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Payroll Tax Requirements: A Step-by-Step Breakdown for Business Owners

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One of the many requirements a business owner needs to be aware of is the various tax rules and jurisdictions that apply to the business. These rules and regulations can be different for each business and where they choose to operate, and non-compliance can result in hefty penalties as well as time-consuming and costly audits of the business. Making sure the business is keeping up and staying compliant with federal, state, and local tax obligations is critical for the company to stay in good legal standing. Delinquent or unresolved tax issues could result in audits, penalties, and interest, and could even hurt the company’s chances of acquiring new business.

 

Being aware of the different requirements and keeping up with the ever-changing laws can be a full-time job in itself, and it’s no wonder why many companies hire or partner with tax experts to ensure the business taxes are accurately reported, deposited, and filed with the appropriate authorities on a timely basis. However, making sure the tax obligations of the company are fulfilled is ultimately the responsibility of the business owner, and understanding at least the basics of what is required of the business can be extremely beneficial in ensuring the company’s compliance.

 

The first step to compliance with employer tax requirements is knowing what the requirements are. Filing requirements can vary based on the company’s business structure. For many small businesses, income is passed through to the owners, and gains or losses are reported and taxed on the owners’ personal tax returns, and filers are responsible for self-employment taxes unless the company is designated as an S Corporation. If the business is set up as a corporation, the business is taxed separately from its owner(s) and the corporation is required to file its taxes with the IRS on form 1120. https://www.irs.gov/forms-pubs/about-form-1120

Do you need an EIN?

Any business that pays employees should apply for an Employer Identification Number (EIN) with the IRS. The EIN will allow the business to open bank accounts, apply for business licenses, and submit business tax returns. New businesses should also register with the appropriate agencies to obtain tax ID numbers. Each state has its own rules and requirements for businesses when it comes to registering for a state tax ID and the process and documents needed may vary. Many states also have requirements for employment taxes, which can include state unemployment, short-term or temporary disability (SDI/TDI), paid family medical leave (PFML), transit programs, and other programs that may be funded by contributions made by employers.

 

If a business has employees – which can include the owner(s) – the business may be required to withhold the appropriate payroll taxes from employee paychecks. These taxes will also be required to be filed and deposited regularly to avoid penalties and interest.  At the federal level, payroll taxes include Social Security, Medicare, and income taxes. Each state has its own rules as well, and employers may be responsible for income tax, unemployment, and other state-level payroll taxes such as workers’ compensation and temporary disability insurance. Some cities, municipalities, or even school districts may have additional rules and requirements for businesses with operations or employees residing in certain locations.

 

For detailed information and registration instructions, follow the link to your state’s online resources below.

 

Alabama Hawaii Massachusetts New Mexico South Dakota
Alaska Idaho Michigan New York Tennessee
Arizona Illinois Minnesota North Carolina Texas
Arkansas Indiana Mississippi North Dakota Utah
California Iowa Missouri Ohio Vermont
Colorado Kansas Montana Oklahoma Virginia
Connecticut Kentucky Nebraska Oregon Washington
Delaware Louisiana Nevada Pennsylvania West Virginia
Florida Maine New Hampshire Rhode Island Wisconsin
Georgia Maryland New Jersey South Carolina Wyoming

 

Information for the District of Columbia can be found here.

 

When it comes time to pay employees, employers should understand and ensure the proper taxes are being calculated and withheld from employees’ pay, as well as the tax liabilities that are calculated at the employer level.

 

FICA

Also known as the Federal Insurance Contribution Act, is made up of two components: Social Security and Medicare

Social Security taxes are assessed on applicable wages at a flat rate of 6.2% to both the employee and employer, up to a wage limit of $147,000 in 2022.

Medicare tax is also assessed at a flat rate (1.45%) to both employee and employer on applicable wages. However, unlike Social Security, there is no wage limit on Medicare taxes. In addition, employees with over $200,000 in wages per year are assessed an additional 0.9% in Medicare taxes on the earnings in excess of that amount.

 

FUTA

Under the Federal Unemployment Tax Act, or FUTA, employers are required to pay federal unemployment taxes which are calculated at a rate of 6% on employee wages up to the first $7,000 in applicable wages in 2022. While the rate is 6%, most states are allowed the maximum credit of 5.4% against the tax, effectively lowering the rate to 0.6%. States may borrow from the federal government to cover their own unemployment liabilities. If a state has outstanding balances on federal unemployment insurance loans, they may be subject to a reduction in credits, which could increase the FUTA rates for employers operating in those states. FUTA applies to employers only and does not impact employees’ pay and deductions.

 

Federal income tax

Sometimes referred to as FIT, federal income tax is an employee tax. Withholding amounts will vary from employee to employee, based on each individual’s taxable earnings and Form W-4. Details regarding form W-4, income tax tables, and calculation methods can be found on IRS Publication 15-T.

