Understanding the Various Payroll Taxes
An important responsibility of any employer is to deduct taxes from their employee’s pay and remit this to the government. It is the responsibility of the employee to ensure the amount their employer is deducting is the appropriate amount. The process of managing payroll can be confusing at times and difficult to navigate. In this article, we will review the main types of payroll taxes so that you can understand what they are and why they are needed.
Before we get started it is worth pointing out that, according to the IRS, an individual who is performing services for a company can be classified as either an employee or an independent contractor. If a worker is deemed an employee the business is responsible for deducting payroll taxes and remitting them to the government. The business is also responsible for paying certain taxes based on their employee’s pay. If a worker is deemed an independent contractor, the business is not responsible for deducting and remitting taxes. The actual independent contractor is responsible.
To know if a worker performing services for you is an employee or independent contractor the IRS created three guidelines that revolve around the degree of control you have over the worker and the amount of independence the worker has. Here are the three guidelines (according to the IRS):
Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
Financial: Are the business aspects of the worker’s job controlled by the payer (these include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
Type of Relationship: Are there written contracts or employee benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Each of these three guidelines must be taken into consideration as a whole. Since these are guidelines, the business must decide based on these guidelines as a whole, is a person performing services for them an employee or independent contractor. It is also helpful to make the decision through the lens of the IRS; how would they classify a worker?
Now that we understand the difference between an employee and independent contractor, let’s look at the different payroll taxes that must be deducted and/or remitted to the government from the paychecks of those workers deemed as employees.
Federal Income Tax
An employer must deduct a certain amount of money from an employee’s check and remit it to the federal government for the employee’s share of Federal Income Tax. Only the employee pays this, the employer does not contribute. The amount that is deducted and remitted to the federal government depends on the employee’s Form W-4.
State Income Tax
This tax functions the same way as the Federal Income Tax. The employer deducts a certain amount of money and remits it to the appropriate state for the employee’s share of the State Income Tax. The amount of money that is deducted and remitted to the state depends on the employee; each state has their own version of a Form W-4.
Local Income Tax
Depending on where the business is located, there may be certain taxes paid to fund the local government and/or other local agencies such as the school system.
This is a tax to fund Social Security and Medicare. FICA stands for the Federal Insurance Contributions Act. This tax is required to be paid by both the employee and the employer. Each party pays half of what is owed by the employee. The Social Security tax is 12.4% and the Medicare tax is 2.9%. Together, the amount sent to the government is 15.3% of the employee’s wages. For the Social Security tax, the employee pays 6.2% and the employer pays 6.2%. For the Medicare tax, the employer and the employee each pay 1.45%. The employee’s share is deducted from their wages, whereas the employer’s share is considered an expense of the business. The amount of an employee’s earnings that can be taxed is capped at $128,700.
Commonly known as FUTA, which stands for Federal Unemployment Tax Act, this tax funds the government agency who issues funds to those individuals who have lost their job. The amount of money that is deducted for FUTA depends on what has been paid towards the state version of this tax, called SUTA. The federal government gives credit for any amount paid towards SUTA, any balance owed is then deducted for FUTA. The FUTA tax is 6% of wages, capped at $7,000. This tax is paid by the employer, not the employee.
In this article we looked at how to know if you are responsible for remitting taxes on behalf of the worker based on their status as an employee or independent contractor. We also reviewed the major payroll taxes, Federal, State, Local, FICA, and FUTA. It is very important that your business stays on top of the various laws and regulations to ensure that you stay in compliance. It is also advisable to seek the assistance of a tax professional or payroll service.