Most business owners probably already use some form of accounting assistance, whether it's a bookkeeper or software, but even with support, paying employees can be challenging. Those who plan on doing their own payroll and want to avoid payroll mistakes must thoroughly understand employer payroll taxes.
Preparing for employer payroll taxes when hiring employees
Before new hires start working, they typically fill out Form W-4 so that their employers can withhold the correct amount of federal income tax from their pay. They may also have to complete a separate withholding certificate for state income tax depending on the state. Some simply use the federal Form W-4 for this purpose and others don’t collect income tax at all.
How employer payroll taxes work
Employers are responsible for deducting the correct amount of taxes from their employees’ wages, calculating their own share of taxes, depositing the payments and filing returns with government agencies on time. The taxes that generally must be paid every pay period include:
Social Security and Medicare taxes
Federal Insurance Contribution Act (FICA) taxes support the federal Social Security and Medicare programs. The total due every pay period is 15.3% of an individual’s wages – half of which is paid by the employee and the other half by the employer. This means that each party pays 6.2% for Social Security up to a wage base limit of $142,800 and 1.45% for Medicare with no limit. Employees who earn more than $200,000, however, may be charged an additional 0.9% for Medicare, which employers don’t have to match.
Federal income tax
Paid for only by the employee, federal income tax is calculated based on the wages earned over the pay period and Form W-4 details.
State and local income tax
These taxes vary by location and are paid solely by the employee.
Federal and state unemployment
Typically, only employers pay unemployment taxes, but in a few states, employees also contribute. The federal rate ranges from 0.6 to 6% (as of 2021), depending on how much the employer pays in state unemployment tax.How to calculate federal payroll tax withholdings
Unlike the flat rate FICA taxes, calculating federal income taxes is a little more complex. To determine what to withhold for an employee who earns up to $100,00 per year and has completed the revised 2020 Form W-4, employers may use the IRS wage bracket method as follows:
- Adjust employee’s wage amount
Wage adjustment may be necessary when employees complete Step 4 on Form W-4. To do this, take any additional income that’s not from a second job, divide it by the number of pay periods and add it to the total wages. Next, if the employee is claiming deductions other than the standard deduction, divide this figure by the number of pay periods and subtract it from total wages.
- Determine the tentative withholding amount
After the employees’ wages are adjusted, use the wage bracket tables from Publication 15-T to determine their tentative withholding amounts. Cross reference the adjusted wage ranges in the two columns on the left with the various 2020 filing statuses in the six columns on the right. So, for example, if an employee earns an adjusted weekly wage of $900 and is filing as head of household with standard withholding, the tentative withholding amount is $60.
- Account for tax credits
Employees used to be able to claim allowances for children and other dependents on their Form W4, but the IRS simplified the process in 2020. Now, on Step 3 of Form W4, employees have a total credit amount for claimed dependents. Divide this figure by the number of pay periods and subtract the result from the tentative withholding amount.
- Tally the final withholding amount
Employees may withhold extra taxes each pay period by entering a desired amount in Step 4(c) of Form W-4. Add this number to the tentative withholding amount.
Note that calculation methods can vary depending on the employee’s total income. Those who earn more than $100,000 per year may require the IRS percentage method instead of the wage bracket method. See IRS publication 15-T for more information.
A payroll tax withholding example
Let’s say a business has an employee named Bob who is married, has two children and a spouse who also works. How would his federal tax withholding each pay period be determined if he earns $1,000 per week?
First, see if Bob’s wages need to be adjusted. Since he isn’t claiming any additional income from investments, dividends or retirement and he’s chosen the standard deduction, his wages remain $1000.
Second, look at the weekly pay period bracket table on 15-T. For married filing jointly with the Form W-4 Step 2 checkbox withholding option, the tentative withholding amount is $88.
Third, account for tax credits. Bob has two children, so he may get $4000 in tax credits. Divide this number by 52 since he’s paid weekly and subtract the result from $88 (the tentative withholding amount). The result is $11.08.
Finally, if Bob requested an additional $1000 withheld from his taxes each year on his Form W-4, divide that number by 52. The result is $19.23, which when added to $11.08, equates to a final withholding amount of $30.31 per pay period.
Other employer payroll tax requirements
As the pay periods go by and tax money is withheld from employees’ paychecks (in addition to employer contributions), businesses may eventually have to file quarterly tax returns with federal, state and local governments. The deadline for filing IRS Form 941, Employer's Quarterly Federal Tax Return is usually the last day of the month following the end of a quarter. So, if the first quarter of the year ends March 31, then the first Form 941 would be due April 30. Payments can be made via the Electronic Federal Tax Payment System® (EFTPS).
- Form W-3 – reports the total W-2 earnings from all employees to the Social Security Administration
- Form 1096 – is a summary and transmittal form that accompanies other IRS forms
- Form 944 – used for filing employer taxes annually instead of quarterly
Getting help with employer payroll taxes
With all of the numbers to juggle, calculating employer payroll taxes can quickly become complicated. That’s why many businesses hire a dedicated payroll administrator or work with a payroll service provider, who can automate the process and save time.
This guide is intended to be used as a starting point in analyzing an employer’s payroll obligations and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.