Payroll and Tax Compliance For Employers
When you think of payroll tax compliance, legislation changes and withholding calculations probably come to mind. Even the most experienced payroll and HR professionals get headaches over compliance. However, payroll and tax compliance headaches don’t have to overwhelm you.
Whether you’re new to payroll and taxes, or a veteran still wading through pages of legislative documents, then this blog is for you. As you read, you’ll better understand what payroll tax compliance is and the difference between payroll tax and income tax. From there, you’ll find information on the specific forms required to complete a payroll tax process. Finally, you learn how partnering with a payroll provider can alleviate the burden of payroll tax compliance.
What Is Payroll Tax Compliance?
Payroll tax compliance is the process of withholding taxes from employee paychecks and paying those taxes on behalf of the employee to the U.S. government. This process has to follow strict guidelines to ensure taxes are consistent across three different entities: employees, employers, and the government. But, how does this process work? Let’s take a quick look at how this process works for each group:
- Employees: Local, federal, and state payroll taxes are withheld from an employee’s paycheck. These taxes consist of income taxes, Social security taxes, Medicare taxes, and other state and local taxes.
- Employers: Employers follow local, state, and federal payroll tax guidelines to ensure taxes are collected from employee paychecks on time. Each quarter that employer reports tax withholdings to the required governing authority.
- Governing Authority: The IRS requires most businesses with employees to withhold federal payroll taxes, with several states and local cities requiring additional withholdings. Some states, however, don’t require withholdings or only tax income from interest or dividends, which is why it’s essential to check your local guidelines frequently.
Now that you understand which entities are involved in payroll and tax compliance let’s move on to another critical question: how does payroll tax work?
Payroll Tax vs. Income Tax
What is payroll tax? Payroll taxes usually refer to taxes withheld from employee pay based on a specific rate. These taxes fund programs like Social Security and Medicare. Businesses pay an employer share of payroll taxes and submit them via Form 941.
Income taxes fund the U.S. Treasury. They are taxes deducted from employee wages based on Form W-4, which considers an employee’s marital status, new life event, and additional amounts an employee wants to be withheld from their paycheck. Employer responsibilities for payroll taxes include providing workers with copies of their income tax information in the form of W-2s each year.
While payroll taxes and income taxes are often summarized together, the two are very different. Understanding payroll taxes is essential for employers so they can remain compliant with local and federal regulations. Utilizing a payroll and HR provider who keeps track of payment deadlines can also help. These providers can file payments on your behalf to prevent payroll mistakes and help you maintain overall payroll and tax compliance.
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Federal Payroll Taxes
Federal payroll taxes are used to fund different federal programs. These come in the form of:
- Income taxes withheld from employee wages
- FICA taxes split between employees and employers
- FUTA taxes, which are solely paid for by employers
While federal tax compliance requires employers to withhold income taxes from an employee’s wages based on the information provided on their Form W-4, FICA taxes are withheld based on a set percentage. FUTA taxes are also based on a fixed percentage but only applicable to employers. Let’s look at a breakdown of federal payroll tax rates and how each tax grouping makes up federal payroll taxes.
The U.S. currently has seven federal income tax brackets for different income levels. Employers are required to utilize these brackets to conduct income tax withholdings from employee wages. National income tax rates are progressive, which means when taxable income increases, your income then gets taxed at higher rates. Different rates are weighted against income brackets depending on the employee’s filing status.
Compliance with FICA, which stands for the Federal Insurance Contributions Act, is based on a U.S. federal payroll tax calculated on a percentage of wages. It is used to fund Social Security and Medicare and is paid for by employers and employees. Both tariffs are split equally among workers and employers so that each pays 7.65% of the 15.3% total requirement. Here’s a breakdown of that percentage:
- Both employers and employees pay Social Security taxes at 6.2%
- Both employers and employees pay Medicare taxes at 1.45%
Employers are also required to withhold an additional 0.9% Medicare tax if an employee is married, files jointly, and has annual wages are greater than $200,000 or $250,000.
FUTA, which stands for Federal Unemployment Tax Return, funds the federal government’s employment insurance. Employers must pay FUTA taxes every quarter and file them on Form 940 annually.
The amount an employer pays is approximately 6% of the first $7,000 in wages paid to an employee. However, most employers are entitled to a credit of 5.4%. This credit reduces the amount an employer owes in FUTA tax to 0.6%. Generally, you’re entitled to this credit if you paid your state unemployment taxes in full, on time, and the state isn’t determined to be a credit reduction state.
