Payroll taxes are those taxes withheld from your employees’ paychecks, as well as those taxes you pay as an employer based on the wages you pay your employees. These include:
- Social Security and Medicare
- Federal and state unemployment
- Personal income tax (federal and state)
- Miscellaneous other state taxes
Most payroll taxes, such as income tax, apply to all earnings. However, some taxes have what is called a wage cap–the maximum annual earnings per employee that is subject to that tax. These caps may be adjusted by the governing agency (typically annually).
Social Security and Medicare taxes are paid by both employers and employees. As an employer, you withhold the employee’s part of the taxes and also pay a matching amount.
The employee tax rate (amount withheld) for Social Security is 6.2%. The employer tax rate for Social Security is also 6.2% (12.4% total). This is a tax with a wage cap, which means that the tax is calculated only up to a maximum dollar amount of wages per employee each year. For 2010, the wage cap for Social Security is $106,800.
The employee tax rate (amount withheld) for Medicare is 1.45%. The employer tax rate for Medicare tax is also 1.45% (2.9% total). There is no wage cap for Medicare tax, which means the tax is paid on all of the wages that the employee earns. (The exception is exempt wages–see “Special Tax Exemptions” below.)
The amount of federal income tax withheld from employees’ paychecks depends on their marital status, the number of withholding allowances (exemptions) they claim on Form W-4, and their projected annual income.
In addition, all but nine states have a personal income tax (exceptions are AK, FL, NV, NH, TN, TX, SD, WY, and WA). It may be a flat tax rate (as in Illinois), regardless of projected income, or a graduated tax rate based on annual income, like the federal income tax.
In some states, employees also pay local tax (to cities, school districts, or counties) through their paycheck.
Form W-4. An employee reports several items on Form W-4:
- Filing Status. This is the marital status that dictates which tax table will be used to calculate income tax withholding. For federal income taxes, there are four filing status options: single, married filing jointly, head of household, and married filing separately.
- Withholding Allowances. Also called exemptions, withholding allowances reduce taxable income by a designated amount per allowance. The IRS updates allowance amounts periodically. Factors such as number of dependents influence how many allowances an employee will claim.
- Additional Amount to be Withheld. This amount is added to the income tax calculated for each paycheck. It is on top of the amount of income tax withholding based on the employee’s filing status and withholding allowances. An employee working multiple jobs might choose to have an additional amount withheld to compensate for understatement of annualized wages (and therefore understatement of his real tax rate) by each employer.
The W-4 includes several worksheets intended to help the employee arrive at the most accurate projection of tax liability possible. Some states have similar forms for state tax liability.
The Federal Unemployment Tax Act (FUTA), along with the state unemployment systems, provides for payments of unemployment compensation to workers who have lost their jobs. For 2010, the effective FUTA tax rate is 0.8%. The tax applies to the first $7,000 employers pay to each employee as wages during the year, so your maximum FUTA liability per employee is $56.00 per year.
However, if any of your employees are exempt from State Unemployment Insurance (for example, they are Directors or Officers), your FUTA tax may be higher. Also, if your state has borrowed funds from the federal government to cover shortfalls in its unemployment insurance program, all employers in your state may be subject to additional tax liability at the end of the year to repay those loans.
All states maintain a reserve for unemployment that is funded through an unemployment insurance tax. In most cases, SUI is paid only by the employer. Employees in some states, such as New Jersey and Pennsylvania, also contribute to SUI through their paychecks.
Most states have established a starting SUI rate for new employers. (Wherever possible, we provide this rate to you.) After a designated period of time, employers are assigned an experience rate, which may be higher or lower than the new employer rate depending on the employer’s reserve account balance. You will receive a notice from the state if your rate changes.
Some states administer disability insurance (SDI) or workers compensation as a tax collected through payroll. Many states also have a tax paid jointly with SUI that is used to fund job training programs. Where applicable, we calculate these taxes for you.
Some types of employees are exempt from one or more payroll taxes, which means that they do not pay those taxes. For example, a minor working for a parent who is a sole proprietor does not have to pay social security, Medicare, or FUTA.
In addition, certain portions of regular employees’ wages may be exempt from one or more payroll taxes. For example, tax-sheltered or pretax insurance plans save both the employer and the employee money by exempting premium amounts from all federal taxes and some state taxes. Some fringe benefits, like S-Corporation owners’ health insurance, are also taxed differently from regular wages.
If your company is a not-for-profit 501(c)3 corporation, you do not pay FUTA at all–regardless of who your employees are.
