Payroll Taxes Explained

Get Your First Month of Bookkeeping Services for FREE!

As a business owner, it is important to understand the financial responsibilities you will be facing. In the beginning phases of your business, it may be just yourself doing everything, but eventually, you most likely will need to hire some employees. If you have employees, you need to know all about payroll taxes, including what you are responsible for and how to calculate them.

What are Payroll Taxes?

A payroll tax is a tax on the wages or salary of a person that is paid to the government. An employer will withhold the amount from an employee’s pay and pay the government on their behalf. Even if your business does not have any employees, payroll taxes still need to be paid for yourself, although in this case, it is referred to as self-employment tax. This article will focus on payroll taxes for businesses with employees.

What are the two types of payroll taxes?

There are two types of payroll taxes, employee and employer. Employee payroll taxes are the taxes an employer withholds from the employee’s pay and sends to the government on their behalf. Employer payroll taxes are the taxes that come out of the employer’s pocket and are paid to the government.

What taxes do Employers Pay? What taxes do Employees Pay?
FICA – Social Security and Medicare FICA – Social Security and Medicare
FUTA – Federal Unemployment Taxes Federal Income Taxes
SUTA – State Unemployment Taxes State Income Taxes
Local taxes for employers Local taxes for employees

What are FICA taxes and how do you calculate them?

The Federal Insurance Contributions Act (FICA) is the payroll tax that you must pay to the government for social health programs (like Medicare and Social Security). The FICA tax is split equally between employer and employee, meaning the amount you pull out of an employee’s paycheck to send in is the same exact amount that you will pay out of pocket.

Currently, the tax rate is as follows:

Employers Employees
Social Security 6.2% on the first $147,000 of earnings 6.2% on the first $147,000 of earnings
Medicare 1.45% 1.45%
Total 7.65% 7.65%

Now that you know the percentage to take out of your employee’s paycheck, let’s look at an example of actually calculating the FICA tax.

Imagine your employee’s gross pay for the period is $450.

First, we will calculate how much to pull out for Social Security. We multiply the total gross pay by 6.2% to get the amount to withhold.

Social Security $450 x .062 = $27.90

Next, we will calculate the amount to withhold for Medicare. Remember, the tax rate for Medicare is 1.45% and we multiply this by the gross pay amount.

Medicare $450 x .0145 = $6.53

So, for this pay period, you would withhold $27.90 for Social Security and $6.53 for Medicare. As the employer, you will match these amounts to pay out of your pocket to the government.

Employer Pays: Employee Pays
Total FICA taxes for the period (in this example) $34.43 (27.90 + 6.53) $34.43 (27.90 + 6.53)

Keep in mind that you only pay Social Security tax on the first $147,000 your employee earns each year. This number increases every year.

Also, if your employee makes over $200,000 a year (filing as single), the Medicare tax rate will increase by 0.9% for all earnings over that $200,000. If they file as joint (married), the amount increases after $250,000.

What are FUTA & SUTA taxes?

Both the FUTA (Federal Unemployment Tax Act) and SUTA (State Unemployment Tax Act) are payroll taxes that an employer must pay. While the SUTA tax rate varies greatly for each state, the FUTA tax rate is 6% and is only paid on the first $7,000 an employee earns per year. However, you could pay as little as 0.6% after receiving certain state credits.

What is the difference between FICA and FUTA taxes?

As we went over earlier, FICA taxes fund Social Security and Medicare programs. FUTA taxes are used to fund unemployment programs.

As we went over earlier, FICA taxes fund Social Security and Medicare programs. FUTA taxes are used to fund unemployment programs.

Also, to file FICA taxes you will use form 941. This is due on the last day of the month of each quarter.

To file FUTA taxes, you will use form 940. The due date for this is January 31st.

We’ve gone over the taxes an employer has to pay out of pocket (except state and local taxes, as those vary depending on where your business is located), so let’s finish up looking at what you must withhold from your employee’s pay.

How do you calculate the federal income tax amount?

We’ve gone over some of the taxes you must withhold from your employee’s paycheck (FICA taxes), now let’s dive into figuring out how much federal income tax to withhold. First, your employee will need to fill out a W-4 form. This form was redesigned in 2020, so the process is a little different depending on which version of the form the employee uses. Next, you will need to know the gross pay of your employee.

Two methods are typically used. The Wage Bracket Method and the Percentage Method. As many business owners will tell you, the Wage Bracket Method is the easiest method of the two. Due to it being easier to understand, we will be using the Wage Bracket Method for this article.