State Payroll Taxes
State Income Tax
The State Unemployment Tax Assessment (SUTA) is a type of payroll tax used to provide unemployment benefits to workers. It is a tax that only employers pay unless you have employees in Alaska, New Jersey, and Pennsylvania. Employees in those states are required to pay state unemployment taxes or SUI. SUTA can mean a few different things depending on the state in which you operate. Other names for SUTA are:
- State Unemployment Insurance
- State Reemployment Tax
SUTA is based on a percentage of an employee’s taxable wage base. While some states apply formulas to determine the taxable wage base, others use a portion of the state’s average annual wage or follow the FUTA wage base. For employers to be SUTA compliant, each state requires employers to submit a quarterly contribution and wage report
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Local Payroll Taxes
Local payroll taxes are taxes imposed by city, county, or parish governments. Local taxes vary greatly depending on the country or city in which your business operates. For example, San Francisco, California, has a local income tax of 1.5%. This tax applies to both residents and nonresidents who work in the city. As an employer, you could expect to withhold this tax from your employee’s paychecks and pay it to the proper governing authority.
These types of taxes fund local programs such as education grants, parks, and community improvement. A good rule of thumb is to check with your local tax department to see whether they collect additional employer taxes.
Payroll Tax Forms
The Employment Eligibility Verification Form (Form I-9) is used to verify the identity and employment authorization of individuals hired for employment. This form is provided by the United States Citizenship and Immigration Services (USCIS) to help employers avoid hiring unauthorized individuals for work.
Form I-9 consists of three main parts:
1. One part for an employee to establish their identity.
2. One part for an employer to verify employee documents.
3. One part for an employer to refresh information based on a rehire.
This form requires information like passports, identification cards, birth certificates, etc., that verify citizenship levels and employment eligibility.
The USCIS requires employers to store Form I-9s with personnel records onsite or at an off-site storage facility. These forms can be stored electronically, via paper, or microfilm. While businesses don’t have to refresh their I-9s as new versions are released, they are required to update them when an employee’s employment authorization document (EAD) or receipt thereof expires.
A W-2 form, also known as a Wage and Tax Statement, is the tax form used to report employee wages for the previous year. Unlike a W-4, which tells employers how much tax to withhold from employee paychecks, Form W-2 is a statement that provides employees with information about the previous tax year. Form W-2 determines whether a person owes the IRS a tax payment or is getting a refund during tax season. It includes information on taxable income, Social Security and Medicare income, and state income.
All organizations with non-contract workers making at least $600 must give those employees a Form W-2. Employers are also required to provide employees with copies of Form W-2 each year at the end of January to report their earned wages to the IRS for tax filing purposes. Companies will send these copies, known as Copy A of their employee’s W-2s, to the IRS, Social Security Administration (SSA), and other governing authorities along with a Transmittal of Wage and Tax Statement (Form W-3) to fulfill their payroll tax obligations.
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The W-4 is a form that employees complete and give their employers to indicate how much money to withhold from their paycheck for federal taxes. It’s different from a W-2 in that it’s what an employee completes and files with their employer.
If you’re an employer, the Form W-4 will tell you pieces of information like an employee’s filing status, job adjustments, amount of credits, amount of other income, amount of deductions, and any additional amount to withhold from each paycheck. This combination of information is used to compute the total amount of federal income tax that needs to be withheld from employees’ pay.
An employee must complete the form when they start a job and before processing their first paycheck. The IRS recommends that employers remind employees to submit a W-4 each year or as often as necessary to reflect any life changes. Such changes include but aren’t limited to a marriage, a new baby’s birth, additional jobs, etc.
Our blog, What’s the New W-4 And How Does It Affect Me, is an excellent resource for employers and employees navigating W-4s. It provides the information you can use to ensure employees are not overpaying or underpaying on federal taxes during the year.
IRS Form 940 is the federal report form for unemployment taxes. Each year in January, businesses file this form to report and pay unemployment taxes to the IRS. It calculates a business’ federal unemployment tax liability and makes adjustments based on state unemployment taxes paid. Businesses have to file Form 940 if:
Employers paid wages of $1,500 or more to employees in a calendar quarter of the year.
Employers had at least one employee for 20 or more weeks during the calendar year. Employers must count all full-time, part-time, and temporary employees, but not owners or partners.