The Essential Guide to Payroll Taxes for Employers

May 7, 2019
Posted in: Payroll Taxes

New business owners are often intimidated and confused by payroll taxes. When you start off in your first year, discovering how to do payroll may be a stress-inducing experience. Not only do you have to know which types of funds to withhold, but you also have to know how much to withhold and when to deposit the taxes. In addition, regular payroll filings need to meet proper federal and state agency requirements, such as reporting to the IRS (Internal Revenue Service) the amounts of taxes owed and paid. With so many strict requirements surrounding payroll taxes, it should come as no surprise that many business owners prefer to outsource this cumbersome task. According to the Journal of Accountancy, 47% of U.S. companies outsource their payroll process.

If you’re debating whether you should take a DIY route, or you just want a better understanding of how to do payroll for your business, read on. We’ve prepared this guide to give you a basic overview of how payroll taxes work. We’ve also included several links below to give you a detailed breakdown of each subtopic.

Table of contents:

Payroll Taxes vs Income Taxes

Although many people use the terms “payroll tax” and “income tax” interchangeably, there are stark differences between the two. Here are a few ways these terms differ from one another:

  • Income taxes: Employed workers will pay these taxes. Income taxes include federal income tax and in most cases, state income tax. There are, however, a few states in the US with no state income tax. These states include Washington, Wyoming, Texas, South Dakota, Nevada, Florida, and Alaska.
  • Payroll taxes: Both employers and employed workers will pay this tax. Payroll taxes help fund Social Security, Medicare, and other social insurance programs.

Types of Payroll Taxes

There are four types of taxes an employee is responsible for:

  1. Federal income tax: employees pay this annual tax to the federal government from their earned wages.
  2. State income tax: If required in their resident state, employees pay this annual tax to their local state government.
  3. Social Security tax: Employees pay this tax to fund the federal social security program, which covers disability, retirement, and survivor benefits. Both employers and employees pay this tax.
  4. Medicare tax: Employees also pay tax to fund the Medicare program, which provides coverage for medical and health care costs for older beneficiaries. This tax is also shared by employers and employees.

On the other hand, employers and business owners are responsible for these four taxes:

  1. Federal Unemployment Tax: Also known as FUTA, employers pay this tax in order to cover workers who have lost their jobs.
  2. State Unemployment Tax: Or known as SUTA or SUI. This tax rate varies from state to state. Employers pay this tax to their local state agencies, which pay out unemployment insurance to unemployed workers.
  3. Social Security: Employers pay this tax to fund the federal social security program, which covers disability, retirement, and survivor benefits. Both employers and employees pay this tax.
  4. Medicare: Employers also pay tax to fund the Medicare program, which provides coverage for medical and health care costs for older beneficiaries. This tax is also shared by employers and employees.

Social Security and Medicare are jointly referred to as FICA (Federal Insurance Contributions Act). As you can see, these two taxes are the responsibility of both the employer and the employee, while only the employer pays for state and federal unemployment taxes.

Payroll Calculations


To get a general idea of how these different tax rates look on paper, here is an example showing how payroll is calculated:

Employee portionEmployer portionTotalCapDescription
Social Security
6.2%6.2%12.4%$132,900Benefits retirees, their families, and people with disabilities.
Medicare1.45%1.45%2.9%No capCovers people on Medicare
State Unemployment TaxVariesVariesVariesVariesPays for unemployement benefits or disability.
Federal Unemployment Tax0%6%6%$7,000Covers Unemployment insurance and job service programs

Penalties

Forgoing tax payment or paying late will incur severe penalties that accrue interest. It is important to note that deposits must be made on time and in the exact amount using the EFTPS Online System, a program which allows business owners to pay taxes online. Business owners can enroll in the program by submitting an online application here.

The IRS uses a four-tier penalty system for late deposits. Here is a breakdown of the penalty rates:

  • 2% penalty for deposits 1-5 days late,
  • 5% penalty for deposits 6-15 days late,
  • 10% penalty for deposits 15 days late,
  • 15% penalty (a 5 percent addition to the 10 percent for late payment for all amounts still unpaid more than 10 days after the date of the first notice requesting payment of the tax due or the day on which the taxpayer received notice and demand for immediate payment, whichever is earlier.)

