A payroll tax is unavoidable for most small businesses with paid employees. But with proper planning, you won't be caught off guard when it's time to pay Uncle Sam. Read on to learn what the taxes cover and how to collect and submit them.
What is included in payroll tax?
Businesses with employees are legally required to report and submit taxes to Uncle Sam based on employee earnings. These taxes are known as payroll taxes. But small businesses will be happy to know that the burden of the payroll tax is shared by employees and employers. It is the employer's responsibility to withhold the employee component taxes, which include the following taxes:
- Federal income tax
- State income tax (43 out of 50 states impose state taxes. They do not apply in Alaska, Florida, Nevada, South Dakota, Texas, Washington or Wyoming.)
- Local tax (e.g. city- or county-level)
- Social Security tax
- Medicare tax
- Additional Medicare tax (This tax only applies to employee earnings in excess of $200,000.)
Employers must pay the employer component of payroll taxes separately from employee-withheld taxes. This portion of payroll taxes includes:
- Social Security tax
- Medicare taxes
- Federal unemployment tax (FUTA)
- State unemployment tax (SUTA).
How much is payroll tax?
The following 2018 rates for the payroll tax components are as follows:
- Federal income tax: The tax rate depends on the employee's tax bracket, number of allowances and tax filing status. See the withholding tables in IRS Publication 15.)
- State income tax: The tax brackets and rates vary depending on the state. See state government resources for the tax tables for your state.
- Local tax (Tax rates vary by locale. Contact your local government for tax rates.)
- Social Security tax: The total tax rate amounts to 12.4 percent of employee earnings. Employers pay out 6.2 percent and employees pay 6.2 percent from their paychecks on up to $128,400 of earnings.
- Medicare tax (The total rate is 2.9 percent. Employers and employees pay 1.45 percent each.)
- Additional Medicare tax (Employees who owe these taxes pay 0.9 percent with no employer match.)
- FUTA: Employers pay 6 percent on the first $7,000 of employee earnings. Depending on where you operate, paying state unemployment taxes on time can reduce the federal tax rate all the way down to 0.6 percent.
- SUTA: Minimum and maximum tax rates vary by state. See state government resources for rates.
How do you calculate payroll tax?
Now that you know which taxes you need to pay and the tax rate for each, you can calculate the amount of payroll taxes you owe.
- To figure how much federal income tax to withhold from employee earnings, use the Wage Bracket Method, Percent Allocation Method or an alternate method recommended in IRS Publication 15 to figure out how much federal income tax to withhold from an employee's paycheck per payroll period based on the employee's taxable income, tax status and the withholding allowances claimed in his or her W-4 form.
- To figure how much state income tax and local tax to withhold, similarly use the state and local tax tables to calculate the amount to withhold based on state and local taxable income.
- Calculate the Social Security tax withholdings by multiplying the employee's gross income by 6.2 percent. Ensure that you don't impose the tax on earnings in excess of the maximum. Then, allocate an equal amount for the employer share.
- Determine the Medicare tax withholding by multiply the employee's gross income by 1.45 percent. Then, allocate an equal amount for the employer share. Similarly, calculate any additional Medicare tax owed by multiplying the gross income by 0.9 percent.
- To figure how much FUTA you owe, multiply the first $7,000 of earnings by 6 percent. The exception is if you live in a state that allows for reducing your FUTA tax rate if you make on-time SUTA payments. In this case, your FUTA tax rate could be as low as 0.6 percent.
- To figure how much SUTA you owe, consult your state unemployment tax rate tables and multiply the rate by the employee earnings.
How do you file payroll tax?
You should deposit your payroll taxes to the IRS through EFTPS on a semi-weekly to monthly basis depending on a payroll deposit schedule the IRA sets forth for your business. The schedule depends on your Social Security and Medicare tax liability for a 12-month period ending June 30. You will also have to file certain forms, such as Form 941, 945, Form W-2 and Form 940 or 940EZ.