Understanding Payroll Tax
Before knowing how to plan or calculate payroll tax, the foremost thing for an entrepreneur is to be aware of the key basic details regarding the same.
Employers withhold a percentage as payroll tax from employees’ pay and then pays it to the government on the latter’s behalf. This tax is based on salaries, tips and wages paid to employees.
Moreover, business owners must note that several laws exist that define whether or not a worker is subject to payroll taxes. In general, if an employer controls and directs not only the work results but how a worker does the work, then such a worker is classified as an employee and subject to payroll taxes. Otherwise, the worker may be considered an independent contractor and therefore not subject to payroll taxes. Part-time workers can be regarded as employees for payroll tax.
If a business owner fails to withhold taxes or misclassifies a worker as a contractor, the Internal Revenue Service (IRS) can impose penalties.
Calculating Payroll Tax
Business owners need to calculate payroll taxes using the employees’ total wage or gross earnings and several other deductions to compute the take-home or net pay. While this does sound simple, it demands attention and considerable accuracy.
To calculate net pay, business owners can apply the following formula:
Net pay = Employee’s gross pay (pay rate x number of hours worked) – statutory payroll tax deductions – voluntary payroll deductions.
As per the law, business owners need to withhold the statutory payroll tax deductions from the paycheck of an employee each pay period. Following that, they should transmit these withholdings to different tax agencies.
On the other hand, entrepreneurs must note that they can withhold the voluntary payroll deductions from the paycheck of an employee only if the latter has agreed to the same. These deductions contribute toward or pay for different benefits that an employee has opted to participate for.
What Do a Business Owner’s Payroll Tax Obligations Consist of?
The payroll tax obligations of a business owner comprise a combination of these:
- FICA taxes: A part of the taxes that business owners withhold from wages of employees are FICA (Federal Insurance Contributions Act) taxes, covering Medicare and Social Security contributions. Both the employees and the employer pay an equal share of FICA taxes.
- Federal income tax withholding: Every employee should fill out a W-4 form to list their withholding exemptions, marital status, and other factors affecting withholding. Business owners use the IRS tax tables to calculate the amount to withhold. The main purpose is to arrive close to every employee’s year-end tax liability.
- State and local payroll taxes: If the business is based in a state with a personal income tax, the employer will likely have state tax withholding and reporting obligations. Sometimes local tax withholding and reporting obligations are also applicable. A majority of the states allow a business owner to use reporting methods that are similar to those utilized for federal purposes.
- Unemployment taxes (FUTA): By paying payroll tax depending on various factors, business owners are responsible for contributing to funding the unemployment tax system. These factors include the age and type of business, the unemployment claims filed against the business, and the amounts they pay employees.
It is imperative to keep in mind that if your organization lacks proper infrastructure related to risk management, HR, and payroll, you can face hassles to plan payroll tax. For that matter, you can consider us as a viable option to manage these key areas. Additionally, you can go through our blogs to gain an insight into what we do.
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