Today, I’m going to explain the intricacies of payroll tax. I’ll show you the best ways for a business to manage its payroll taxes, reduce errors, and increase bookkeeping efficiency.
What Is Payroll Tax?
Payroll taxes consist of two types of taxes employers are required to pay:
- Withholding taxes, which are taxes employers are required to withhold from the wages of every employee. These are also known as Pay-As-You-Earn (PAYE) taxes.
- Other employer taxes, which are required from all employers in order to cover federal programs like Social Security and unemployment insurance. Both employers and employees are required to pay their portion of these taxes.
Most of the world’s developed countries have federal and state-level systems designed to assess and collect payroll taxes.
In the United States, payroll taxes are imposed on all employers and employees. Specific payroll taxes include:
Income tax withholding: Income tax withholdings are assigned by the federal, state, and local governments. Employers are required to withhold tax from each paycheck paid to an employee in that particular jurisdiction. Contrary to what some people believe, income tax withholding payments aren’t technically viewed as final income tax payments; instead, they’re simply viewed as prepayments.
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Social Security and Medicare taxes: After income tax withholding, Social Security and Medicare taxes tend to be the largest deductions from a paycheck. All employers and employees are required to deduct 6.2% of their wages for Social Security (up to a maximum of $110,100), and 1.45% of their wages for Medicare.
Unemployment Taxes: According to the Federal Unemployment Tax Act employers are required to contribute a percentage of their taxable income towards unemployment insurance. The specific amount varies from state to state. In addition to unemployment taxes, some states will also require disability insurance deductions from employers. Those states include California, New York, and Hawaii, among others.
How Much Do Americans Pay For Payroll Tax?
Americans often complain about high taxes. However, compared to other countries around the world, Americans pay relatively low income tax rates.
The highest marginal income tax rate in America is 39.6% for the highest tax bracket. However, income and payroll tax rates average out to a much lower percentage. Here’s how income tax typically breaks down in the United States:
- If you make an average income of $18,400 before taxes, your effective income and payroll tax rate will be 2.0%
- If you make an average of $42,500 before taxes, your effective income and payroll tax rate will be 9.1%
- If you make an average of $64,500 before taxes, your effective income and payroll tax rate will be 12.7%
- If you make an average of $94,100 before taxes, your effective income and payroll tax rate will be 15.7%
- If you make an average of $264,700 before taxes, your effective income and payroll tax rate will be 20.1%
Income tax brackets range from 10% for the lowest income tax bracket (less than $8,925 in income per year) to 39.6% for the highest tax bracket (over $400,000 in income per year).
How Does Payroll Tax Change From State To State?
Payroll tax varies widely from state to state. The top 10 states with the lowest tax rates are as follows:
- Wyoming (No income tax)
- South Dakota (No income tax)
- Nevada (No income tax)
- Alaska (No income tax)
- Florida (No income tax)
- Washington (No income tax)
- Texas (No income tax)
- Tennessee (6% income tax rate on all income from stocks and bonds, although wages are not taxed)
- New Hampshire (5% tax on interest and dividend income, although wages are not taxed)
- Utah (Flat 5% income tax rate at all brackets)
On the other hand, some states have unusually high income tax rates. California, Hawaii, New Jersey, New York, and Oregon all have exceptionally high income tax rates.
Which Payroll Taxes Are Legally Required For Employers In The United States?
Americans companies are required to pay the following payroll tax deductions:
- Social security taxes (6.2% up to the annual maximum payment, which changes from year-to-year)
- Medicare taxes (1.45% of employee wages)
- Federal Unemployment Taxes (FUTA)
- State Unemployment Taxes (SUTA)
As mentioned above, some states require additional deductions. It’s important to remember that total payroll taxes for social security and Medicare are twice the above percentages: employers and employees split a total deduction amount of 15.3%. This deduction about is called FICA, which stands for the Federal Insurance Contributions Act.
FICA is split between the employer and the employee. The employer pays 6.2% of social security taxes and 1.45% of Medicare taxes, and the employee also pays 6.2% of social security taxes and 1.45% of Medicare taxes for a total of 15.3%.
Those who are self-employed do not avoid paying this 15.3% total. Instead, since those who are self-employed are both employers and employees, which means they are required to pay the entire 15.3% charge.
Which Payroll Tax Deductions Are Voluntary For Employers In the United States?
Not all payroll tax deductions are required by law. Many employers charge additional payroll tax deductions based on scheduled benefit plans, health insurance premiums, retirement plan premiums, or employee meals, equipment, and union dues.