 

State income tax

Like federal income tax, withholding amounts can vary from employee to employee. Some states may also have specific withholding forms to determine employees’ withholdings. Note that not all states have income tax – employers in Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming don’t need to worry about calculating and withholding state income taxes from their employees’ checks.

 

Other taxes and required withholdings

Some localities may have additional tax requirements, which means employers in those locations are required to withhold even more from employees’ wages. City taxes, short-term or temporary disability insurance, paid family leave programs, and school district income taxes are some examples of additional withholdings that may be required for employers. These taxes and withholding requirements may apply to employees, employers, or both.

 

Keeping track of and knowing how to calculate each of the required tax and withholding amounts can be a daunting task. Thankfully, most payroll service providers and specialized payroll software systems are generally able to handle the calculations. Many, especially if they are cloud-based, will automatically update rules and calculations as legislation is updated. In some systems, updating the business and/or employee address in some systems might even automatically apply the appropriate tax and withholding rules based on the location.

 

What do you do after the taxes are calculated?

Applying and calculating the required taxes and other withholdings from employees is just one part of the process. After the amounts have been withheld, they’ll need to be submitted and reported to the appropriate agencies. Federal income taxes withheld, as well as employee and employer amounts for Social Security and Medicare taxes should be deposited with the IRS via electronic fund transfer using the Electronic Federal Tax Payment System (EFTPS), either on a monthly or semi-monthly schedule. Although EFTPS is a free service, some employers may choose not to use the system for their tax deposits. In these cases, a tax professional, financial institution, payroll service, or other trusted third party may be employed to make electronic deposits on behalf of the business.

 

The deposit schedule for a business is determined by the taxes reported during a specified lookback period (new employers are considered monthly depositors for the first calendar year). Due dates for monthly depositors fall on the 15th day of the month following the payment of wages. Semi-monthly depositors have due dates that fall on Wednesdays and Fridays, depending on the day of the week on which the pay dates fall. If a due date happens to fall on a weekend or legal holiday, the deposit may be made on the next business day. A special exception to the deposit timing applies when the tax liability exceeds $100,000 in a single day. Aptly referred to as the $100,000 next-day deposit rule, this rule requires the tax deposit to be made by the next business day, regardless of the current deposit schedule observed by the business. The $100,000 next-day deposit rule also states that monthly depositors who accumulate a $100,000 tax liability on any day during the deposit period, becomes semiweekly depositors for the current and following calendar year. Penalties may be assessed for federal tax deposits that are not made on time. Amounts can vary based on the number of calendar days from the original due date of the liability, and can be as high as 15% of the amount owed.

 

FUTA taxes must also be deposited in a timely manner; generally on the last day of the month following the end of each calendar quarter. If the FUTA tax liability of the business is less than $500 for a quarter, the business may choose to carry over the liability to the next quarter, until the total liability reaches the $500 threshold for deposit. More details on federal employer taxes can be found in IRS Publication 15. https://www.irs.gov/forms-pubs/about-publication-15

 

Many states follow similar rules to the federal government when it comes to the timing of payroll tax deposits but could differ based on location. Also similar to the federal due dates, different state and local withholding items can have varying due dates for deposits, so businesses should confirm with the agency or check with their local tax expert to avoid penalties.

 

Filing periodic returns is another component of making sure the business is in compliance with tax withholding and reporting. The agency will compare the amounts reported against the periodic deposits that were made. In a perfect world, the amounts will always match. Unfortunately, that is not always the case. If a discrepancy exists between the reported amounts and the sum of the periodic deposits made for the corresponding quarter, it could be an indication that an error exists somewhere, or that something was recorded, reported, or deposited incorrectly.

 

Errors and corrections found after periodic filings are complete will mean the business will have to prepare and submit amended filings of the appropriate forms, which can be time-consuming and adds an unnecessary burden to the team. It is recommended to perform periodic audits of payroll calculations and data to identify and address issues early and to minimize the chances of running into problems during reporting periods.

 

How do I report payroll taxes?

IRS Form 941, which is required to be filed on a quarterly basis, is the most common form that employers will use to report income taxes withheld from employee’s paychecks, as well as both the employee and employer portion of Social Security and Medicare taxes. Form 940 is filed annually and is used for FUTA tax reporting.

 

Of course, we can’t forget about form W-2. The W-2 is an annual summary of wages and taxes for an employee. The information reported on each W-2 issued by an employer is summarized on form W-3, which should correspond to the totals of all 941 filings for the year. Again, periodic audits of payroll data can be helpful to minimize problems and cut down on the number of W-2C forms that need to be issued and filed.

 

Dealing with payroll tax issues can be challenging and time-consuming, especially for employers who are dealing with multiple states and jurisdictions. Working with an outsourced provider for payroll and the associated taxes is a great option for employers because it allows them the ability to take advantage of the knowledge and expertise that the service provider can offer, while keeping costs down and decreasing the administrative burden on their own teams. Contact Valor Payroll Solutions and see how we can help!

 

 

Christina Hageny

Christina Hageny

President - Valor Payroll Solutions

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