetting to deposit taxes
- Borrowing from payroll tax funds
- Poor organizational system
- Dealing with unusual circumstances (like the effects of a natural disaster)
- Evading taxes
Payroll taxes are a pain – we get it – but that’s no excuse for forgetting and/or failing to pay payroll taxes. If you forget, you could find yourself in hot water with the IRS.
Approximately 70 percent of the annual revenue the IRS collects comes from payroll taxes. And it’s estimated that underreported and unpaid taxes account for roughly $72 billion in losses per year. In other words, the IRS knows that businesses try to skirt the rules and they crack down hard when they find offenders.
According to the IRS, employers who fail to follow employment tax laws may be subject to civil and criminal penalties. However, in most cases, fines are the answer. And these fines depend on a couple of factors: how much you owe and how late the payment is. You can see a breakdown of the fees here.
End of Year Payroll Tax Tips
Take some time at the end of each calendar year to complete important payroll tasks. This will help you prepare for tax season and avoid any issues that could stem from missed payments or unallocated funds.
The end of the year is the perfect time to verify Form W-4 and W-9 for each employee. If there are any name or address changes, these need to be reported. If an employee wants to adjust the amount that’s withheld from their federal income taxes, now is the time.
This is also a convenient time to figure out taxable amounts for employee benefits and to ensure wages are recorded properly. If you’ve done a thorough job of this throughout the year, this will be more of a final look over to ensure you’re in compliance with the IRS.
How to Reduce Payroll Taxes
Taxes deplete profits. So it’s only natural that you’d want to look for ways to reduce the amount of payroll taxes you owe. Here are some commonly used tactics:
Strategically Structure Benefits
Instead of giving raises to employees this year, look for ways to add fringe benefits (as they’re exempt from both FICA and FUTA taxes) that employees would be purchasing anyway. This may include:
- Accident and health benefits
- Group-term life insurance
- Employee discounts
- Education assistance (up to $5,250 per year)
- Dependent care assistance (up to $5,000 per year)
- Retirement planning services
- Meals and lodging on business premises
- Health savings account contributions
By funneling raises through these benefits, you’re able to reward your employees without increasing taxes. It’s a win-win situation.
Use Accountable Plans
If your employees travel a lot and you reimburse them for their expenses, you may consider using accountable plans. Any money sent through an accountable plan is not taxable to employees and is exempt from employer FICA and FUTA taxes. You can learn more here.
Pay Corporate Directors
Did you know that all corporations are required by law to have directors and to hold annual meetings? If you own a corporation, you can actually use this to your advantage by paying a portion of an employee’s wages into a director’s fee. As long as the employee continues to receive a reasonable compensation for the work they perform as an employee, there’s nothing illegal about this. It won’t save you a ton of money, but whatever you do pay in director’s fees are not subject to employment taxes.
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