The true cost of paying each of your employees is significantly higher than their hourly rate. Even if you don’t offer benefits or paid vacation, there are some unavoidable taxes and expenses you’ll incur having employees on your payroll.
Social Security Tax
The tax you pay as an employer funds Social Security benefits. For 2017, you’ll pay 6.2 percent on each employee’s wages up to $128,400. After an employee’s annual wages exceed $128,400, no more tax is levied.
These contributions go toward the general Medicare fund. For 2017, you’ll pay 1.45 percent of each employee’s salary as Medicare tax. Unlike Social Security, there’s no wage base limit for the Medicare tax. However, you do need to withhold an additional 0.9 percent from each employee’s paycheck after the person’s wages exceed $200,000 in a calendar year.
Federal Unemployment Tax Act (FUTA)
The federal unemployment insurance system, along with the state systems, funds benefit payments for unemployed workers. For 2017, the FUTA rate is 6 percent of the first $7,000 of employee wages.
State Unemployment Tax
Along with the federal unemployment tax, you may be subject to a state unemployment tax. Tax rates and policies vary by state. Luckily, employers can take a credit for the state unemployment tax they pay against the FUTA tax. The maximum credit is currently 5.4 percent.
There are other expenses that are hard to avoid when you bring on an employee. All states require that you purchase workers’ compensation insurance once you have someone on payroll. Rates vary by state, but a 2014 report [PDF] from the state of Oregon noted that the median rate is around $1.85 per $100 of payroll, or 1.85 percent of an employee’s salary. If you’re in California, you could pay up to 3.5 percent of total wages to cover workers’ compensation.
Calculating, withholding, and remitting payroll taxes is a complicated and time-consuming process. An experienced payroll bookkeeper may be able to handle it, but it may not be worth their time for just one or two employees. It might make more sense to pay a third-party payroll provider to handle the process.
What You’ll Pay
Fit Small Business ran the numbers and estimates that employers should expect to pay 10 percent or more to cover payroll taxes, unemployment taxes, and workers’ compensation insurance. Because unemployment taxes and social security taxes phase out after a certain compensation level, you will pay a higher relative percentage for low-paid employees than you will for well-paid ones. If you do business in a state with a high unemployment tax rate and a higher workers’ compensation rate — like New York or California — that will also add on a few more percentage points.
If you don’t want to pay extra taxes, insurance, and payroll processing costs, consider independent contractors and consulting firms. They’ll probably charge a higher rate than what you’d pay an hourly employee, but it may be worth avoiding the taxes and hassle. If you truly need to hire an employee for help, consider your family members first. The IRS offers payroll tax perks to sole proprietors and partnerships that hire children and spouses. If they meet the requirements, small-business owners don’t have to pay Social Security, Medicare or FUTA taxes when they employ their children, and can avoid FUTA tax if they hire a spouse.