Can a Business Receive an Exemption from Payroll Taxes?

Among an employer’s obligations are payroll taxes and other employment related details, such as FICA and income tax withholdings, federal and state unemployment insurance, and workers’ compensation insurance.

But is every business with employees responsible for payroll taxes? Most employers are, although there are a few exceptions. I’ve provided some information about those special scenarios below.

FUTA Exemption

The following businesses do not have to pay FUTA (federal unemployment tax):

• 501(c)3 nonprofit organizations
• Employers that have paid less than $1,500 in wages during each calendar quarter of the prior and current tax years and had no employees who were employees for at least some part of a day in any 20 or more different weeks in prior or current tax years

These businesses might also be eligible for an exemption from SUTA *state unemployment tax) depending on the state’s laws and policies.

Social Security and Medicare Tax Exemption

Typically, employers must pay half of their employees’ Social Security and Medicare tax liability and withhold the other half from employees’ pay. However, nonimmigrant and nonresident aliens with particular visa classifications, depending on the length of the non-immigration status, are exempt from those taxes. Therefore, employers neither must withhold or pay those taxes on the wages they pay to those employees.

Federal Tax Credits and Relief

The IRS provides tax credits and relief to businesses that meet specific qualification requirements.

Payroll Tax Credit for Small Businesses that Conduct Research

The IRS provides an income tax credit to businesses for qualified research activities. A small business may claim a portion (up to $500,000) of its credit as a payroll tax credit. Employers must make the payroll tax credit election on or before the due date of their annual income tax return. The portion of the credit used against payroll taxes is allowed in the first calendar quarter beginning after the date that the qualified small business filed its income tax return. The payroll tax credit first goes toward reducing the employer share of Social Security tax (up to $250,000 per quarter) and any remaining credit will reduce the employer share of Medicare tax for the quarter.

IRS forms required:

• Form 6765 – The election and determination of the credit amount that will be used against the employer’s payroll taxes are made on Form 6765, Credit for Increasing Research Activities.
• Form 8974 – The amount from Form 6765 must then be reported on Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities.
• Form 941, 943, or 944 – The employer must report the credit information from Form 8974 on Form 941, 943, or 944, and any remaining credit gets carried forward to the next quarter. Most employers must remit Form 941 quarterly, while agricultural employers who pay wages to farmworkers use Form 943. Form 944, to be filed annually, is exclusively used by employers with an annual liability of $1,000 or less in Social Security, Medicare, and withheld federal income taxes.

Disaster Tax Relief

The IRS provides taxpayers impacted by disasters (such as storms, flooding, wildfires, earthquakes, tornadoes, and pandemics) extensions on their federal income tax reporting and payment deadlines. You can find information about the federal tax relief announcements on the IRS website. Certain tax-exempt organizations may also qualify for payroll tax (FUTA relief in addition to income tax relief.)

Exemptions for Children Employed by Their Parents

Payroll tax obligations vary depending on the situation:

• Children of any age employed by their parents are generally subject to income tax withholding unless the payments are for domestic work in the parent’s private home. In addition, children paid by their parents for domestic work in the parent’s private home are not subject to FUTA, Social Security, and Medicare taxes until the child reaches the age of 21.
• Children employed in the parent’s Sole Proprietorship or Partnership – In a parent’s Sole Proprietorship or a Partnership in which each partner is the child’s parent, payments to the child (regardless of age) are subject to income tax withholding. However, the child’s compensation is not subject to Social Security and Medicare taxes until the child reaches age 18. Also, wages paid to children under 21 years old are not subject to FUTA taxes.
• Children employed by a parent’s Corporation (or a Partnership with any partners who are not the child’s parents) – No matter the child’s age, all payments for their services are subject to income tax withholding, Social Security and Medicare taxes, and FUTA.

State and Local Payroll Tax Exemptions

State tax codes and rules vary regarding tax withholdings and payment exemptions.

For example, some states have reciprocal agreements with other states that exempt employees from state income tax withholding if they live in one state and work in another. Also, many states exempt non-military spouses of service members from state income tax if they meet certain criteria.

Most states offer SUTA (state unemployment tax) exemptions to employers who fall under a specified threshold for wages paid to employees and to 501(c)(3) nonprofit organizations. Keep in mind that this does not mean nonprofits have no responsibility for providing unemployment compensation to employees who lose their jobs through no fault of their own. States typically give nonprofits the option of contributing to the state unemployment fund (i.e., paying SUTA tax) or reimbursing the state for any benefits paid to their former employees.

Also, some cities and counties provide exemptions to employers who meet their eligibility criteria. For instance, employers in certain industries might not be subject to municipality-specific payroll taxes. This is one way cities and counties promote growth and development in industries they wish to see more of in their jurisdictions.

Because the regulations can vary so much from state-to-state and municipality-to-municipality, I encourage employers to research the rules and enlist the help of a payroll tax professional to ensure they understand their responsibilities.

More About Payroll

• What Is Payroll?
• What Are Payroll Deductions?
• What Are Payroll Taxes?
• What is FUTA?
• What is FICA?
• Is State Unemployment Insurance Required?
• Registering for Payroll Taxes
• What Is Payroll Processing?
• Setting Up Payroll for an LLC or Corporation
• Tax Registration: What You Need to Know
• Payroll Mistakes That Can Hurt Your Small Business
• How Do You Pay Yourself as a Sole Proprietor?
• How Do LLC Owners Get Paid?
• How to Manage Payroll for Restaurants
• Hiring Family Members in a Small Business
• Hiring Remote Employees in Another State
• Legal Requirements for HIring Out-of-State Employees
• Independent Contractors vs. Employee
• What Every Small Business Should Know About 1099s
• State Timelines & Delivery Methods Guide