As your payroll staff or provider can likely tell you, your organization is responsible for meeting several types of payroll tax obligations throughout the year. If you fail to do so, you may face adverse tax consequences and hefty penalties. Following is an overview of the basic rules relating to every employer's payroll tax responsibilities.
Generally, employers are required to report and deposit payroll taxes on a regular schedule, typically quarterly. This includes amounts withheld from employee compensation based on the frequency of payment. If employers don't fulfill this obligation, they may be charged substantial penalties.
For example, the IRS's failure-to-file penalty is 5% of unpaid taxes for each month or part of a month that a tax return is late. The maximum penalty for failing to file and pay payroll tax is 47.5% (22.5% for late filing and 25% for late payment) of the tax. Talk to your tax advisor about possible penalties for specific late dates and failures to pay.
Of course, you're responsible for other tax withholding tasks as well, such as accommodating deferrals to 401(k) plans and Flexible Spending Accounts. But this article will focus only on payroll taxes.
There are six major types of payroll taxes that employers generally handle:
1. Federal. Employers must withhold federal income tax from employee paychecks. The amount of income tax withheld from regular pay depends on two factors:
Additional withholding rules apply to commissions and other forms of compensation.
2. State and local. Comparable to federal income tax withholding requirements, state income tax withholding rules apply to many employers. However, seven states (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming) have no income tax and two (New Hampshire and Tennessee) don't tax wages. Certain cities — including New York, Detroit, Philadelphia and San Francisco — also impose income tax. And in some places, withholding is required to cover short-term disability, paid family leave or unemployment benefits.
3. FICA. Payroll taxes authorized under the Federal Insurance Contributions Act (FICA) are composed of two components. The first is Social Security tax. The Old-Age, Survivors, and Disability Insurance portion is taxed at a 6.2% rate on the amount up to an annual "wage base." In 2023, that wage base is $160,200. The second FICA component is Medicare tax. The Hospital Insurance portion of the tax is 1.45% on all wages. Note that both employers and employees must pay FICA tax. Employers must withhold the employees' share.
4. FUTA. Although Uncle Sam doesn't pay unemployment benefits, it does help states pay employees who have been involuntarily terminated from their jobs. The Federal Unemployment Tax Act (FUTA) created a special tax that applies to the first $7,000 of wages of every employee. The basic FUTA rate is 6%, but employers can benefit from a credit for state unemployment tax of up to 5.4%, resulting in an effective tax of 0.6%. However, the credit is reduced if a state borrows from the federal government to cover its unemployment benefits liability and doesn't repay the funds.
5. State unemployment. States are responsible for paying unemployment benefits to eligible workers who are involuntarily terminated. The rate employers must pay is based on their claims experience. The more claims made by former employees, the higher the tax rate. States update these rates annually.
6. Additional Medicare. This payroll tax often flies under the radar. Part of an Affordable Care Act provision, the additional Medicare tax of 0.9% applies to employee wages above $200,000 (single filers) or $250,000 (joint filers). Note that this tax is paid by employees only. However, you're responsible for withholding it, when applicable.
Payroll taxes must be deposited with the IRS in a timely manner. The IRS sets tax deposit deadlines for federal payroll taxes. Most employers follow the monthly schedule, but some larger corporations are required to deposit taxes on a semiweekly basis.
Naturally, there's some additional paperwork involved. Employers usually must file with the IRS Form 940 ("Employer's Annual Federal Unemployment [FUTA] Tax Return") and Form 941 ("Employer's Quarterly Federal Tax Return"). Your organization also must use Form W-2 ("Wage and Tax Statement") to report withholding to employees and Form W-3 ("Transmittal of Wage and Tax Statements") to report total earnings and other information to the Social Security Administration.
The payroll tax responsibilities outlined above apply only to employers' obligations regarding their employees. If your organization uses independent contractors, they're exempted from these rules and are responsible for paying their own employment-related taxes.
Even so, your accounting department may find payroll duties overwhelming. For this reason, many employers outsource payroll processing to niche payroll companies or allow their tax advisors to handle the job. Contact us for help.
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