Take a moment to think back to your first real paycheck. You may recall some shock in seeing that the amount of your check was much less than the amount you earned. Of course, your employer had reduced your pay with a number of deductions for various taxes. And as an employer, you too will withhold taxes from your employees' pay and deposit those amounts with the appropriate tax agencies. You’ll also pay certain taxes from your own funds based on what you pay your employees.
What are payroll taxes?
The taxes you're required to withhold and those you're required to pay directly comprise your payroll taxes. Amounts withheld include federal, state, and perhaps local income taxes and one half of the FICA taxes (Social Security and Medicare). Amounts paid directly from employer funds include the other half of the FICA taxes, federal and state unemployment taxes, and, in some states, disability insurance taxes.
Five steps to controlling your payroll taxes
The key to controlling your payroll tax obligations is making all your payments when they're due, so you avoid getting hit with costly penalties. To that end, we'll help you stay on top of the rules by leading you through the following topics:
- Step 1: Understand who your “taxable” workers are. First, determine which of your workers are "employees" rather than independent contractors. Payroll taxes are due only with respect to employees. Generally speaking, the key question is the degree of control you exercise over the worker. If you have the right to determine what the worker does and when, where, or how the work is done, then the worker is an employee.
- Step 2: Identify what compensation is taxable. Next, determine which forms of employee compensation are taxable in addition to basic wages and salaries and which forms may reduce the amount of taxable compensation. Among the different elements you’ll want to consider are: tips, expense reimbursements, fringe benefits, health and life insurance premiums, bonuses, retirement contributions and noncash payments.
- Step 3: Determine which payroll taxes apply. Know the various types of tax obligations that arise when you have employees. You generally withhold federal and state income tax from your employees' wages. You also withhold half of FICA taxes (Social Security and Medicare taxes) from your employees' wages. In addition, from your own funds, you typically pay the matching half of the FICA taxes as well as federal and state unemployment taxes. Learn how to compute and pay the amounts that must be paid. IRS Publication 15, (Circular E) Employer's Tax Guide, can help you understand your federal tax obligations.
- Step 4: Get familiar with payroll tax returns and payments. Learn about the forms, returns, and the filing and payment procedures for payroll taxes. Know the filing and payment deadlines, and mark important dates on your calendar. IRS Publication 15, noted above, provides useful information on federal deposit and filing requirements. Note that payment schedules often differ from return filing schedules, and unemployment taxes are reported and paid separately from income tax and FICA payments. Beware of the penalties you'll incur if you fail to make payments or file timely returns.
- Step 5: Determine your self-employment taxes. Even if you don't hire anyone else to work in your business, you're always going to have at least one "employee," and that would be yourself. Whether or not you are incorporated will make a big difference in your taxes. If you run your business as a corporation, you're likely to have all the same payroll tax obligations you would have if you actually hired another employee. If you are a sole proprietor, you'll have to pay estimated income tax and self-employment (SECA) taxes. In essence, self-employment taxes are like FICA taxes for people in business for themselves.