Today, you’re going to meet Hector—a small business owner running a bakery in the sunny state of California. As a business owner, Hector has a lot on his plate. Not only is he responsible for baking delicious treats for his customers, but he also has to abide by the law and pay payroll taxes to Uncle Sam.
Calculating payroll taxes can be difficult, especially for business owners like Hector whose passion is creating mouth-watering pastries—not crunching numbers in the back room. To help small business owners like Hector and yourself, we’ve created this guide and video about how to calculate payroll taxes. Make sure to subscribe to the QuickBooks YouTube channel for more content like this, and smash that like button if you find this video valuable.
Now, let’s get to the fun part. Read through to learn about the different payroll taxes and how to calculate them.
Payroll taxes are taxes based on salaries, wages, commissions and tips an employee makes. They are withheld from their paychecks by their employer, who then pays them to the government. Payroll taxes are used to fund social insurance programs like Social Security and Medicare and show up as FICA and MedFICA on pay stubs.
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It’s important not to confuse federal payroll taxes with federal and state income taxes, even though both are taken out of an employee’s pay. The difference between these two taxes is that payroll taxes fund specific social programs, while income taxes go to the U.S. Treasury’s general funds. Additionally, every worker pays a flat payroll tax rate, while income taxes vary based on an employee’s earnings.
So far, 2020 has proved to be a tumultuous year, especially for business owners. When Congress passed the Coronavirus, Aid, Relief, and Economic Security Act (CARES Act), it allowed employers to defer the deposit and payment of the employer’s share of Social Security taxes from March 27, 2020, to December 31, 2020. Self-employed workers were also permitted to defer payment of certain self-employment taxes. This payroll tax deferral was put in place to help offset some of the financial burden business owners were facing when COVID-19 closed the economy.
However, this doesn’t mean business owners are off the hook from paying 2020’s payroll taxes. The employer’s share of Social Security tax must be deposited by the following dates:
- December 31, 2021: 50% of the eligible deferred amount is due; and
- December 31, 2022: The remaining amount is due.
Let’s say Hector’s bakery was hit hard and keeping up with his share of payroll taxes would send his business under. With the CARES Act, he’s eligible to defer $10,000 for the payroll tax deferral period. Then, on December 31, 2021, he will have to pay $5,000, and the remaining $5,000 by December 31, 2022.
Now that you know what payroll taxes are, where do you start? As a small business owner, there are numerous taxes you are responsible for paying. Some taxes for small business owners include:
- Payroll taxes
- Federal and state income taxes
- Capital gains taxes
- Self-employment taxes, when applicable
- Property taxes
- Dividend taxes
Employers aren’t the only ones responsible for paying taxes, either. Employees also have to contribute their fair share, including payroll taxes and federal and state income taxes.
Whether you’re a salaried employee, an hourly employee, seasonal employee, part-time employee, or full-time employee, you’re taxable. If you hold a job in the United States, you are responsible for paying payroll taxes on top of federal and state income taxes. All employee gross income, tip income, commissions, stock options, bonuses, and gifts are taxable.
When it comes to payroll taxes, there are a few different taxes you will pay, including:
- Federal income taxes
- State and local taxes
In the sections below, we’ll cover each of these taxes and how to calculate them.
As stated earlier, income taxes are different from payroll taxes but are taken out of an employee’s paycheck. Federal income taxes are levied on an employee’s wages, salaries, or other sources of income. They are collected by the IRS and sent to the U.S. Treasury’s general fund to pay off debt, issue loans, and for other reasons. Employees fill out IRS Form W-4 to notify their employers of how much tax they want to withhold from their paycheck each pay period. This is based on their filing status, dependents, and any anticipated tax credit and deductions.
To calculate federal income taxes, the IRS uses tax tables (or wage brackets) and an employee’s filing status, also called marital status. The tax brackets for 2020 go as follows:
- 12%: Incomes over $9,875 ($19,750 for married couples filing jointly)
- 22%: Incomes over $40,125 ($80,250 for married couples filing jointly)
- 24%: Incomes over $85,525 ($171,050 for married couples filing jointly)
- 32%: Incomes over $163,500 ($326,600 for married couples filing jointly)
- 35%: Incomes over $207,350 ($414,700 for married couples filing jointly)
- 37%: Incomes over $518,400 ($622,050 for married couples filing jointly)
Federal income taxes are taxed at a marginal rate, which is the tax rate you’d pay on one more dollar of taxable income. For example, let’s say one of Hector’s employees is a single filer making $40,000. That employee would be in the 22% tax bracket. However, let’s say Hector promotes that employee, giving them a $5,000 raise, making their salary $45,000. The first $40,125 would be taxed at 22%, while the additional $4,875 would be taxed at 24%.
Depending on the state you live in, you may have to pay state and/or local income taxes. There are currently seven states that do not impose a state income tax, including Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
Generally, state and local taxes are lower than federal income taxes and go toward the state government. Each state and local government has its own tax rates, which means the amount you pay can vary. Fortunately, the IRS allows taxpayers to claim a deduction on their federal tax return for the amount they paid in state income tax.
If you recall, Hector’s bakery is located in the sunny state of California. California has one of the highest state income tax rates in the country. There are nine tax rates in California, starting at 1% and going up to 12.3%. Similar to calculating federal income taxes, taxpayers have to make adjustments to their gross income to get to their adjusted gross income. Adjustments are made by taking certain tax deductions and credits into consideration. You will then use your state’s tax rates to determine how much state income tax you owe.
