What is payroll tax: A guide for small businesses

What is payroll tax? You probably ask yourself this question when your paycheck amount is less than you expected. Simply put, payroll taxes refer to taxes employers and employees pay to fund government programs.

Now, as a small business owner, you have to perform the crucial task of putting together pay stubs and summarizing the payroll withholdings correctly. If you find these concepts difficult, read on to learn about payroll taxes, including what they are and your obligations as a small business owner to pay them.

How does payroll tax work?

The payroll tax process involves the process in which employers calculate the taxes, withhold them from employee wages, and pay them to the government.

Taxpayers sometimes get confused by payroll tax vs. income tax, but the major difference is that employees and employers both pay payroll taxes, while only the employees pay income taxes.

The payroll tax process includes the following steps:

1. Understand the different types of payroll taxes: The payroll taxes comprise FICA taxes (Social Security taxes + Medicare taxes), Federal Unemployment Tax (FUTA), and Federal Income Tax.

2. Withhold employee taxes: The employer withholds the correct amount of payroll taxes from their employee’s salaries based on their W-4 form details.

3. Deposit taxes to IRS: You’re responsible for depositing the withheld taxes from employees’ wages along with your share of FICA taxes to the Internal Revenue Service (IRS). You can do this electronically through EFTPS (Electronic Federal Tax Payment System). The frequency of the deposits depends on the tax liability of the employers.

4. Report taxes: Report any wages, tips, and additional compensations that you have paid to the employees. You can do this by filing forms 941, 943, 944, 945, and 940 either through e-file or on paper.

5. Correct previously filed payroll tax errors: If there are any errors in a previously filed tax return, you can correct them with a 94X-X form. In case you overpay the payroll taxes, you can even request a refund.

6. Keep accurate records: As a small business owner, you also have to occasionally update financial records for accuracy.

Who pays payroll taxes?

In general, employers and employees pay payroll taxes. However, the responsibility does vary depending on different factors. Read on to find which payroll taxes are paid by employers and which are the employee's responsibility

For FICA taxes, both employees and employers pay their share. Depending on the worker’s classification, you, as the business owner, may pay half or none at all. If you employ a(n):

• A traditional employee who receives a W-2 form—you each pay half of the 15.3% (7.65%) 
• Independent contractor—the employer doesn’t pay any payroll taxes. Since an independent contractor is self-employed, they pay their full 15.3% self-employment tax.

For FUTA taxes, the business owner pays the full amount without assistance from the employee. 

For SUTA taxes, the payer is dependent on the state requirements. For example, states like New Jersey require the employer and employee to pay SUTA taxes. 

What are the implications of late payroll tax deposits?

As an employer, failing to pay your taxes on time can lead to payroll tax penalties or employment tax penalties. Among the payroll tax penalties, the most common is the Trust Fund Recovery Penalty (TFRP), which happens when employers either fail to collect taxes or forget to pay them.

The employment penalty cost depends on several factors, such as the business’s size, the amount owed, and the extent of the delay.  The longer the penalty is overdue, the more it will cost. The penalty rates are represented in the table below:

What percentage is payroll tax?

Payroll taxes are categorized based on employee classification and tax credits. It’s time to dig deep into the percentages for FICA, SUTA, and  FUTA taxes. 

FICA taxes:

The grand total for FICA payroll tax is 15.3%. If you have a traditional employee or statutory employee, you are responsible for 7.65% (half), with the employee being responsible for the other half. 

If you have self-employed people, they are responsible for the full 15.3% without any contributions from the business, commonly referred to as self-employment tax. 

For 2023, the Social Security tax has a wage limit of $160,200, whereas there is no wage limit for Medicare tax.

While calculating payroll taxes, keep in mind that inflation or other factors can influence wage limits and their adjustments. For example, exceeding the Social Security wage cap could lead to overpayment of taxes, increasing your financial strain.

FUTA taxes:

FUTA payroll taxes are the sole responsibility of the business owner. The cost is $420 per employee annually—specifically, 6% of the first $7,000 you pay to each employee per year.

SUTA taxes:

SUTA taxes aren’t as streamlined across the board as FUTA and FICA taxes. Since SUTA is a state-mandated tax, each state has its own tax range. Check with your state workforce commission for your range, if any.

With state unemployment taxes (SUTA taxes), you are eligible for a tax credit. This tax credit goes up to 5.4%, ultimately lowering your FUTA tax rate to .6%. You can achieve this by filing Form 940. Generally, everyone who qualifies for the SUTA tax also receives this tax break.

How to calculate payroll tax

To calculate payroll taxes, first, calculate the correct percentage of taxes that you need to withhold from your employees’ salaries. For this, you will need a copy of Form W-4 and your employee’s gross pay. 

You can use either the Wage Bracket Method or the Percentage Method to determine the taxes:

1. Wage Bracket Method

The bracket method is simpler than the percentage method and uses ‘Wage Bracket Method Tables’ to find the specific salary range of each employee. This method benefits employees whose salary range falls within the standard brackets defined by the IRS and those who find the automated payroll system a bit harder to understand.

