As a new employer, you probably have questions about what it means to “do payroll.” This document will provide you with an introduction to payroll processing and some background about your obligations as an employer.
There are three main things you need to do related to payroll:
- Pay your employees: calculate gross pay and taxes withheld each pay period
- Pay taxes: pay taxes withheld from employees’ paychecks as well as tax liabilities you incur as an employer to the appropriate government agencies, such as the IRS or your state’s department of revenue
- File tax forms: these must be dealt with every quarter. Even if you’ve paid everything you owe, you still have to file tax forms that report your liabilities.
This introduction is designed to get you comfortable with the assistance our service provides and to familiarize you with some common payroll jargon.
Payroll taxes are those taxes withheld from your employees’ paychecks, as well as those taxes you pay as an employer based on the wages you pay your employees. These include:
- Social Security and Medicare
- Federal and state unemployment
- Personal income tax (federal and state)
- Miscellaneous other state taxes
Most payroll taxes, such as income tax, apply to all earnings. However, some taxes have what is called a wage cap–the maximum annual earnings per employee that is subject to that tax. These caps may be adjusted by the governing agency (typically annually).
| Tax Rate | Who Pays | 2011 Wage Cap | |
|---|---|---|---|
| Social Security (SS) | 4.2% (employee) 6.2% (employer) |
Employee and Employer | $106,800 |
| Medicare | 1.45% | Employee and Employer | unlimited |
| Personal Income Tax (PIT) | Varies based on projected annual income | Employee | unlimited |
| Federal Unemployment (FUTA) | 0.6% (starting July 1, 2011) |
Employer | $7,000 |
| State Unemployment Insurance (SUI) | Varies based on employer’s experience rate | Employer in all states; some states have employee contribution | Varies by state |
Social Security and Medicare taxes are paid by both employers and employees. As an employer, you withhold the employee’s part of the taxes and also pay a matching amount.
The employee tax rate (amount withheld) for Social Security is 4.2%. The employer tax rate for Social Security is 6.2% (10.4% total). This is a tax with a wage cap, which means that the tax is calculated only up to a maximum dollar amount of wages per employee each year. For 2011, the wage cap for Social Security is $106,800.
The employee tax rate (amount withheld) for Medicare is 1.45%. The employer tax rate for Medicare tax is also 1.45% (2.9% total). There is no wage cap for Medicare tax, which means the tax is paid on all of the wages that the employee earns. (The exception is exempt wages–see “Special Tax Exemptions” below.)
The amount of federal income tax withheld from employees’ paychecks depends on their marital status, the number of withholding allowances (exemptions) they claim on Form W-4, and their projected annual income.
In addition, all but nine states have a personal income tax (exceptions are AK, FL, NV, NH, TN, TX, SD, WY, and WA). It may be a flat tax rate (as in Illinois), regardless of projected income, or a graduated tax rate based on annual income, like the federal income tax.
In some states, employees also pay local tax (to cities, school districts, or counties) through their paycheck.
Form W-4. An employee reports several items on Form W-4:
- Filing Status. This is the marital status that dictates which tax table will be used to calculate income tax withholding. For federal income taxes, there are four filing status options: single, married filing jointly, head of household, and married filing separately.
- Withholding Allowances. Also called exemptions, withholding allowances reduce taxable income by a designated amount per allowance. The IRS updates allowance amounts periodically. Factors such as number of dependents influence how many allowances an employee will claim.
- Additional Amount to be Withheld. This amount is added to the income tax calculated for each paycheck. It is on top of the amount of income tax withholding based on the employee’s filing status and withholding allowances. An employee working multiple jobs might choose to have an additional amount withheld to compensate for understatement of annualized wages (and therefore understatement of his real tax rate) by each employer.
The W-4 includes several worksheets intended to help the employee arrive at the most accurate projection of tax liability possible. Some states have similar forms for state tax liability.
