Whether you’re a sole proprietor and your company’s only employee, or a corporation with 40 employees, you are responsible for collecting and paying employment taxes to federal and state tax agencies. However, while federal payroll taxes are the same no matter where your business is located, state employment taxes differ according to income tax rates in the various states.
Payroll taxes can be a bit confusing and overwhelming to new business owners. In today’s article, I’ll break down payroll taxes so you know all the ins and outs of keeping your business in compliance.
First Steps First: Obtain an EIN
While all the states and many cities have their own employment registration requirements, the first step for most businesses is to register for an Employer Identification Number, or EIN. An EIN (or Federal Tax ID number) is optional if your business is a sole proprietorship, but, in most cases, if your business acts as a C corporation, limited liability company, or a partnership, you are required by law to have one.
You can apply for your EIN online through the IRS website (or let CorpNet do it for you). Once obtained, you will use the number throughout your business’s life on company documents, service agreements, bank accounts, and more. An EIN is how the IRS tracks business transactions and tax records.
You will keep the same EIN number unless certain circumstances, such as changes in ownership or legal structure, require a new number.
Sole proprietorships and LLCs with no employees can conduct business under the owner’s social security number since they pay their business taxes on their personal returns but check with your accountant to be sure of your options.
During the application process, you’ll need to provide your business’s legal business name, location, name, and address. You must also provide a general statement about the business’s activities and the business’s structure, location, and the number of employees.
Once you obtain your business’s EIN, your next task is to understand the payroll taxes you are responsible for withholding and paying. Here’s a rundown.
Federal Payroll Taxes
It’s up to you to verify that each new employee is legally eligible to work in the United States. You do this by completing the U.S. Citizenship and Immigration Services (USCIS) Form I-9, Employment Eligibility Verification. Sole proprietors do not need to fill out an I9 on themselves but must do so for any employees they hire. Use the Social Security Number Verification Service (SSNVS) to verify that names and social security numbers match. It’s important to note, a person may have a valid SSN but not be authorized to work in the U.S., so use E-Verify to confirm employment eligibility.
Once you verify eligibility, have the employee fill out IRS Form W-4, so you know how much income tax to withhold. Income taxes are based on the employee’s Form W-4 and the withholding tables described in Publication 15, Employer’s Guide. If you use a payroll application through your bank or another provider, the system can determine this for you.
Most employers must withhold, deposit, report, and pay employment taxes per the Federal Insurance Contributions Act. FICA taxes include Income tax, Social Security tax, Medicare tax, and FUTA tax. The 2020 employer and employee tax rate for Social Security is 6.2% for 2020, both employers and employees pay 6.2%. The 2020 tax rate for the employer and employee Medicare tax is 1.45%, also paid equally by both employers and employees. Employers must also withhold an extra 0.9% of Medicare tax when an employee’s wage exceeds $200,000 ($250,000 for married couples filing jointly).
Federal Unemployment Tax or FUTA is paid separately from federal income tax, social security, and Medicare. Only employers pay FUTA taxes; no funds come from employees’ wages.
Sole proprietors pay Self-Employment Tax (SE tax), which comprises Social Security and Medicare taxes.
Employers are required to deposit FICA payroll taxes either monthly or semi-weekly, depending on your total tax liability. FUTA taxes are paid quarterly.
Finally, the IRS requires businesses to use electronic funds transfer (EFTPS) to make all federal tax deposits.
State Payroll Taxes
As part of the payroll process, employers are also required to withhold state income tax in states that collect income tax. There are currently seven states with no state income tax (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming). New Hampshire and Tennessee do not tax wages; however, they do tax investment income and interest. In states with state income tax, the amount withheld is based on employees’ W4s.
In addition to state income tax, some states also require employers to pay a State Unemployment Tax, or SUTA. SUTA is paid to your state’s unemployment benefits fund. If an employee is laid off, he or she can collect state unemployment insurance.
Out of State Payroll Taxes
Let’s say you have employees living in different states from where the business is located (all the more possible with so many remote workers getting hired), what do you do then? As an employer, you have to withhold and deposit federal taxes and withhold state income taxes in the state where the employee lives.
Employing workers in other states requires your business to register with that state’s tax agency, acquire a state income tax withholding number, get an unemployment insurance number, and withhold income taxes. You must also register with the state’s Department of Labor and follow the state’s laws for employees including, minimum wage, labor regulations, state disability insurance, and worker’s compensation rules.
Beware of Penalties
The penalties for not paying payroll taxes on time vary depending on the circumstances. The IRS can choose to see your failure to pay as tax evasion, and you could face criminal penalties. For deposits made up to 10 days late, the penalty is anywhere from 2-15% of the deposit amount due.
Tips for Controlling Payroll Taxes
- Hire independent contractors (ICs). ICs are not considered employees, and therefore, your business does not have to pay or match payroll taxes. Be careful to stick to the guidelines established for IC status, or the IRS and/or the states’ tax boards could come after you for back payment of employer taxes.
- Elect S Corp status. S Corps are structured as a pass-through business entity, which means profits and losses are passed through to the company’s owners/shareholders. S Corp owners are also considered employees, so their taxable salaries can be lowered, and there are fewer payroll taxes to be paid. C Corps and LLCs can elect to be taxed as S Corps, as long as they meet S corporation requirements.
- The CARES Act. Currently, the CARES act has initiated the following tax savings for employers:
- Payroll Tax Deferment. Employers are temporarily eligible for delayed payroll tax payments. You can defer the company’s portion of Social Security tax on employee wages during the period from March 27, 2020, through December 31, 2020—half of the deferred amount must be paid by December 31, 2021, and the other half paid by December 31, 2022. (Payroll tax deferment is also available for the self-employed.) If you received a PPP loan, you cannot defer the deposit and payment of the employer’s share of Social Security taxes.
- Employee Retention Tax Credit. If you had to fully or partially suspend business operations during any quarter of 2020 due to COVID-19, then you are eligible to claim an Employee Retention Tax Credit. The business is also eligible if gross receipts have substantially declined. Once again, a company is not eligible for an employee retention tax credit if it received PPP funding. The credit is equal to 50 percent of employee wages from March 12, 2020, to January 1, 2021. (In this case, the self-employed individuals are not eligible.)
CorpNet is Here to Help!
CorpNet is focused on helping entrepreneurs start their business and stay in compliance. We know payroll taxes can be one more item on a long list of growing start up requirements.
We want to help you succeed, so we offer payroll tax registration services in all 50 states. You can let us worry about business compliance, so you can worry about finding and hiring the staff you need to build your new business into a success.
Learn more about our payroll tax registration and how we can simplify the process for you and your new business.