Payroll taxes for small business

Hiring employees is an important milestone for small business owners who finally have seen their dream come true. But with success and growth, comes new challenges, like payroll taxes. Employers who are unprepared for this responsibility or have minimal accounting skills may quickly find that they need assistance from a payroll service provider to maintain their bottom line.

What are payroll taxes?

Payroll taxes exist to fund government assistance programs, such as Medicare, Social Security and unemployment. Employers and employees generally share this tax liability, but in some cases, only the employer is responsible.

What is a taxable employee?

Taxable employees are individuals whose wages are subject to income tax and payroll taxes. Employers can refer to the IRS common-law rules for help determining who is an employee and who may be an independent contractor.

What taxes do employers need to pay?

Small business owners must pay all of the taxes mandated by the federal government, as well as those required in the state and local governments where they have employees. If unsure about what they owe, employers should consult a licensed tax professional.

What is the difference between payroll tax and income tax?

Payroll taxes have flat rates and are sent directly to the program for which they are intended, e.g., Medicare, Social Security, etc. Income taxes, on the other hand, have progressive rates that vary with total income and go to the U.S. Department of the Treasury, where they may be used to fund various government initiatives. In addition, some payroll taxes have a wage base limit, after which the tax is no longer deducted from the employee’s wages for the remainder of the year. Income taxes have no such cap.

Types of small business payroll taxes

While employers have several different types of payroll taxes to worry about, the key to remember is that like income taxes, they’re based proportionately on employee wages. Here are some of the most common:

• Federal Insurance Contribution Act (FICA) taxes
  FICA is a two-part tax covering Social Security and Medicare. The current rate is 15.3% of employee gross earnings with 12.4% going to Social Security and 2.9% going to Medicare. In both cases, the tax liability is split evenly between the employer and the employee, so each contributes 7.65% in total for FICA. Also note that Social Security has a wage base limit of $168,600, which means that after employees earn that much money, they no longer pay into the tax for the remainder of the year. Medicare has no such cap.
• Additional Medicare Tax
  High wage earners may need to pay an additional 0.9% to Medicare. This applies to single individuals making $200,000 per year, married couples filing jointly earning $250,000 per year and married couples filing separately making $125,000 per year. Employers are required to deduct Additional Medicare tax from the wages of employees who meet these criteria, but don’t have to match it.
• Federal Unemployment Tax Act (FUTA) taxes
  Small businesses generally are subject to FUTA if they pay $1,500 or more to employees in any calendar quarter or have one or more employees for at least some part of a day in 20 or more different weeks. The rate is 6% on the first $7,000 that an employee earns per year and is paid only by employers.
• State Unemployment Tax Act (SUTA) taxes
  States have their own unemployment programs, each with different tax rates. The good news, however, is that if employers pay SUTA on time and aren’t in a credit reduction state, they may be eligible for a federal tax credit of 5.4%, effectively lowering their FUTA rate to 0.6%. SUTA tax liability, as with FUTA, only applies to employers, except in a handful of states where employees also contribute.
• State and local payroll taxes
  Depending on where in the country a business employs people, it may have to pay additional payroll taxes for short-term disability, paid family medical leave and other assistance programs. Employers should check with their local governments or a licensed tax professional for the latest rates and criteria.

Calculating payroll taxes for small businesses

In addition to applying the appropriate rates, there are two additional parts of the equation when calculating small business payroll taxes:

1. Determine who is subject to the taxes
   Employers are only required to pay payroll taxes on employees, not independent contractors. An employee is generally one whose work – both what will be done and how it’s done – is controlled by the person paying for the services. Other financial factors and the nature of the relationship must also be considered.
2. Verify taxable wages
   Some types of employee earnings – such as business expense reimbursements, non-monetary holiday gifts and cash advancements – are not taxable. Before withholding taxes, employers must also consider pre-tax contributions to benefits packages and whether the employee has reached any wage base limits, e.g. Social Security, FUTA, etc.

Withholding small business payroll taxes

FICA taxes and in some states, SUTA taxes, are withheld from employee wages. This means that employers must first determine each employee’s gross taxable earnings and then apply the payroll tax rates. For example, if an employee’s gross taxable earnings for a particular pay period is $550, then that individual’s Medicare tax contribution would be $550 x 1.45% = $7.98.

Payroll tax compliance

Since they are deducted from employee wages and held in trust by the employer until remitted to the relevant agency, FICA taxes are considered a type of trust fund tax. This means that a compliance violation can expose businesses to the trust fund recovery penalty (TFRP). Infractions occur when the individual(s) responsible for collecting, accounting and paying taxes willfully fails to do so. The IRS defines willfulness as having awareness of the outstanding taxes and either intentionally disregarding the law or behaving indifferently to its requirements.

How to report and pay payroll taxes

Once employers have withheld the necessary federal payroll taxes from their employees’ wages, they generally can submit the payments, along with their own tax liability, to the IRS using the Electronic Federal Tax Payment System (EFTPS). They also must report the federal taxes deposited using the forms most appropriate to their particular business. Options include:

• Form 941, Employer's Quarterly Federal Tax Return
• Form 944, Employer's Annual Federal Tax Return
• Form 943, Employer's Annual Federal Tax Return for Agricultural Employees
• Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return

The process for paying and reporting state payroll taxes vary by location.

