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Payroll Taxes for Small Businesses: The Basics

By Cyndia Zwahlen

As the owner of a small business, it’s important that you know about payroll taxes and whether or not you owe any. The penalties for not paying, or even paying late, can be severe. If your business has employees, you, as a business, are responsible for collecting and paying payroll taxes based on their wages. Even if you don’t have employees but your business is incorporated, then your own paychecks from the business are subject to payroll taxes. And even if you use a payroll service, as the business owner you are still ultimately responsible for your company paying its payroll taxes correctly and on time. So it makes sense to have a working knowledge of what that entails. Below, we walk you through the basics so you can be confident you know what your responsibilities are as a business owner when it comes to payroll taxes.

Payroll tax glossary: Common acronyms

FICA: Federal Insurance Contributions Act (FICA), which requires Social Security and Medicare taxes to be paid on wages.

FTD: Federal tax deposit, which are the taxes you send to the IRS.

FUTA: Federal Unemployment Tax Act, which requires employers to pay unemployment insurance taxes. The money is used to help states administer unemployment insurance programs.

OASDI: Old Age, Survivor and Disability Insurance (OASDI), otherwise known as Social Security. The OASDI tax is one of the FICA payroll taxes. The other is the Medicare tax.

SUTA: State Unemployment Tax Act, which mandates the collection of payroll taxes to pay for unemployment benefits for eligible workers who lose their jobs through no fault of their own.

What are payroll taxes?

Payroll taxes are different from income taxes. Payroll taxes are the other taxes employees owe based on their wages, but these taxes also include an employer contribution component. Both the employee and the employer owe payroll taxes on an employee’s wages.

Federal payroll taxes

There are two main federal payroll taxes. They are both mandated by the Federal Insurance Contributions Act (FICA). They are:

Social Security: Social Security taxes are also known as OASDI taxes. OASDI stands for Old Age, Survivor and Disability Insurance. These taxes fund Social Security benefits.

Medicare: The Medicare tax is also known as the Medicare Hospital Insurance (HI) tax. These taxes fund the hospital insurance component of Medicare benefits.

There is a third, smaller federal payroll tax:

Unemployment insurance: The Federal Unemployment Tax Act (FUTA) helps pay for the federal-state unemployment insurance system. Only the first $7,000 of a worker’s wages are used to calculate this tax. The FUTA money is mostly used to pay for state unemployment insurance program administration.

State payroll taxes

Unemployment insurance: The State Unemployment Tax Act (SUTA) tax provides state unemployment benefits to eligible workers who lose their jobs through no fault of their own.

Disability insurance: Five states, listed below, and Puerto Rico also require employers to provide short-term disability insurance for non-work related injuries and sickness that prevent an employee from working.

If your company does business in any of these locales, you may have to withhold taxes from your worker’s pay and/or pay the taxes to cover the insurance costs. Some states just charge workers. Others charge employers. Some charge both.

For state-specific details: California, Hawaii, New Jersey, New York, Rhode Island, Puerto Rico.

Employer payroll tax responsibilities

Payroll taxes are divided into what the employer owes and what the employee owes. Here’s a closer look at the employer breakdown:

6.2% for Social Security.  As the employer you pay 6.2% , or half, of the 12.4% Social Security tax owed on the first $118,500 of an employee’s wages. That maximum wage cap bumps up to $127,200 in 2017.

1.45% for Medicare. The employer also splits the Medicare tax owed on an employee’s wages.

6%, up to $42 a year, max, for the federal unemployment insurance tax that is based on the first $7,000 in wages for each employee. The actual rate is typically 0.6% because employers get a 5.4% credit for the state unemployment insurance tax they also have to pay, in most cases. Only employers pay the FUTA tax.

The state unemployment insurance tax rate for employers varies by state.

Employee payroll tax responsibilities

6.2% for Social Security

1.45% for Medicare

0% for state unemployment insurance taxes, except in Alaska, New Jersey and Pennsylvania. These are the only three states that regularly charge employees a state unemployment insurance tax. That employee tax money has to be withheld by the employer and paid to the state with the employer’s own quarterly unemployment tax payments.

Payroll tax payment schedule and deadlines

Payroll taxes you owe to the federal government have to be paid monthly or semi-weekly (twice a week), depending on how much payroll tax you typically owe.

If the federal taxes were $50,000 or less over a 12-month period, you deposit the taxes monthly.

If over $50,000, you deposit the taxes twice a week.

If your payroll taxes are less than $1,000 a year, you can request to pay them annually.

These federal tax deposits have to be made electronically through the Electronic Federal Tax Payment System. But your small business can still mail a check to cover payroll taxes if it owes less than $2,500 per quarter.

For more information, check the IRS website here.

State payroll taxes are generally due monthly or quarterly, depending on how big your payroll is. Check your state’s employment department for the correct timetable for your small business.

How do I report payroll taxes?

Federal payroll tax returns are filed separately from the payroll tax payments. Your small business will need to file federal payroll tax returns quarterly or once a year, depending on how big your payroll is. You’ll use IRS Form 941, Employer’s Quarterly Federal Tax Return, to report your payroll taxes. IRS Form 940 is used to report the federal unemployment (FUTA) taxes you paid.

What if I can’t pay my payroll taxes, or I pay late?

The federal government considers payroll taxes a special category of taxes because the employee’s share belongs to the employee, not the employer. It may be going into the employee’s Social Security account, for example, to earn credit for future benefits. So small businesses tempted to use the money for other purposes are punished with steep penalties and interest on late payments. The IRS can withdraw the money you owe directly from your bank account, put a tax lien on your property or, in severe cases, threaten time in prison.

Here’s one example of how fast penalties can rack up, from the IRS publication, “The ABCs of FTDs”:

FTD Penalty on a Late, $3,000 Quarterly Tax Deposit:

1 – 5 days: 2%, $60
6 – 15 days: 5%, $150
16 + days: 10%, $300
10 days after the IRS bill/notice: 15%, $450

That’s an example of a failure to deposit penalty. You’d also owe a failure to file penalty of 5% per month of the unpaid tax, up to 25% of the total. And a failure to pay penalty of 1/2% to 1% per month, up to 25% of the total. And interest on the unpaid taxes, which recently varies between 3% and 6% of the total. So learn the facts about payroll taxes and keep your small business focused on growth, not tax penalties!

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