Here are some examples of voluntary payroll tax deductions assigned by employers:
- Health insurance premiums for medical, dental, and eye care insurance plans
- Life insurance premiums
- Employee stock purchase plans, including ESPP and ESOP deductions
- Employee equipment, meals, uniforms, training fees, job-related expenses, and union dues
- Retirement plan contributions, including 401(k) plans
Obviously, just because a payroll tax deduction is considered voluntary does not mean that it’s optional for the employee to pay that charge.
What Is The Best Way To Report And Pay Payroll Tax?
Federal law requires employers to provide all employees with annual reports on income tax deductions. These annual reports are known as IRS Form W-2 statements and disclose all wages paid over the fiscal year as well as federal, state, and local tax withholdings. A copy of this statement must be sent to the IRS and certain states also require copies.
In terms of the best way to pay payroll tax, employers are required to use electronic funds transfer (EFTPS) to make all federal tax deposits. There are no other options.
How To Accurately Report And Manage Payroll Tax Data Using Payroll Software
Managing payroll taxes can be one of the biggest headaches of running a business. Even in a business with just four or five employees, payroll taxes can take up a significant amount of time and distract employers from the more important parts of running a business.
That’s why the majority of employers choose to use some sort of payroll tax software. Payroll tax software is available at a number of different price levels. Payroll tax software is designed to perform a few essential functions for your business:
- Accurately manage payroll tax data and information
- Send invoices to clients
- Manage direct deposit information for employees
- Manage, monitor, and send paychecks to employees
- Track hours and overtime for employees and contractors
Today’s payroll software programs are better than ever before. Most services come with mobile apps and desktop software programs that let employers easily manage payroll data wherever they go. Cloud computing makes this process as secure and convenient as possible.
You won’t find any good free payroll software out there. Payroll software should be seen as a necessary cost of doing business. Even if you do find free payroll software, it’s unlikely to provide accurate tax information or secure payroll management services.
With that in mind, employers can typically expect to pay between $20 to $100 per month for good payroll software. Software at the lower end of that budget may come with only a basic range of features, while the higher budget range may allow you to manage dozens of employees using a wide array of features and invoicing options.
Payroll software lets you avoid learning the intricacies of payroll taxes and payroll tax law. Instead of searching up specific tax information for your state or locality, you can simply enter all information into the payroll tax software.
Then, when each pay period is complete, the software will deduct contributions from the employee’s paycheck and send out funds via direct deposit or paycheck. Payroll software is automatically configured to deduct the appropriate FICA totals and other deductions from employee paychecks according to the state in which the business is located. Employers may also choose to configure the software to remove additional voluntary deductions for insurance premiums, stock purchase plans, or equipment costs.
What Is The Penalty For Avoiding or Misrepresenting Payroll Tax?
Contrary to what some people seem to believe, you can’t just ignore tax payments. The cliché about death and taxes is true: they’re both unavoidable.
With that in mind, those who don’t pay their taxes in a “timely and proper” manner are assessed a penalty of 2% to 10%. Additionally, certain states and local governments may apply more penalties on top of that. If you or an employer fails to file monthly and quarterly tax returns, still more penalties may apply.
Al Capone famously went to jail for tax evasion and you could go to jail too if you don’t pay your taxes. Anyone who has not paid federal income tax or Social Security taxes to the IRS may be assessed a penalty of up to 100% of the amount not paid. This penalty can apply to the employer as well as the employee. If you do not pay these taxes, you may be charged with tax evasion and convicted of a criminal offense.
Important Payroll Tax Due Dates
Employers must follow a series of strict due dates in order to avoid incurring penalties from the IRS. Those due dates include:
By January 31:
- File Form 940, which explains the Employer’s Annual Federal Unemployment (FUTA) Tax Return. If you have already deposited all of your FUTA tax when it was due, then you have 10 additional calendars days to file Form 940.
- File Form 943, which details the Employer’s Annual Federal Tax Return for Agricultural Employees. If your business paid wages to any farmworkers, and those wages were subject to social security and Medicare taxes, then you’ll need to fill out Form 943.
- File Form 944, which covers the Employer’s Annual Federal Tax Return for the previous calendar year. Form 944 is only required if the IRS has notified you in writing to submit Form 944. Otherwise, proceed with a normal Form 941 statement, which is the Employer’s Quarterly Federal Tax Return statement due by April 30, July 31, October 31, and January 31.
- File Form 945, which covers the Annual Return of Withheld Federal Income Tax. This form is used to report any non-payroll income tax that was withheld in the previous year. Just like with Form 940, employers have 10 extra days to file Form 945 if they have deposited all taxes when due.