Using IRS Publication 15-T, you will locate the Wage Bracket Method tables. There are two separate sections depending on which version of the W-4 form was used.

Here are the steps to fill out the worksheet to determine the amount to withhold from your employee’s wages.

Wage Bracket Method: Employees using a Form W-4 from 2019 or earlier
1 Locate the applicable worksheet for the version of Form W-4 used by your employee.
2 See if your employee indicated they file as single or married on the W-4 and the number of allowances they claim.
3 Enter the employee’s total taxable wages for the payroll period on line 1a of the worksheet.
4 Take the amount on line 1a and the number of allowances listed on the W-4 to look up the Tentative Withholding Amount listed in the table based on the payroll frequency (weekly, biweekly, etc.). Enter this amount on line 1b.
5 Enter any additional amount to be withheld (listed on the W-4) on line 2a.
6 Add lines 1b and 2a, and record it into line 2b. This is the amount to withhold from your employee’s pay for the period.
Wage Bracket Method: Employees using a Form W-4 from 2020 or later
1 Locate the applicable worksheet for the version of Form W-4 used by your employee.
2 See if your employee indicated they file as single or married on the W-4 and the number of allowances they claim.
3 Enter the employee’s total taxable wages for the payroll period on line 1a of the worksheet.
4 Enter the number of pay periods per year on line 1b (using Table 5).
5 Enter the other income amount from Step 4a of the W-4 into line 1c.
6 Divide the amount on line 1c by the number on line 1b, and enter this amount on line 1d.
7 Add lines 1a and 1d, and enter this amount on line 1e.
8 Enter the amount listed on step 4b of the employee’s W-4 on line 1f.
9 Divide the amount on line 1f by line 1b, and enter it on line 1g.
10 Subtract line 1g from line 1e, and enter it on line 1h. (If it is negative, enter zero.)
11 Use the amount on line 1h to look up the Tentative Withholding Amount listed in the table based on the payroll frequency, the employee’s filing status, and whether the employee checked the box in Step 2 of the W-4. Enter this amount on line 2a.
12 If there is an amount listed on step 3 of the W-4, enter it on line 3a and divide that amount by the number in line 1b, this amount goes on line 3b. Subtract line 3b from line 2a. (If it is negative, enter zero.) Enter this amount on line 3c. If step 3 is not filled out on the W-4, enter the amount from line 2a on line 3c.
13 Enter the amount listed on step 4c of the W-4 on line 4a. Add lines 3c and 4a, and enter it on line 4b. This is the amount to withhold from your employee’s pay for the period.

That may seem overwhelming, especially if your employee using the Form W-4 that was designed in 2020, but it is still much easier than the Percentage Method.

Submitting your Federal payroll taxes

You’ve done the math, you withheld the payroll taxes from your employee’s check, how do you submit it to the government? Well, the choice is easy since there is only one: you must enroll in the Electronic Federal Tax Payment System (EFTPS). You can access the EFTPS at www.eftps.com.

Employee State and Local Payroll Tax Withholdings

Just as with employers, employees must pay state and local payroll taxes. You, as the employer, will withhold these amounts from the employee’s paycheck as well each pay period and submit them on their behalf. State and local taxes vary depending on your location. You can learn more about payroll tax rates in your specific state and local area on the Federation of Tax Administrators website.

Outsourcing your payroll tax duties

Now that you have a basic understanding of payroll taxes, you might be exhausted just thinking about figuring it all out every pay period. Good news, you don’t have to do it yourself! Outsourcing your payroll might be what is best for your business, especially once you realize the penalties you may be facing if you do it incorrectly or late.

This time-consuming, complex task can be handled on your behalf so you can rest assured knowing it is getting done on time and accurately. Once the company you choose calculates all of the taxes on your behalf, your bookkeeper can then record it all in your books leaving the entire process handled and stress-free.

What’s Remote Books Online?

Remote Books Online is an online bookkeeping service that aims to meet all of your bookkeeping needs on a timely basis. Once you sign up for Remote Books Online’s services, you will be assigned a dedicated bookkeeper and lead accountant. There is no contract, and your first month of bookkeeping is on us! We would love the opportunity to show you how we can take the stress out of the bookkeeping process and provide you with accurate and up-to-date financial statements every month.

Get Your First Month of Bookkeeping for FREE!