This method tells the amount, up to $100,000, to be deducted from the employees’ salaries for taxes and is primarily based on the marital status and length of the pay period. There are two possible scenarios:

Forms W-4 from 2019 or Earlier

Forms W-4 from 2020 or Later

2. Percentage Method

The percentage method is a bit more complex and is used in cases when an employee's annual salary exceeds the highest value in the wage bracket method. 

Employers with automated payroll systems prefer this method for detailed calculations. Employees commonly use this approach to calculate withheld payroll taxes for high-income earning employees. To learn more about the percentage method in-depth, you can refer to IRS Publication 15-T).

What is payroll tax used for?

Payroll taxes are put in place to help fund unemployment, Social Security benefits, and Medicare contributions. The taxes ensure that these programs get a regular flow of income to operate efficiently.

Everyone who earns a salary or wage—no matter the amount—is subject to pay into these contributions. Here’s how they split income taxes:

• Social Security contributions: 12.4% total (6.2% from the employer and 6.2% from the employee). The Social Security program supports those with income losses for reasons such as retirement, death, or disability and provides financial protection to the affected population.

• Medicare contributions: 2.9% total (1.45% from the employer and 1.45% from the employee). The Medicare program is responsible for providing health care services for people aged 65 years or above, young people with disabilities, and individuals diagnosed with the last stages of renal diseases.

Unemployment contributions: Up to 6% of the first $7,000 (this is entirely paid by the employer. The Unemployment program lends a helping hand to those suffering from unemployment.

How to file payroll taxes as a small business owner?

As a small business owner, you have to ensure proper filing of taxes, meeting the deadlines, and keeping track of all the updated tax-related forms and regulations.

Depending on the date of the tax deposit, you have to report federal (FICA and FUTA) and state (SUTA) taxes post-payroll to file payroll taxes.

Federal tax deposits

There are two main types of federal tax deposits a small business owner will file: FICA and FUTA.

• FICA tax deposits: You are required to pay FICA taxes either monthly, semiweekly, or the next day, depending on your predetermined tax deposit date.

• FUTA tax deposits: You’ll only pay FUTA taxes (unemployment taxes) on a quarterly basis to the IRS. However, if your FUTA tax contributions are less than $500, you roll them over to the next quarter and pay biannually. 

If you’re in the last quarter of the year and still haven’t hit $500, use Form 940 to pay the tax by January 31.

In addition to paying the FICA and FUTA tax deposits electronically, you also need to report your taxes on Forms 941 and 940. 

• Form 941 is for your quarterly federal tax return for your FICA taxes. You will fill out and submit a Form 941 for each quarter, summing all of your FICA taxes paid within those months.
• Form 940 is mainly for your yearly federal unemployment (FUTA) tax return. You will fill out and submit Form 940 annually, summing all of your FUTA tax contributions for the previous year. If your FUTA contributions haven't reached $500 by the last quarter, use Form 940 to pay the tax by January 31.

While you can also file these forms electronically, you can still mail them to the IRS. 

State tax deposits

SUTA tax is state-specific and varies from state to state. Find out the state-specific SUTA tax rates and requirements by registering with the state’s unemployment agency. After registering, you will get an employer tax number. Most states will ask to file a yearly return and make quarterly payments.

For filing taxes, you have to calculate SUTA taxes based on the state’s wage base (SUTA wage base/wage limit) and the tax rate assigned to you. SUTA wage refers to the amount of your employee’s earnings that are taxable under the SUTA Act, and it is the same for all employees living within a state.

For example, in Florida, the wage base is $7000, so if an employee earns $40,000 per year, the SUTA tax will only be calculated on the first $7000 of the salary and not on the entire $40,000. In this case, the employer will pay the taxes and not the employees.

Just make sure to regularly check your state government’s official website for updates on the wage limits.

Payroll tax examples

As a small business owner, the percentage of payroll taxes you’ll have to pay will vary depending on the type of employee.

For example, a traditional employee who receives a W-2 at the end of the year is eligible for partial assistance with their FICA taxes as well as full assistance with FUTA taxes.

If the employee’s income is $25,000, both the employee and employer will each contribute 7.65% toward FICA taxes, totaling $3,825. The employer also contributes to FUTA taxes, which is 6% on the first $7,000 of income. 

As for independent contractors, who don’t receive a W-2 or tax benefits from you (the employer), they are responsible for the full 15.3% of FICA taxes and receive no FUTA benefits. 

Find peace of mind come tax time

Payroll taxes play a significant role in our government's program contributions by ensuring basic benefits such as Social Security, Medicare, and unemployment for all workers. 

As an employer, you should keep track of the different types of taxes you owe and the potential tax penalties in case you miss a deadline. You can accomplish this using the QuickBooks tax penalty protection feature to safeguard your business from paying expensive penalties. 

Before you dive in, make sure you’re categorizing your employees appropriately as traditional, statutory, or independent contractors. This way you don't underpay or overpay your payroll taxes when the time comes.

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