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Everyone has come to accept that taxes are a fact of life. But how often do we stop and take a look at what these taxes really are?
While business and income taxes make the headlines, few of us actually know what payroll taxes are and how they work.
This isn’t a personal fault—we’re all busy. As long as the check clears, we’re happy. We all do it. We read the total paid without taking a careful look at the deposits (amounts put in) and withholdings (amounts taken out).
While it’s understandable that we don’t know much about payroll taxes, the truth is we should.
Put simply, payroll taxes are the taxes used to fund programs like Medicare, social security, and unemployment insurance. (You’ve heard of them. You just might not have known the lingo.)
But (and there’s always a but), because the U.S. government is divided into federal, state, and local jurisdictions, there are federal, state, and local payroll taxes. Just as it sounds, all these levels of legislation have a multiplier effect. The more taxes there are, the more rules there are to follow.
In a previous post on the complexity of payroll taxes, small business expert Rieva Lesonsky noted that between 2001 and 2012 there was an average of one change a day to the more than 15,000 tax codes in the United States.
In the context of payroll, the three main federal payroll taxes are:
Like the federal government, state and local governments also have payroll taxes, including state income tax and state unemployment taxes (SUTA). Local taxes vary and can be anything from a flat income tax to a tiered transportation or school board tax.
Payroll contributions, like bonuses, commissions, overtime pay, back pay, and accumulated sick pay are all considered taxable income. As a result, these bonus wages are subject to a 25% flat tax by the IRS and an additional percentage by the state. Basically, almost every form of income falls under some kind of taxation.
Employer responsibilities for payroll taxes include:
January 31st is a key annual deadline for employers. By this date, employers must have given each employee a W-2 reflecting income and tax amounts. (One part of each W-2 is sent to the Social Security Administration as well.)
IRS Forms 940 Employer’s Annual Federal Unemployment (FUTA) Tax Return and 941 Employer’s Quarterly Federal Tax Return are also due on January 31st. (As its name implies, Form 491 is also due once a quarter. The deadlines are April 30th, July 31st, and October 31st.)
On a state level, employers must file quarterly wage detail reports to document SUTA amounts.
The term for following all these rules is compliance. The more you learn about payroll and payroll taxes, the more you’ll hear about compliance.
An employee’s role in relation to payroll taxes is primarily advocacy—specifically with providing correct information when providing a W-4 to an employer. When completing this document, employee must accurately provide their full legal name, social security number, and current address. And they must accurately select which tax exemptions apply.
Throughout the year, employees should review their pay stubs to ensure that right deductions are made and that the numbers add up. If anything seems off, the employee should speak up and ask questions.
Whenever there’s a change to the employee’s tax exemptions, like getting married or having a child, the employer needs to be notified, using a revised W-4, so that this can be applied to the payroll taxes. Name and address changes should also be shared with employers. If the information doesn’t match up at the tax agency, it can cause problems and delays.
Note: The exchange of accurate information should be a collaborative process. It’s also a good idea for employers to check in with employees once or twice a year to ensure that all of their personal and tax information is up to date.
With the sheer number of taxes, rules, and process, mistakes are almost par for the course. Using small business accounting software and payroll software definitely help by automating calculations, withholdings, deposits, and reporting. However, they are only tools and only as good as the information that’s entered.
This is why, time and again, the ultimate responsibility for any mistake falls back to the employer (business owner). In extreme cases, the IRS will even seize personal assets and seek criminal charges.
In addition to the legal and financial consequences, payroll mistakes also impact employee morale. Employees trust that their employers will pay them accurately and on time. Once this trust is broken, it can take a long time to repair.
While this post is detailed, it really only scratches the surface of everything that’s involved with payroll taxes. Employers who want to learn more about payroll taxes can use any of these resources to track down the information they need:
One of the mottos for all things entrepreneurs is never stop learning. Find the news sites and blogs you like and stay up-to-date on the topics that matter to you and your business.