One of the many responsibilities employers deal with is staying on top of the numerous payroll taxes at the local, state, and federal levels. Payroll taxes fund social insurance programs including Social Security and Medicare and are the second-largest source of revenue for the federal government. The rules for payroll taxes can be complex, but penalties for noncompliance are severe, making it critical for employers to take necessary measures when handling them. Given that they bear the ultimate responsibility for fulfilling all tax obligations, understanding which taxes are payroll taxes and how to report them is a must for every employer.
Which Taxes Are Payroll Taxes and What Are They Used For?
Payroll taxes are all taxes collected by federal, state, and local governments, based on salaries and wages paid to employees. All employers that have employees need to withhold these taxes from their salaries and remit them on a monthly or semi-weekly basis, depending on the quantity owed.
Employers are also required to make regularly scheduled reports to the Internal Revenue Service (IRS) and to state and local taxing agencies about the amount of taxes owed and paid. However, they are not required to withhold payroll taxes on wages paid to independent contractors, while self-employed individuals are responsible for paying their own payroll taxes.
While the withholding percentage may vary, all employees are subject to a minimum of federal payroll taxes, including federal income, Social Security, federal unemployment, and Medicare taxes. In addition to the minimum required federal payroll taxes, different states may also require specific withholdings.
In order to know which taxes are payroll taxes, employers need to distinguish different types of federal and state that they cover, such as:
Social Security Tax
The Social Security tax is one of two taxes all employers are required to withhold under the Federal Insurance Contributions Act (FICA). This is a percentage of gross wages that most employees, employers and self-employed workers must pay to fund the federal program.
As of 2022, the Social Security tax rate is 12.4%. Half of the tax, or 6.2%, is paid by the employer, and the employee portion is usually withheld from each individual paycheck throughout the year. This tax rate is assessed on all types of income earned by an employee, including salaries, wages, and bonuses.
Medicare Tax
In addition to the Social Security tax, employers are required to withhold the correct amount of Medicare tax in accordance with the FICA.
The Medicare tax is a percentage of gross wages that all employees, employers and self-employed workers must pay to fund Medicare. Failure to do so can result in significant penalties.
The Medicare tax rate is 2.9% and, unlike with Social Security tax, there is no limit on the income subject to this tax.
Additional Medicare Tax
Some high-income taxpayers must pay an extra Medicare tax over and above the 2.9% rate.
The Additional Medicare Tax (AMT) was added by the Affordable Care Act (ACA) in November 2013. The ACA increased the Medicare tax to 3.8% for taxpayers whose incomes are over a certain threshold based on their filing status.
Federal and State Income Taxes
Federal and state income taxes have to be withheld from employee pay and paid to the IRS and states as required by law. They are withheld by the employer from all employees’ wages, based on the information provided by employees on their Form W-4.
Federal Income Tax Withholding
When it comes to the federal income tax system, taxpayers generally must pay income tax during the year as they earn or receive income. For employees, employers make periodic tax payments on their behalf by withholding income tax on their wages.
Employers calculate the wage withholding amount based on the information the employee provides on their Form W-4. Wage withholding depends on whether a worker is an employee and is paid wages under the income tax withholding rules.
Federal Unemployment Tax
Federal unemployment taxes are paid by an employer, based on the gross pay of all employees. These taxes are paid quarterly or annually and are reported on Form 940.
State Income Tax Withholding
Both state and local governments can impose withholding on wage income but only based on their own tax rates. While both state and federal income taxes can be withheld, they cannot be withheld twice at both levels.
Some states, such as Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming, do not have an income tax.
State Unemployment Tax
In addition to the federal unemployment tax paid under the Federal Unemployment Tax Act (FUTA), employers need to pay state unemployment tax to support the unemployment insurance system. They are also known as SUTA or SUI taxes.
Each year, states evaluate each individual business and provide a new tax rate. Businesses must update their records to ensure they are paying at the correct rate and avoid overpayment or underpayment.
Local Taxes
Employers must comply with many different types of local payroll taxes, based on where their employees work and live. Some types of local taxes are only imposed on employers doing business in a locality. To ensure compliance, employers need to check with their local tax department to determine whether they collect any additional employer-paid taxes.
Compliant Payroll Tax Administration
Understanding which taxes are payroll taxes is critical for every employer. Not meeting them is against the law, and if the sums are large and the pattern repeats, the IRS can impose criminal sentences and even close businesses. In addition, employers need to closely monitor changing payroll taxes regulations and any updates made to the necessary IRS forms.
Managing payroll taxes can be a time-consuming and difficult administrative task. Even with a great third-party payroll processing vendor, issues still arise while navigating the complex environment of federal, state and local payroll taxes. The right solution can simplify your tax management and give organizations time back to focus on other areas of the business. Payroll tax consulting from Experian Employer Services utilizes “best-in-class” technology, maintains high-level security protocols and avoids unnecessary disruptions to both internal processes and third-party payroll providers.