Payroll Tax


Federal Payroll Tax

Wages subject to federal tax include pay given to an employee in exchange for services performed for the employer, whether or not the payments are in cash. Taxable wages also includes bonuses, vacation pay, and fringe benefits such as memberships, tickets, and property determined at the fair market value.

Expense reimbursements to employees, on the other hand, do not generally fall under taxable income if accounted for properly per IRS rules.

Federal taxes on wages include federal income tax withholding, Social Security, Medicare, and federal unemployment taxes.

Federal Income Tax Withholding

Employers are required to withhold federal income tax based on the employee’s W-4, or the Employee’s Withholding Allowance Certificate. The W-4 bases federal withholding on marital status and withholding allowances. The goal of using the W-4 is to match the federal income tax withholding with federal income tax the employee owes on wages by year-end.

Social Security and Medicare Tax

The Federal Insurance Contributions Act (FICA) uses federal funding to provide old-age, survivors, and disability care and is financed by Social Security Tax.

Medicare provides for hospital insurance and is funded and reported separately under Medicare tax.

Effective in 2011, Congress lowered the employee Social Security tax rate from 6.2% to 4.2%. The employer Social Security tax rate is still 6.2%. The Medicare tax rate is 1.45% for both employees and employers, unchanged from 2010.

Social Security has a wage base limit, or a maximum wage that is subject to the tax per employee. For 2011, the wage base limit for Social Security remains unchanged at $106,800.

Medicare tax does not have a wage base limit.

An employer is required to withhold the Social Security and Medicare tax from employee pay, and to also pay a matching amount for these taxes.

Reporting Federal Taxes on the 941

Federal income tax, Social Security, and Medicare amounts are reported on form 941on a quarterly basis. The total that should be reported on the 941 equals all federal withholding for the quarter, 10.4% of Social Security wages (employee withholding of 4.2% plus employer matching of 6.2%) and 2.9% for Medicare wages (employee withholding of 1.45% plus employer matching of 1.45%).

Depositing Federal Payroll Taxes

Employers must deposit federal income tax withheld from employees pay, and pay both the employer and employee portion of Social Security and Medicare taxes either monthly, semi-weekly, or by the next business day.

To determine the deposit schedule, look at the total taxes on line 8 from July 1 to June 30 of last year, called the “lookback period.” You are a monthly schedule depositor if you reported a total of $50,000 or less on line 8 of form 941 for the four quarters in the “lookback period.” You are a semiweekly depositor if you reported more than $50,000 total for all four quarters.

New Employers and Federal Tax Deposits Requirements

You are a monthly schedule depositor if you are a new employer because your tax liability was zero during the four quarter lookback period. Monthly depositors deposit tax on the 15th of the month following the payroll date.

$100,000 Next-Day Deposit Rule

Regardless of your deposit schedule, if you accumulate $100,000 or more of federal taxes on any day during a deposit period, you must deposit the tax by the next banking day. This is required whether you are a monthly or a semiweekly schedule depositor.

Federal Deposit Schedule and Required Returns

Tax Type Lookback Period July 1 – June 30 Deposit Schedule Tax Return Requirement
Social Security, Medicare, federal withholding $50,000 or less for all four quarters Monthly 941 Quarterly, W-2’s and W-3 annually
More than $50,000 for all four quarters Semiweekly
$100,000 on any one day Next-Day

Federal Unemployment Tax (FUTA)

Federal unemployment tax is paid only by the employer and is not withheld from employees’ wages. The FUTA tax rate is 6.2% for the first $7,000 in wages for each employee. However, you can generally take a credit of 5.4% for the amounts you pay for state unemployment. Therefore, the FUTA rate is generally .8% (6.2% – 5.4%) for the first $7,000 in wages for each employee, or $56 annually for each employee that makes $7,000 or more.

After June 30, 2011, the FUTA tax rate is scheduled to decrease to 6.0%. With the credit of 5.4% for state unemployment paid, the federal unemployment rate effectively becomes .6% (6.0% – 5.4%).

FUTA taxes are paid quarterly on the last day of the month following the quarter, and filed annually using form 940.

State Payroll Tax

State Unemployment Tax

Employers are required to pay state unemployment taxes for employees working within the state, regardless of where the employee lives. The state unemployment tax is paid quarterly and filed quarterly with the state Department of Labor. A separate account number is generally required for state unemployment filing than the account number used for state income tax filing since these taxes are reported to different departments.

The state unemployment rate will vary for each employer depending on the employer’s past activity in the state. However, the wages subject to unemployment tax are applied uniformly to each employer within the state, though the wage caps vary across each state (from $7,000 to over $30,000 in some states). Therefore, the employer pays the rate assigned to its account times the wage cap per each employee within the state.

For example, if your state unemployment rate is 5.4%, and you have 20 employees that made $50,000 working in the state for the year, and the wage cap is $7,000 per employee, you will owe $378 for the year ($7,000 x 20 x 5.4%).

Because of the wage caps, employers will generally incur greater state unemployment taxes in the earlier quarters during the year and less tax as the year progresses and the wage cap is exceeded per employee. New hires will generally generate more tax in the quarter hired.

The quarterly returns must be filed quarterly regardless of the total tax liability in order to account for each employee’s wages and calculate the total unemployment tax.

State Unemployment Reports and Payments Schedule

Quarter # Dates of Quarter Tax Reports and Payments Due
1 Jan. 1 – March 31 April 30
2 April 1 – June 30 July 31
3 July 1 – Sept. 30 Oct. 31
4 Oct. 1 – Dec. 31 Jan. 31

State Disability Tax

Disability insurance provides coverage to employees for injuries and illnesses that are not related to work.
Some states require disability insurance payments either from the employee, the employer, or both. The following states have a disability tax: California, Hawaii, New Jersey, New York, and Rhode Island. Employers must also make a contribution to disability insurance in the states of Hawaii, New Jersey, and New York. Disability taxes are generally paid monthly.

State Withholding

Employers are required to withhold state income tax similar to federal income tax. The withholding is either based on the federal W-4 form, or on a separate withholding allowance form required by the state. State withholding is generally paid monthly or quarterly, with tax filing due at the end of each quarter. Additionally, states require the state copy of the W-2’s with an annual summary of state wages and withholding.  The annual return should reconcile with the four quarterly returns filed during the year to account for total state wages and withholding.

Seven states do not have a state income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming.

Two others, New Hampshire and Tennessee, tax only dividend and interest income.

Local Payroll Tax

Some localities require tax withholding or tax the employer based on the number of employees. The most common local payroll taxes are cities, boroughs, and townships located throughout Pennsylvania, including Philadelphia, parts of Ohio, cities within New York, and San Francisco.

Local taxes can be based on either resident or nonresident status, and require withholding and deposits, quarterly and annual filings, and a separate account number similar to state and federal guidelines. Check with the city where you operate a business or have employees residing for any local tax filing requirements.

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