In addition, any deposits not paid through the EFTPS system will incur a 10 percent penalty.

DIY (Do-It-Yourself) Payroll

Sorting through the initial payroll process can be overwhelming, but once you familiarize yourself with it, you’ll feel more comfortable with the procedures in the long-run. If you feel informed and confident to handle the payroll process yourself, here are some suggested steps to take.

Preparation

  1. The first step to take is deciding which accounting system to use. Quickbooks or Xero are both fine options for business owners.
  2. After you decide which system is right for your business, make sure you have collected all W-4 forms from all your employees.
  3. Setup a separate bank account for payroll and use this account to pay employees and deposit withholdings.

Paying Employees

  1. When paying your employees, first calculate the gross pay.
  2. After calculating gross pay, you will need to calculate withholdings. One tool you can use to calculate federal income tax are these IRS tables. Calculating FICA (social security & medicare) is straight forward. 15.3% of the gross pay is withheld; half from the employee, half from the employer. However, note the withholding limits as referenced in the table above. State income taxes for your business can be found here. Alternatively, we recommend using an online payroll calculator to calculate withholdings.
  3. Once you have calculated both the gross pay and withholdings, you can then write paychecks (or direct deposit) and disburse funds to your employees.

Paying the Government

Depending on the amount of payroll taxes withheld, there are differing timeframes for payroll tax deposits:

  • If your payroll tax obligation is <= $2,500 a quarter, you can deposit these taxes in a “timely filed return.”
  • If your total payroll taxes for the is <= $50,000 in the previous 12 months, you can deposit monthly. Monthly deposits must be made by the 15th day of the following month.
  • If your total payroll taxes >= 50,000 you must make deposits semi-weekly. Payrolls paid on Saturday, Sunday, Monday, or Tuesday must have payroll taxes deposited by the following Friday. Payrolls paid on Wednesday, Thursday, or Friday must have payroll taxes deposited by the following Wednesday.

The IRS requires that all payroll tax deposits are made through the EFTPS Online System. For local and state tax deposits, check with your local state agency to see how payment is preferred. Each state agency handles payroll taxes with its own filing and depositing requirements. For example, in the state of California, employers will deposit payroll taxes to the EDD (Employment Development Department). Similar to the federal schedule, there are varying timeframes for deposits based on withholding amounts and the above-referenced federal deposit requirement. If you are on a Monthly, Quarterly, or Annual Federal Deposit Requirement:

  • If your payroll tax obligation is <= $350 payroll taxes are due quarterly: April 30, July 31, October 31, January 2020.
  • If your payroll tax obligation is >= $350 payroll taxes are due on the 15th of the following month.

Outsourcing To Payroll Companies

If you’re feeling overwhelmed and don’t want to do the payroll tax calculations on your own, there are plenty of resources to consider. Many local companies are excellent in managing these procedures. Here are just a few of the most popular payroll services:

  • Paychex offers payroll services for any business, but they outshine competitors with their small business product, Paychex Flex. Employers can file their payroll online, by e-mail, or phone.
  • ADP is one of the oldest and most well-known payroll firms. They service businesses of all sizes from mom-and -pop shops to multinational conglomerates. In addition to payroll, ADP offers HR, benefits planning, insurance services, timecards, and much more.
  • Gusto, formerly known as ZenPayroll, has its pros and cons. There are many pros including: cheaper per-employee pricing than Paychex/ADP, employees can self-onboard, integration with Quickbooks and Xero, and transparent pricing tiers. However, there is one con: Gusto requires employers to handle more of the legwork when it comes to payroll.
Pricing for Gusto

Ultimately your decision in selecting a payroll company should come down to these factors:

  • Budget
  • Features
  • Industry

All payroll companies offer the same essential payroll services but differ in levels of service, software features, and pricing. Some payroll companies offer free trials and free quotes so there’s no need to rush in selecting a company. Our advice would be to try out a few different companies, compare packages and pricing, and see which company will be the right fit for your business. In the end, selecting the right company will free up time for you so you can focus on running your business.

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