Denice R. Preston
One of the issues small-business owners have to contend with is staying current with the many obligations for local, state, and federal taxes. While most business owners hire an accountant or a tax professional to deal with tax-related issues, understanding the tax system is essential to those responsible for fulfilling all tax obligations. This article will focus on the business owner’s obligations regarding payroll taxes.
What Are Payroll Taxes Obligations?
Any business with employees must withhold payroll taxes from employees’ paychecks and pay applicable federal, state, and local taxes. The taxes usually withheld from employee paychecks include FICA (Medicare and Social Security taxes) and federal, state, and local income taxes, if applicable.
Other withholding obligations include FUTA (Federal Unemployment Tax Act) and, in states such as California, Hawaii, New Jersey, New York, and Rhode Island, disability insurance taxes.21 Failure to pay taxes or missing a payment may result in heavy fines and penalties, so it is essential to calculate the amount of payroll taxes owed and to pay them on time.
If the small-business owner does not have outside employees but is incorporated, the above rules apply to the owner’s paychecks as well because they are essentially the sole employee of the corporation.3 If the business is not incorporated and there are no employees, the owner must pay estimated taxes on self-employment income each quarter.
There are three steps to calculating payroll taxes:
Determine taxable workers.
Determine taxable wages.
Calculate withholding amounts.
Identifying Taxable Workers
Workers can be employees or independent contractors. Employees are treated as taxable workers subject to payroll taxes, while independent contractors are responsible for paying their taxes. Usually, workers are considered employees if they have the right to direct and control the way they do their work rather than merely the work results.5
However, the lines between independent contractors and employees are not always clear-cut. To help business owners determine which workers are taxable employees, the Internal Revenue Service (IRS) has standard law rules, which include behavioral, financial, and relationship tests.
Financial Test
This test looks at the degree of control an employer has over the financial aspects of the job. In some professions, having significant control over supplies used for work supports a worker’s status as an independent contractor.7
One definite way to distinguish an independent contractor from an employee is by the availability of services. An independent contractor is not tied to one company and can advertise services; an employee can only advertise services if they are working outside the company as an independent contractor.7
Relationship Test
This test refers to how the employer and the worker perceive their relationship. If an employer-worker relationship is expected to last until the end of a specific project or for a specified period, then the worker is an independent contractor. On the other hand, if the relationship has no boundaries, the worker is a taxable employee.8
Determining Taxable Wages
Taxable wages are compensation for services performed, including salary, bonuses, or gifts. Some forms of payment, such as business-expense reimbursements for travel or meals, do not qualify as taxable wages. For the expenses to be nontaxable, employees must verify them through receipts or expense reports. They must also be necessary, reasonable, and business-related.
Calculating Withholding
After you’ve figured out which workers qualify as taxable employees and which wages are taxable, the next step is determining the amount you must withhold for federal, state, and local taxes, as well as FICA and FUTA.
Federal Taxes
Every paycheck must withhold federal income taxes for the applicable period. The IRS has two tax tables employers can use to calculate withholding amounts: the wage bracket tables and the percentage tables.
The wage bracket tables are segregated into five payroll periods (daily, weekly, bi-weekly, semi-monthly, and monthly). To determine withholding amounts, employers pick the applicable pay period and wage bracket for employees, then read across the table to the column that shows the filing status.
U.S. federal tax brackets range from 10% to 37% based on income.
Like the wage bracket tables, the percentage tables are available for five payroll periods (daily, weekly, bi-weekly, semi-monthly, and monthly) and are segregated by filing status. Employers start by reducing wages by the value of exemptions claimed. Next, they use the table corresponding to the employee’s filing status and look for the withholding amount based on the wage bracket.
As a business owner, you are responsible for looking at the two sets of tables and determining which is appropriate for your business. The percentage tables are more inclusive regarding payroll periods, so if you are in a situation where employees are paid at different payroll periods, the table should be the choice.
For example, if your employees are paid quarterly, the percentage tables will be more appropriate than the wage bracket tables.14 To get these tables, visit the IRS online to access Publications 15 and 15-T.
State Taxes
Most states use tables similar to federal tax tables, and you can get them by going to the tax section of your state’s website or contacting the Small Business Administration. You do not need to withhold state taxes in jurisdictions that do not impose state taxes on income, such as Alaska, Florida, Texas, Wyoming, and Washington.15 Other exceptions include states whose personal income taxes are a fixed percentage of the federal tax, like Arizona, and where state taxes are a fixed percentage of gross wages, such as Pennsylvania.1617
The Bottom Line
Calculating payroll taxes can be very complicated, and timely payments are essential to avoid penalties and late fees. Federal tax payments must be made online through the Electronic Federal Tax Payment System (EFTPS).
FUTA taxes are usually paid quarterly, and income and FICA taxes are deposited semi-monthly or monthly.22 The IRS usually sends business owners a notice at the end of each year detailing which method to use for the upcoming year.
In general, the timeliness of a deposit is determined by the date it is received; however, if you are late, you can be penalized up to 15%.22 To learn more about small-business employers’ payroll duties and obtain the relevant forms, visit the IRS website or call the IRS live helpline for businesses at 1-800-829-4933.