Payroll tax schedules and deadlines

Federal payroll taxes typically can be paid monthly or semi-weekly, depending on how much tax liability an employer reported during a previous time frame or lookback period. Payments made monthly are due by the 15th of the following month, whereas semi-weekly payments vary based on the employer’s payroll schedule. If a pay period ends on a Wednesday, Thursday or Friday, the tax payments are due by the following Wednesday and if a pay period ends on a Saturday, Sunday, Monday or Tuesday, the tax payments are due by the following Friday.

What happens if payroll tax payments are late or unpaid?

Many small businesses, especially those that are still in their infancy and struggling to make a profit, can’t afford to miss a tax payment. The IRS charges penalties that progressively increase, depending on how many days it is late. What’s more, employers may be hit with civil or criminal sanctions if the IRS believes that they acted willfully in neglecting to pay their taxes.

How can employers avoid payroll tax penalties?

Employers who proactively manage their payroll taxes are more likely to avoid penalties than those who don’t. Here are some preventive tips:

• Classify employees correctly
  Misclassifying employees as independent contractors to avoid paying FICA and FUTA taxes is illegal.
• Withhold and pay taxes on time
  Using payroll funds to pay another creditor instead of the IRS is an example of willful disregard and may result in a TFRP.
• File tax reports using the proper forms
  Employers must file amended returns if they make a mistake or use the wrong form.
• Stay up-to-date with tax law changes
  Payroll tax rates and wage base limits are subject to change by federal, state and local governments.
• Partner with a qualified payroll service provider
  Payroll software automates FICA calculations, deductions and payments to help ensure accuracy.

How ADP can help with small business payroll taxes

ADP offers flexible, affordable solutions that have helped nearly 800,000 small businesses improve their payroll processes. In fact, nearly two thirds of our clients say that they’re able to comply with payroll taxes and regulations better than they did with a previous provider.¹

Our services for small business include:

• Fast payroll processing from anywhere, on any device
• Automated tax calculations, deductions and payments
• 24/7 customer support with experienced payroll professionals
• Software that proactively flags potential errors
• Assistance with quarterly and annual tax reports

Frequently asked questions about
small business payroll taxes

How much does a small business pay in payroll taxes?

A small business’s total cost in payroll taxes largely depends on how many employees it has, how much it pays them and where it employs them. Effective payroll processing is also a factor, since mistakes or late payments that result in penalties further increase tax expenses.

What percentage does a business pay in payroll taxes?

The current percentage rates for federal payroll taxes are as follows:

• Social Security – 12.4%
• Medicare – 2.9%
• Additional Medicare – 0.9%
• Unemployment (FUTA) – 6%

State payroll taxes vary by location; employers can check with their local government or a tax professional for the latest rates.

How do payroll taxes work?

Payroll taxes are charged as a percentage of employee wages using these general steps:

1. Calculate employee gross earnings
2. Deduct any pre-tax contributions to health insurance or retirement plans
3. Apply the appropriate tax rates to determine total tax liability for the pay period
4. Withhold the employee portion of FICA taxes from wages
5. Withhold employee contributions to state payroll taxes, if applicable
6. Send both the employee and employer payroll tax payments to government agencies

Do employers pay taxes on employees?

Yes, businesses are generally charged payroll taxes if they have employees. Examples include, but are not limited to:

• Medicare and Social Security, or FICA
• Federal unemployment, or FUTA
• State unemployment, or SUTA

Can you go to jail for not paying payroll taxes?

If the IRS believes that employers willfully neglected to pay their payroll taxes, it can file civil or criminal sanctions against them. Any example of willfulness is using available funds to pay another creditor instead of the government.

How much can you pay an employee without paying taxes?

Under certain circumstances, an individual may be exempt from income tax, but this rule does not apply to payroll taxes. Employers are required to deduct FICA from all employee wages regardless of how much they earn.

Does everyone pay payroll tax?

In general, most employers and employees pay Social Security and Medicare taxes. Exemptions apply, however, for certain classes of nonimmigrant and nonresident aliens. Examples include nonimmigrant students, scholars, teachers, researchers and trainees (including medical interns), physicians, au pairs, summer camp workers, and other nonimmigrants temporarily present in the United States in F-1, J-1, M-1, Q-1 or Q-2 status.

What is the federal payroll tax rate?

The current FICA tax rate is 15.3%. Paid evenly between employers and employees, this amounts to 7.65% each, per payroll cycle.

Is payroll tax flat or progressive?

Unlike income taxes, payroll tax rates are flat, which means that all employees pay the same percentage regardless of their total income. Some payroll taxes, however, have wage base limits.

How do I pay payroll tax?

Federal payroll taxes are paid online using the Electronic Federal Tax Payment System. Payment methods for state and local payroll taxes vary by location.

¹Internal survey of 752 RUN Powered by ADP customers in 2020.

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.