- File Form W-2, which is the Wage and Tax Statement and reports all wages, tips, and compensation paid to an employee during the previous calendar year
By February 28:
Note: The February 28 due date only applies for forms submitted by paper. For all electronically-submitted forms, proceed to the March 31 due date.
- File Copy A of all paper Forms 1099 with the IRS with Form 1096, Annual Summary and Transmittal of U.S. Information Returns.
- File Copy A of all paper Forms W-2 with the Social Security Administration (SSA) with Form W-3, Transmittal of Wage and Tax Statements.
- File paper Form 8027, which details the Employer’s Annual Information Return of Tip Income and Allocated Tips, with the IRS.
By March 31:
- File electronic Forms 1099 and 8027 with the IRS
- File electronic Forms W-2 with the Social Security Administration
By April 30, July 31, October 31, and January 31:
File Form 941, which is the Employer’s Quarterly Federal Tax return. This form will cover the fourth quarter of the previous calendar year. The January 31 deadline will be extended by 10 additional days if you have deposited all your taxes when due.
For more information about payroll tax, payroll due dates, and downloadable IRS forms, visit this page at IRS.gov.
Payroll Tax Deposit Schedules
Payroll tax deposit due dates vary depending on your deposit schedule. There are two deposit schedules, including monthly and semi-weekly schedules. You must identify which schedule you need to follow at the beginning of each calendar year. Your tax schedule is assigned based on your company’s total tax liability as reported on Form 941 in the lookback period. You can read more these rules in this official IRS document.
Monthly payroll tax deposit rules: Monthly deposit schedules require employers to deposit payroll taxes and deductions from the previous month on the 15th day of the following month. If you are on a monthly deposit schedule, you’ll only need to report those deposits on a quarterly or annual basis depending on whether you file a Form 941 or Form 944.
Semi-weekly payroll tax deposit rules: The semiweekly payroll tax deposit rules state that employers must deposit deductions and payroll taxes for payments made on Wednesday, Thursday, or Friday by the following Wednesday. Payments made on Saturday, Sunday, Monday, and/or Tuesday require deposits to be made by the following Friday. Just like with monthly payroll tax deposits, employers only need to report these deposits quarterly or annually depending on whether you file a Form 941 or Form 944.
FUTA deposit schedule: FUTA taxes need to be deposited by the last day of the first month that follows the end of the quarter. If the last day of that month falls on a Saturday, Sunday, or legal holiday, then that deposit can be made the following business day.
Payroll Tax Resources
If you want to learn more about which payroll taxes you should be paying, then the best resource to look at is the IRS.gov website. The IRS publishes all relevant payroll tax information here. That information explains payroll tax for employers including important due dates, depositing and reporting information, and e-file tax forms.
Otherwise, the best payroll tax resource is your very own payroll software, which will help you avoid manually digging around for tax forms online. Payroll software helps you avoid countless payroll-related headaches and instantly see which taxes and deductions are legally required for wherever your business is located.
Furthermore, payroll software also keeps you up-to-date on the latest payroll tax due dates. The best software sends you alerts long before important forms are due and will even fill out these forms for you based on employer and employee information.
Ultimately, payroll tax isn’t nearly as complicated as many people think. Payroll tax involves just a few simple charges: FICA, income tax withholdings, and unemployment taxes.
The payroll tax question becomes more complicated when you look at taxes on a state-by-state level, but the general principal remains the same: payroll taxes are a necessary part of doing business and must be paid by both the employee and the employer of companies operating in the United States.
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Thanks for breaking down payroll taxes so well. My area of expertise is definitely not financial, so it’s nice to see things broken down to simple terms. I never knew that there were states that did not charge an income tax. Knowing that, I’m glad I at least live in one that has a relatively low tax.
We’re glad that you found the article helpful.
I am a bookkeeper processing payroll for several small companies using the Intuit desktop payroll version. I read your payroll reviews; does Zenpayroll have an accountant subscription version like Intuit? So far I know only of Intuit providing an accountant subscription of enhanced payroll for $479/yr for up to 50 companies.
ZenPayroll also does have multi-company management for accountants.
I have a small fleet claim processing business with 7 employees. I still use QuickBooks + Enhanced Payroll.
Based on my experience, it’s very hard to know which software is good until you are well deep into it. A good payroll service should address each of the following.
Integrated w/ bookkeeping software
tax tables subscription (Federal & State)
print checks and stubs
Print Federal tax forms
Print State tax forms
e-file Federal forms
e-file State forms
e-pay Federal taxes
e-pay State taxes (for states that have the option)
direct deposit option
Once your efile/epay accounts have been established with the IRS and your State, your payroll software should be able to automate it.