Payroll Taxes
Payroll taxes fall into the categories listed below. Just click on a topic
that interests you. However, keep in mind that this is just a brief overview
that is neither comprehensive nor complete for any specific business situation.
To understand all of your payroll tax obligations, please consult the legal
and accounting professionals you employ to advise your business.
Federal tax liability
Federal tax liability can include any or all of these components:
- Federal income tax
- Employee social security withheld
- Employee Medicare withheld
- Employer's social security contribution
- Employer's Medicare contribution
- Earned income credit (EIC)
Federal income tax, employee social security, and Medicare withheld are
the actual amounts deducted from an employee's pay. These are based on percentages
or formulas set by the government. While these come from employee wages,
an employer is obligated to correctly calculate, deduct, and pay to the government
the proper amounts.
Employers also contribute a segment of the social security and Medicare
taxes to be paid to the IRS (the concept of employers simply "matching" employee
contributions is a fallacy). A business is liable for the entire tax due,
regardless of the amount actually withheld from employees. So, the total
liability is calculated, the amount collected from employees is subtracted,
and the remaining amount is the employer's portion.
An EIC is a cash credit provided by the IRS to taxpayers who earn less than
a specified amount during a calendar year. Employers add this tax credit
to the pay of eligible employees and subtract it from the federal tax liability.
EIC has no effect on federal income tax withheld from an employee's wages.
Here's an example where an employer issued two payroll checks dated 4/10/05.
Note that the employer's share of Medicare is increased by the Medicare amount
not withheld from the employee on the second check.
| Check # |
Taxable Comp. |
Soc. Sec. |
Medicare |
Federal |
Net |
| 1 |
650.00 |
40.30 |
9.43 |
78.65 |
521.62 |
| 2 |
725.00 |
44.95 |
10.51 |
87.73 |
581.81 |
| Totals |
1375.00 |
85.25 |
19.94 |
166.38 |
1103.43 |
The total federal tax liability for 4/10/05 is:
| Employee Social Security |
85.25 |
|
| Employee Medicare |
19.94 |
|
| Employer Social Security |
85.25 |
($1375.00x12.4%) - $85.25 = $85.25 |
| Employer Medicare |
19.94 |
($1375.00 x 2.9%) - $19.94 = $19.94 |
| Total Liability |
211.07 |
|
| Federal Income Tax |
166.38 |
|
| NET LIABILITY |
$377.45 |
to be deposited with the IRS |
Tax deposits are due on a quarterly, monthly, or semi-weekly basis depending
on the amount of tax liability. Effective July 1, 1997 employers mandated
for EFTPS must make their payments electronically. File Form 941, Employer's Quarterly Federal Tax Return, quarterly to reconcile taxes calculated versus taxes paid.
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Federal unemployment taxes (FUTA)
The Federal Unemployment Tax Act (FUTA) established the employer tax that
finances the federal unemployment program. An employer's liability for this
tax begins January 1 of the year in which one of the following conditions
is met:
- One or more persons are employed, for at least part of a day, in each
of 20 or more calendar weeks during the current or preceding taxable year, or,
- Wages of $1500 or more are paid during any calendar quarter in the current
or preceding calendar year.
When you become liable, you're liable for the entire year, not from
the point when one of the conditions was met. FUTA is strictly an employer
tax, so no part of this tax can be deducted from employee wages. Effective
July1, 1997, employers mandated for EFTPS must make
these payments electronically.
Tax computation for FUTA is done at the end of each quarter and follows
these rules:
- Liability in excess of $100 at the end of the quarter is deposited with
an 8109 coupon on or before the last day of the next month.
- If the liability is exactly $100, or less, it is not due. The liability
adds to the next quarter's liability until the total accrued exceeds $100.
- If, at the end of the year, the unpaid liability is $100 or less, it
may be paid with Form 940 Employer's Annual Federal
Unemployment Insurance Tax Return, or 940-EZ.
Each covered employer must file a Form 940 or 940-EZ annually to report
taxable wages paid during the year and reconcile quarterly deposits. If you
make state unemployment insurance contributions to one state, and the state
is not subject to a credit reduction, you may file Form 940-EZ.
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State and local income taxes
The variety of state and local taxes precludes a detailed description here.
In general, every employer who pays wages to employees is required to withhold
income taxes from each payment of taxable wages, if required by the state
or local taxing agencies. Not all states have withholding and many states
do not have local taxing jurisdictions that affect payrolls.
Some employers face particularly complicated state income tax situations.
Those who conduct business operations in multiple states must meet the requirements
of all the states involved. The same is true for those who have what may
be called "dual-state" situations (employees living in one state
and working 100% of the time in another state, or employees working in more
than one state during a single pay period).
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State Unemployment Insurance (SUI)
All states require employers to pay a state unemployment insurance tax.
Although SUI is basically an employer tax, a few states have an employee
tax as well. SUI is closely tied to the federal unemployment insurance program.
FUTA is collected from employers; however, compensation benefits are paid
from the state fund. If the state fund is depleted, the state may borrow
from the federal government.
Each state has a limit on compensation that is taxable for SUI. The wage
limits vary by state. Each state assigns every subject employer a tax rate
once a year based on their experience or merit rating. The most common method
used by the states to evaluate an employer's experience rate is the "reserve
ratio formula." This method is a two-step calculation:
- SUI contributions paid - benefits received by employees = reserve
- Reserve ÷ taxable payroll = reserve ratio
The higher the reserve ratio, the lower the employer's rate
will be.
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Wage and tax reports
All states require employers to report employee wage and tax information
each quarter. This usually includes the employee's name, social security
number, and gross wages paid for the quarter. This information is used to
verify an employee's eligibility for state unemployment insurance and the
amount of compensation benefits to be paid.
