Alright, myths first.
Myth: I don’t need to know how to calculate payroll taxes for small business if my company has just one or two employees.
Fact: You need to pay payroll taxes even if your company has one employee, given they are taxable employees. That excludes you, however, as you are the owner. You can consult IRS regulations on Common Law Employees to figure out who is a taxable employee in your company.
It is imperative to know how to calculate payroll taxes for small business. Most of the companies hire a significant number of employees.
Therefore, they need to pay them on a weekly, biweekly, or monthly basis. Moreover, the employees also need health and other benefits and compensation for overtime, food, travel, etc.
However, payroll operations don’t simply mean sending paychecks. The company needs to calculate employee’s pay and payroll taxes accurately.
Payroll taxes are an integral part of the tax returns that you file to the Internal Revenue Service.
It is mandatory that the company calculate accurate taxes and ensure compliance with federal and state regulations to avoid penalties or litigations.
This is why you must know how to calculate payroll taxes for small business. This is what this guide is about.
An Overview of Payroll Taxes
Payroll taxes constitute one of the several types of taxes paid by a business owner. Other kinds of taxes are income tax, excise tax, property tax, self-employment tax, etc.
Payroll taxes are a part of the employment taxes and you should not confuse them with the income taxes.
Payroll taxes include the social security and income taxes the company pays on the employee’s behalf. In doing so, the company withholds a fraction of the employee’s income. This covers the charge for social security and Medicare for the employee.
For the companies that don’t withhold an amount of employee’s paychecks, the employees need to file the taxes for social security and Medicare themselves, similar to the self-employed individuals.
A Quick Recall:
Business owners pay the business taxes directly if the company is not a corporation, limited liability corporation, etc. Therefore, in these cases, the self-employment tax is also added to the total tax paid by the business owners.
This is preferably in the case of small and mid-sized businesses. Check with a tax service provider to curate a personalized strategy for planning your business taxes.
What Constitutes the Payroll Taxes?
You must know all the components of payroll taxes before you learn how to calculate payroll taxes for small business.
Payroll taxes are comprised of two major parts – one that the employer pays and another the employee pays. The employer withholds a part of the employee’s paychecks for the second part.
Let us take a look at the different taxes you (the employer) and the employee pay.
Taxes the Employer Pays
1. Federal Insurance Contributions Act (FICA) Taxes
The employee and employer both have to contribute an equal share to the Federal Insurance Contributions Act (FICA) tax.
It covers Medicare and Social Security. The employer is supposed to pay 6.2% for Social Security and 1.45% for Medicare, calculated on the basis of the employee’s income.
2. Federal Unemployment Tax Act (FUTA) Taxes
The Federal Unemployment Tax is used to fund unemployment insurance and employment agencies. The employers are solely responsible for paying the FUTA taxes.
3. State Unemployment Tax Act (SUTA) Taxes
State unemployment tax is similar to FUTA taxes, but you pay it to the state for the interests of unemployed individuals. SUTA tax rates vary with states, so the business should check the specific rate for their state.
Taxes the Employee Pays
1. Federal Insurance Contributions Act (FICA) Taxes
The employee must also contribute an equal share to the Federal Insurance Contributions Act (FICA) tax. It covers Medicare and Social Security.
The employee is supposed to pay 6.2% for Social Security and 1.45% for Medicare, calculated on the basis of the employee’s income.
2. Additional Medicare Tax
High-earning individuals must pay additional Medicare tax introduced by the Affordable Care Act (ACA) in 2013. This is for the individuals who earn more than a threshold amount. The employee pays the additional Medicare tax, which is 0.9% of the employee’s income. This helps fund the premium tax credits (PTC), which is a part of the Affordable Care Act (ACA).
3. Federal Income tax
The employee pays federal income tax, which is withheld from their paychecks. The businesses need to file Form W-4 for the income taxes filed on the employee’s behalf.
4. State and Local Taxes
Like the federal withholdings, the employer must withhold state and local taxes from employee wages.
How To Calculate Payroll Taxes for Small Business
Exploring different types of payroll taxes you might need to pay as a business is easy. The real burden is calculating these taxes accurately. However, we are here to walk you through calculating your payroll taxes.
So, here’s how to calculate payroll taxes for small business systematically.
