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There are a lot of things to be aware of as a small business owner and payroll taxes is one of them. Fortunately, Square Payroll can ease this process for you by calculating and depositing your payroll taxes, and filing the appropriate tax filings to the federal and state agencies.
To make sure you are paying your employees above the board, read below for an overview and information on how payroll taxes generally work. We’ve also provided some links to the IRS and state agencies so you can learn more about payroll taxes and how to calculate an employee’s paycheck.
There’s a lot you should be aware of when it comes to payroll taxes. The IRS provides guidance online but here are some frequently asked questions.
1. What do payroll taxes pay for?
The federal government levies payroll taxes on wages and uses most of the revenue to fund Social Security, Medicare, and other social insurance benefits. Federal income taxes also go towards things like defense and security.
State income taxes go towards a variety of areas, the most important being education and health care, as well as transportation, corrections, state police, parks and recreation.
2. How can I pay payroll taxes online?
After collecting federal withholding tax from employees, an employer can pay them online using the Electronic Federal Tax Payment System (EFTPS). State agencies will generally have their own electronic or manual processes to submit state payroll taxes.
Whether you’re paying payroll taxes in Texas or New York, you must also submit your federal tax filings to the IRS, state payroll tax filings to the related state agency, and Form W-2s to the Social Security Administration.
3. Generally speaking, what are the payroll tax rates?
There are typically four types of taxes that you’ll notice on your pay stub: federal income tax, Social Security tax, Medicare tax, and a state income tax (note that not all states have an income tax, some states may levy additional taxes, and some employees might be excluded from certain taxes).
Both the IRS and state tax agencies publish annual tables to determine the amount of tax to be withheld from each paycheck depending on the employee’s gross wages, filing status, number of withholding allowances (exemptions) and pay frequency. Social Security and Medicare taxes put together are called “FICA” (Federal Insurance Contributions Act) taxes and have specific rates and thresholds.
For 2020, the Social Security tax rate is 6.2% on the first $137,700 of wages paid. The Medicare tax rate is 1.45% on the first $200,000 of wages (plus an additional 0.9% for wages above $200,000).
4. Which states do not have income tax?
There are currently nine states in the U.S. that do not levy an income tax on wages:
- South Dakota
New Hampshire and Tennessee don’t tax wages, but they do tax some dividends and interest income.
Types of Payroll Taxes
Employee payroll taxes are usually made of these four taxes:
- Federal Income Tax
- State Income Tax
- Social Security
Employer payroll taxes are usually made up of these four taxes:
- Federal Unemployment Tax
- State Unemployment Tax
- Social Security
The amounts of these payroll taxes and what they pay for are highlighted in the table below.
Types of Payroll Taxes (2020)
|Employer Pays||Employee Pays||Total||Cap?||What They Pay For|
|Social Security||6.2%||6.2%||12.4%||$137,700||Per dollar, 85 cents goes to a trust fund that pays monthly benefits to current retirees and their families and to surviving spouses and children of workers who have died. The other 15 cents goes to a trust fund that pays benefits to people with disabilities and their families.|
|Medicare||1.45%||1.45%||2.9%||No Limit^||This tax goes to a trust fund that pays for some of the costs of hospital and related care of all Medicare beneficiaries.|
|State Unemployment||Variable||None^^||Variable||Variable||This tax, paid to state workforce agencies, is typically used to pay unemployment benefits to state workers. State law determines individual state unemployment insurance tax rates.|
|Federal Unemployment||6.0%^^^||None||6.0%||$7,000||Unemployment tax, paid for by employers, covers the costs of administering Unemployment Insurance and Job Service programs in all states.|
^ Wages over $200,000 earned in 2020 will be taxed an additional 0.9%
^^ Some states may require or allow employers to withhold a portion of state UI taxes from employee wages
^^^ Employers can take a credit of up to 5.4% of taxable income if they pay state unemployment taxes. This credit is lower in “Credit Reduction States” where the state has not repaid money it borrowed from the federal government to pay unemployment benefits.
How to Calculate Payroll Tax In 2020
An employee’s paycheck generally consists of federal income tax, Social Security, and Medicare. If you are located in a state with state income tax withholding, you will need to withhold state income tax as well.
Social Security is calculated at 6.2% of the gross pay and it’s capped once you hit $137,700 in earnings. This means the maximum amount of Social Security tax you will pay in one year is $8,537.40.
Medicare has no cap and is calculated at 1.45% of an employee’s gross pay. If an employee earns more than $200,000 in a single year, you will need to withhold an additional 0.9% for medicare wages for anything greater than $200,000. This 0.9% is only paid by the employee and not the employer.
Federal and state income tax are a bit more difficult to calculate. Federal income tax is determined by the Form W-4 that an employee submits, showing their filing Status as well as their number of exemptions. You will then need to reference IRS Publication 15B, Section 17: How to Use the Income Tax Withholding Table to see how much tax to withhold from your employee. Please note, this tax table gets updated annually by the IRS.
For state income tax withholding, there is a similar table produced annually by each state that determines how much state income tax to withhold from each employee’s paycheck. For example, if your employees work in California, you can follow the directions on the 2020 Withholding Schedule to determine how much state income tax to withhold from your employee’s paycheck.
Payroll Tax Penalties
Payroll taxes are due to the government. When the taxes are not paid, are paid late, or are paid, but don’t follow the correct guidelines, employers can face severe penalties and accrue interest.
(By hiring a payroll service, you won’t need to worry about submission guidelines, accuracy of payment, or getting your payroll taxes paid on time. It will take care of it for you.)
The three components that make up a correct deposit are: (1) the deposit is made timely, (2) the deposit is in the correct amount, and (3) the deposit is made in the correct manner. A failure to comply with any of these components will subject the deposit to the FTD (Failure to Deposit) penalty. The percentage rate charged depends on the number of calendar days a deposit is late or whether there is a direct payment.
Per IRC 6656(b)(1), there is a time sensitive four-tier penalty system for late deposits. The penalty rate assessed depends on the number of calendar days a deposit is late starting from the due date of the deposit. For liability amounts not properly or timely deposited, the penalty rates are as follows.
- 2 percent for deposits 1–5 days late
- 5 percent for deposits 6–15 days late
- 10 percent for deposits made more than 15 days late. This also applies to amounts paid within 10 days of the date of the first notice requesting payment for the tax due.
- 10 percent for required deposits not paid by EFT (Electronic Funds Transfer)
- 15 percent (a 5 percent addition to the 10 percent for late payment) for all amounts still unpaid more than 10 days after the date of the first notice requesting payment of the tax due, or the day on which the taxpayer received notice and demand for immediate payment, whichever is earlier.
Payroll Tax Changes due to COVID-19
The federal government recently passed the CARES Act to help ease some of the financial burdens on small businesses due to COVID-19. Some of the 2109 tax changes that you should be aware of include the Employee Retention Credit, deferral of payroll taxes, modification of net operating losses, write-off for property improvements, and more. You can read more about tax deductions for small businesses in 2020 in our article, Small-Business Tax Deductions
Please note, this is only intended as an overview of how payroll taxes generally work. It is not tax or legal advice that you can rely upon for your business. For guidance or advice specific to your business, you should consult with a tax or legal professional.