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Disability
The primary purpose of disability taxes is to provide benefit payments to
employees absent from their jobs because of illness, accident, or disease not
related to their employment. Disability taxes provide the fund from
which this type of insurance is paid. Plans vary by state, with employers
paying the full amount in some states, and employers and workers sharing
the cost in others.
When a disability plan is 100% funded by employer contributions, and an
employee receives benefits from that plan, the benefits must be included
as part of the employee's compensation. When the plan is 100% funded by employee
money, any benefits the employee receives are tax free. In plans where both
employers and employees contribute, employees are taxed only on that portion
of the benefit related to employer contributions.
Disability benefit payments included as part of an employee's income are
considered taxable compensation for federal tax withholding, FICA, and FUTA.
However, payments are exempt from FICA and FUTA after the end of six calendar
months after the last month an employee worked for the employer.
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Special rules for food and beverage establishments
Restaurant payrolls are more complicated simply because there are several
forms of compensation, with varying tax treatments, that can make up an employee's
paycheck. There may be regular compensation paid by the employer, tips and
gratuities, banquet tips, service charges, meals, and lodging.
Federal and state laws define the responsibilities of the employer and employee
and the taxability of the different forms of compensation. The employer is
required to withhold FICA, federal, state, and local taxes, and pay FICA,
federal, and state unemployment insurance on any compensation deemed taxable.
Employers of retail and service establishments are governed by the Fair
Labor Standards Act (FLSA), and are required to pay the minimum wage if they
meet the following two conditions:
- Two or more employees are engaged in interstate commerce or in the production
of goods for commerce, and
- Annual gross revenues exceed $500,000 (retail and service establishments).
Family establishments are not subject to FLSA if the openly regular employees
are the owner and spouse, children, parents, or other immediate family members.
FLSA employers must pay wages equal to the minimum wage. "Wages" means
all payment for services, including non-cash items such as meals and lodging,
tips and gratuities, and service charges.
Tips
All tips are taxable to the employer and employee for social security and
federal unemployment tax until the employee's taxable compensation reaches
the wage base limits for these taxes. In most states, the same is true for
state unemployment taxes. All tips are fully taxable for Medicare and federal
income tax. Generally, states and localities follow federal laws regarding
the taxability of tips.
Meals
The value of meals must be included as part of taxable compensation unless
an employer can answer "yes" to all three
of the following questions:
- Were the meals furnished "in kind"? ("in kind" means
meals were provided, not groceries)
- Were the meals provided for the convenience of the employer? (the employee
was on call during the meal period)
- Were the meals provided on the employer's business site?
Lodging
Like meals, lodging is taxable unless an employer can answer "yes" to all four
of the following questions:
- Was the lodging furnished "in kind"? (actual lodging was provided,
not a cash equivalent).
- Was the lodging provided at the convenience of the employer? (was the
employee required to be available for duty at any time).
- Was the lodging provided on the employer's premises?
- Was the employee required to accept the lodging as a condition of employment?
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Workers' compensation
This is insurance on your employee for on-the-job illness or injury. Workers'
compensation rates are determined by the state and are based on the type
of work your employees are doing.
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Outsourcing Your Payroll
Typically, employers have two basic payroll processing options — use an in-house method or outsource the work to an independent payroll service.
In-House Methods
Payroll can be processed in-house using either a manual process or a payroll software program. Employee payroll obligations, payroll deductions, and payroll tax obligations are calculated, checks are written or generated, and payroll-related information is recorded or updated to the general ledger. In most cases, taxes are filed manually. Some employers hire an accountant who specializes in payroll, sometimes only for the purposes of calculating or filing payroll taxes.
Independent Payroll Processors
Payroll service bureaus provide payroll functions that range from basic calculating of employee payroll and tax obligations, producing checks, and preparing management reports to optional services such as filing payroll taxes and preparing W-2s.
What Method is Right for You?
The payroll method that's right for you depends, in large part, on the complexity of your payroll and the actual time and resources it takes to prepare it. Here are some factors to consider for each method:
Independent Payroll Processors
•Have trained personnel to perform payroll-related responsibilities.
•Perform wage and hour calculations.
•Perform federal and state tax calculations.
•Post payroll data to the general ledger.
•Track payroll tax deposit due dates.
•Research changes in federal and state payroll tax rules and legislation.
•Calculate ongoing tax liabilities.
•Calculate and file payroll tax returns.
•Provide other services (e.g., automated tax payment service, direct deposit, Internet access to payroll information, and human resource services including employee benefits).
In-House Methods
•Use personnel for payroll versus other business tasks.
•Entail software-related costs (i.e., purchasing and upgrading).
•Involve costs to train personnel to use software.
•Involve costs associated with hardware (less depreciation) and related maintenance if using a dedicated or shared payroll computer system.
Advantages of Using an Independent Payroll Processor
Focus
By using an independent payroll service, an employer can better focus on what they do best — running their business.
Accuracy
A top priority of any payroll service is ensuring the accuracy of the payrolls they process. Staying current with tax laws and tax computations is a vital part of their business.
Confidentiality
Payroll services reduce the risk of exposing confidential payroll information to unauthorized personnel.
Convenience
Outsourcing makes payroll fast and easy. In general, all an employer has to do is gather and communicate payroll information to the payroll service.
Flexibility
An employer has access to a greater number of services. This has become increasingly important, as the administration of other functions (e.g., insurance, retirement plans, and direct deposit) has become part of the payroll process.
For more information about our products and services, contact a Nazpay representative at 1-866-629-7295, Monday through Friday from 9:00 a.m. to 6:00 p.m. ET. Use our form for a no-obligation quote or get an online quote now.
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