1. Determine the Subjects
Taxable employees are subject to payroll taxes, but this is not the case with independent contractors. Therefore, determine who you’ll need to file employment taxes for.
Moreover, check whether the employee has reached the base limits for FUTA and Social Security.
2. Calculate Taxable Income
Employee’s taxable income is significant for calculating payroll taxes. To calculate taxes, the employer should use the employee’s gross income.
However, this doesn’t include reimbursements for business expenses, holiday gifts (non-monetary), and cash advancements.
The businesses must also take into account pre-tax contributions to benefits packages.
For example, if the employee has contributed to the retirement plans or other pre-tax benefits, subtract this benefit from the total income to calculate the taxable income.
3. Get the W-4 Form Filled
The Employee Withholding Certificate, Form W-4, provides correct information on the employee and their financial situation.
It is essential to calculate the amount to be withheld from employee’s paychecks at their convenience.
The Form W-4 contains information on the employee’s name, social security number, relationship status, and household situation. It gives a clear idea of the employee’s tax situation.
Therefore, before calculating the payroll taxes, get the W-4 form filled by your employees.
4. Calculate the Amount to be Withheld
The W-4 form will contain important information required to calculate the amount to be withheld from employee’s paychecks.
Therefore, get the Employee Withholding Certificate (the W-4 form) ready to calculate the withholding amount.
- Use the total income and corresponding tax table to calculate the amount to be withheld.
- Check if the employee has requested any additional amount to be withheld
- In case the state and local taxes are applicable, you must also file taxes for these. Therefore, check that before proceeding according to your state regulations.
- Check the state withholding tables for calculating the amount to be withheld for state income taxes.
- Check for any pre-tax contributions and deduct them from the amount to be withheld.
- Update the withholding amounts and documents whenever required or if there are changes in the laws.
- Once done, document the accurate records of the employee’s tax withholding calculations and save them for future reference.
5. Calculate Federal Insurance Contributions Act (FICA) Taxes
FICA taxes include Medicare and Social Security coverage for employees.
To calculate the employer’s share of FICA taxes, add 6.2% of the employee’s income for Social Security and 1.45% for Medicare, respectively.
Employees also make the same contribution to FICA taxes, which is usually withheld from their paychecks.
Therefore, the total FICA taxes can be calculated by adding 12.4% for Social Security and 2.9% for Medicare, which can be equally divided between the employee and the employer.
However, the Social Security Tax only applies to the first $160,200. This limit is not permanent and the government revises it depending on the economy.
6. Calculate Federal Unemployment Tax Act (FUTA)
Federal unemployment taxes, also called FUTA taxes, are to be paid solely by the employer. However, there are only limited conditions under which you will need to pay unemployment taxes.
You need to pay the unemployment taxes if:
- You pay USD 1500 or more in the form of wages in a financial quarter.
- You had at least one employee every day for 20 weeks in the calendar year. The weeks don’t have to be consecutive.
To calculate the FUTA tax rate, determine the 6.0% of the employee’s income. However, FUTA is only applied on the first USD 7,000 of the employee’s wage and not any further.
Moreover, it also calculates the State unemployment taxes (SUTA), and the rate for which depends on the corresponding state.
Important Note: You can claim a 5.4% credit If you pay your state unemployment taxes timely, which will mean you only pay a FUTA tax of 0.6%.
7. Sum It All Up
Here’s the last step on how to calculate payroll taxes for small business.
Once you have calculated the different taxes listed above, you can add them to get the total payroll taxes. After preparing the tax documents, you can go about filing tax returns.
Tax Preparation and Planning for Small Businesses!
The above details shall guide you on how to calculate payroll taxes for small business. However, it is a tedious and time-consuming process to calculate the payroll taxes.
No business owner has the time to do this themselves. Therefore, they hire online accountants to carry out payroll operations and file payroll taxes. But, there are two challenges with an in-house payroll accountant.
First, they are expensive, and second, they need management to supervise payroll operations.
To overcome this, we have brought outsourced payroll services for small businesses. Now, you can leave your payroll operations and taxes to us and focus on core business activities.
We carry out all the payroll operations, send paychecks, and accurately calculate payroll taxes. This costs way less than hiring and maintaining an in-house accountant and enhances payroll operations.
Dial toll-free number +1(800) 580-5375 to speak to our advisor and explore our plans for payroll and other accounting services.