How to Help Your Small Business Clients Stay on Top of Payroll Tax Obligations

Tax Law and News withholding and Form W-4

Payroll taxes or employment taxes carry their own set of rules and filing requirements. Tax professionals can always take the opportunity to educate and help small business owners or self-employed clients so they stay on top of their filing responsibilities and avoid missing deadlines and incurring penalties. This article will run through the rules and filing deadlines associated with payroll taxes.

Payroll taxes are paid by employers and employees through the payroll process. The employer withholds certain taxes from employee paychecks and remits these taxes, along with the employer portions, to the various taxing agencies. The employee’s gross pay is reduced by any amounts withheld. Different rules apply for employees who receive tip income.

Federal Income Taxes

Employers must withhold and deposit federal income tax from an employee’s wages to the IRS. The employer uses the employee’s Form W-4, Employee’s Withholding Allowance Certificate, and the withholding tables in Publication 15, (Circular E), Employer’s Tax Guide, to figure out how much to withhold. Since they are not considered employees and don’t receive W-2s, self-employed individuals make quarterly estimates to cover their expected federal tax liability.

Social Security and Medicare Taxes: Federal Insurance Contributions Act (FICA)

Employers are required to withhold Social Security and Medicare taxes from employee wages, match these amounts with employer contributions, and make deposits. The employee tax rate for the Social Security component is 6.2 percent, and the wage limit is $132,900 for 2019. This wage cap is indexed to inflation and increases each year. The employee tax rate for the Medicare component is 1.45 percent, and there is no cap on wages.

Self-employed individuals are required to cover the employer and employee components. These amounts are calculated on the Schedule SE, Self-Employment Tax, of the individual tax return. The business gets to deduct the employee’s share (one-half of the total self-employment tax due) from its gross income.

Additional Medicare Tax

Employers are responsible for withholding a .9 percent additional Medicare tax on employee wages over a certain threshold amount based on the employee’s filing status ($250,000 for married filing joint, $125,000 for married filing separate and $200,000 for other filers). The employer withholds this tax in the pay period when wages exceed the threshold until the end of the year. There is no employer match for this component. In determining when to withhold this tax, be sure not to take into account wages earned from other jobs or wages from a spouse; this can create over- and under-withholding situations.

Federal Unemployment Tax (FUTA)

Employers are required to report and pay FUTA tax separately from federal income tax and FICA taxes. Employers pay this tax from their own fund, and employees are not responsible for this tax. For 2019, the FUTA tax rate is 6.0 percent and applies to the first $7,000 of wages paid to each employee. You can take a credit against FUTA tax for amounts paid into state unemployment funds.

State Payroll Taxes

State payroll taxes include state income tax withholding for the states that impose a tax, which is based on where the employee works. In addition, some states require payroll taxes to cover state unemployment tax funds, state disability funds (California, for example) and state worker’s compensation funds.

Forms to File and Due Dates

  • Form W-2, Wage and Tax Statement, and Form W-3, Transmittal of Wage and Tax Statements: These report wages, tips and other compensation paid to an employee, and are due by Jan. 31. Copies are sent to the Social Security Administration and the employee.
  • Form 1099-MISC, Miscellaneous Income: This is filed for each person paid at least $600 in services performed by someone who is not an employee, such as an independent contractor, and is due by Jan. 31. Copies are sent to the IRS and the recipient.
  • Form 941, Employer’s Quarterly Federal Tax Return: Form 941 is used to report income taxes, Social Security tax and Medicare tax withheld from an employee’s paycheck and the employer’s portion of Social security tax and Medicare tax. It is due by April 30, July 31, Oct. 31 and Jan. 31.
  • Form 940, Employer’s Annual Federal Unemployment (FUTA) Return: Use this form to report annual FUTA by Jan. 31.
  • Depositing employment taxes: There are two deposit schedules: monthly and semi-weekly. Before the beginning of each calendar year, your client must decide which schedule they are required to use. FUTA deposits are required to be made on a quarterly basis.

Practical Tips

Properly classify workers. It’s important to properly classify your workers as employees versus independent contractors. For employees, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages. On the other hand, you don’t have to withhold or pay any taxes paid to independent contractors, in general. Instead, you may have to issue them Form 1099-MISC, Miscellaneous Income, to report payments made. Please refer to the IRS’ explanation about independent contractors (self-employed) or employees to determine the proper classification.

File on time. Be sure your clients file the required forms and pay their payroll tax on time. Otherwise, they can incur some substantial penalties. For example, if W-2s are filed late, the penalty is $50 per form that is up to 30 days late; $110 for each form that is more than 30 days late; and $270 for each form that is more than six months late or not filed at all. And if clients fail to make a timely deposit, the may be subject to a failure to deposit penalty of up to 15 percent.

Finally, according to the IRS, employment tax records should be kept for at least four years.

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