When it comes to payroll taxes, there are two types: FICA and FUTA, which we’ll cover in detail below.
What is FICA?
FICA stands for the Federal Insurance Contributions Act, which are taxes used to fund both Social Security and Medicare programs. Social Security helps older Americans, disabled workers, and families when a spouse or parent dies. Medicare, on the other hand, is a federal health insurance program for people who are 65 or older, certain younger people with disabilities, and people with end-stage renal disease.
For employees, the following amount will be taken out for FICA taxes:
- 6.2% of an employee’s gross pay goes to Social Security tax
- 1.45% of an employee’s gross wages goes to Medicare tax
In total, 7.65% of an employee’s gross wages will go toward the FICA tax. On top of this, employers must match these percentages, for a total of 15.3%. So, while Hector collects FICA taxes from his employees to give to the IRS, he will also be responsible for paying 7.65% of FICA taxes.
However, for employees who make more than $200,000, the employer must withhold an additional amount for the additional Medicare tax. The additional Medicare tax rate is 0.9% of earned income over
- $250,000 for joint filers
- $200,000 for singles
- $125,000 for married persons filing separately
This tax is paid solely by the employee. The only responsibility of the employer is to withhold it.
What is FUTA?
One payroll tax that employees aren’t responsible for is unemployment taxes, called FUTA taxes, named after the Federal Unemployment Tax Act. Instead, employers take on the responsibility of paying FUTA taxes, which help unemployed workers claim unemployment insurance. Typically, employers will pay both federal and state unemployment taxes, deposit the tax each quarter, and file an annual form.
The 2020 and 2021 FUTA tax rate is 6% and applies to the first $7,000 you pay in wages to each employee during the year, which is the federal wage base. However, business owners can take a credit against their FUTA tax for amounts paid to their state’s unemployment funds. The credit can be as much as 5.4% of FUTA taxable wages.
For example, let’s say Hector owes the FUTA tax (6%) and is eligible for the maximum credit deduction (5.4%), which means his FUTA tax liability will be 0.6% of the first $7,000 he pays to each employee. In this scenario, here’s how Hector will calculate his quarterly FUTA liability:
- Hector will add up the wages paid during the reporting period to employees subject to FUTA tax
- $7,000 (Mary the baker) + $4,000 (Paul the cashier) + $5,000 (Daisy the manager) = $16,000 wages earned in Q1
- Hector will then multiply the quarterly wages of his employees by 0.006, assuming he’s eligible for the maximum credit of 5.4%
- $16,000 X 0.006 = $96 FUTA liability for Q1
Similar to federal unemployment taxes, business owners are responsible for state unemployment taxes set forth by the State Unemployment Tax Act (SUTA). However, SUTA tax rates and wage bases vary by state, so you will have to check with your state about these details and requirements.
To calculate the SUTA tax, you will follow the same process as calculating the FUTA tax. For example, California has a wage base of $7,000 per employee and a SUTA tax rate of 3.4%. Because Hector’s bakery is in California, he will follow this example:
- $7,000 per employee X 3 employees (Mary, Paul, and Daisy) X 3.4% = $714 in SUTA tax
The Self-Employed Contributions Act established the SECA tax, which is a tax levied from the U.S. government on those who work for themselves. Self-employed individuals must pay the tax equivalent to both the employer and employee portions of the FICA tax. This means they are taxed at 12.4% (6.2% + 6.2%).
The SECA tax is calculated on the basis of net earnings, which is gross income minus any expenses incurred while doing business. There are also limits to the SECA tax. The Social Security tax is only applied to the first $137,700 of a self-employed worker’s net pay, which results in a maximum tax of $17,075 for 2020.
The Medicare tax rate is 2.9%, and there are no exemptions above a certain income. All in all, the SECA tax comes to 15.3% (12.4% + 2.9%).
For example, let’s say Hector only works for himself and classifies as self-employed. If he makes $100,000, he will have to take out 15.3% of that income for SECA taxes, which would be $15,300 ($100,000 X 0.153%).
While filing and paying taxes isn’t everyone’s favorite thing to do, it needs to be done. If you don’t, you can face some pretty serious penalties. Below are the failure to deposit penalty percentage rates you could face:
- 1–5 days late: 2% penalty
- 6–15 days late: 5% penalty
- 16+ days: 10% penalty
- More than 10 days after the first IRS bill: 15% penalty
In addition to late payment penalties, you can face other payroll tax penalties, such as
- Failure to file penalty: 5% per month of unpaid tax on the due date, reduced by the amount of failure to file penalty for the same month (maximum is 25%)
- Failure to pay penalty: 0.5% per month of unpaid tax, then 1% per month after Notice of Intent to Levy (maximum is 25%)
Along with these penalties, you also have to pay interest. Interest rates are set quarterly and typically vary between 3% and 6%.
You made it! You learned the ins and outs of the various payroll taxes, how to calculate them, and the penalties you can face if you avoid taxes. As a small business owner, you have a lot on your plate. The last thing you want is to make an error when filing your payroll taxes that could result in a penalty or, worse, a tax audit.
To make calculating payroll taxes easier, invest in payroll services and software to calculate payroll taxes. Payroll software is more accurate, less work, and offers tax penalty protection, meaning you can have peace of mind knowing your payroll taxes are in good hands.
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