The Federal Unemployment Tax Act (FUTA), along with the state unemployment systems, provides for payments of unemployment compensation to workers who have lost their jobs. For 2011, the effective FUTA tax rate is 0.6% (starting July 1, 2011). The tax applies to the first $7,000 employers pay to each employee as wages during the year, so your maximum FUTA liability per employee is $56.00 per year.
However, if any of your employees are exempt from State Unemployment Insurance (for example, they are Directors or Officers), your FUTA tax may be higher. Also, if your state has borrowed funds from the federal government to cover shortfalls in its unemployment insurance program, all employers in your state may be subject to additional tax liability at the end of the year to repay those loans.
All states maintain a reserve for unemployment that is funded through an unemployment insurance tax. In most cases, SUI is paid only by the employer. Employees in some states, such as New Jersey and Pennsylvania, also contribute to SUI through their paychecks.
Most states have established a starting SUI rate for new employers. (Wherever possible, we provide this rate to you.) After a designated period of time, employers are assigned an experience rate, which may be higher or lower than the new employer rate depending on the employer’s reserve account balance. You will receive a notice from the state if your rate changes.
Some states administer disability insurance (SDI) or workers compensation as a tax collected through payroll. Many states also have a tax paid jointly with SUI that is used to fund job training programs. Where applicable, we calculate these taxes for you.
Some types of employees are exempt from one or more payroll taxes, which means that they do not pay those taxes. For example, a minor working for a parent who is a sole proprietor does not have to pay social security, Medicare, or FUTA.
In addition, certain portions of regular employees’ wages may be exempt from one or more payroll taxes. For example, tax-sheltered or pretax insurance plans save both the employer and the employee money by exempting premium amounts from all federal taxes and some state taxes. Some fringe benefits, like S-Corporation owners’ health insurance, are also taxed differently from regular wages.
If your company is a not-for-profit 501(c)3 corporation, you do not pay FUTA at all–regardless of who your employees are.
As an employer, you remit taxes to the IRS and to your state agencies either by paying electronically or by using a form provided by the tax agency. Before we cover the timing of tax deposit due dates or deposit frequency, we’ll acquaint you with some common payroll terms.
Constructive Receipt
You become liable for payroll taxes on the date you pay your employees, regardless of when they did the work associated with that paycheck. This rule is known as constructive receipt. If you only pay employees on Fridays, you only report a tax liability on Fridays, even if employees earn wages every day of the week.
A common point of confusion is when work is performed in one tax period, but employees are paid in a different tax period. The IRS only tracks when employees are paid, not the span of time when the money is earned.
Tom’s Market pays employees every two weeks. Employees receive a paycheck on January 4, 2011, which covers work performed during the pay period December 18–December 31st 2010. In which month does the tax liability for this payroll fall?
Answer: Tom’s payroll is considered part of his January 2011 tax liability, even though the pay period fell completely in December 2010.
Lookback Period
This is a reference period used by the IRS to determine your federal tax payment due dates. The IRS evaluates your tax liability during this twelve-month period and determines whether you are a monthly or a semi-weekly depositor (see below) for the coming year.
Most new employers are monthly depositors.
Deposit Period
Refers to the span of time during which tax liabilities accumulate for each deposit due date.
Payment Coupon
The form with which a payroll deposit is submitted. When you pay electronically, you don’t need a payment coupon.
Note: Effective for tax payments after January 1,2011, the IRS has eliminated and will no longer accept the Form 8109 and 8109-B tax payment coupons. All tax payments must be made through the Electronic Federal Tax Payment System (EFTPS).
The following deposit schedules apply to all federal taxes other than FUTA.
Monthly depositors: You are a federal monthly depositor in 2011 if your company’s federal tax liability during the lookback period (7/1/09–6/30/10) was less than $50,000. This is why all new employers are monthly depositors. Monthly depositors pay taxes for a given month by the 15th of the next month. For example, June taxes are due by July 15th. (However, if the 15th falls on a weekend or bank holiday, the taxes are due the next banking day.)
Semi-weekly depositors: If your lookback liability is greater than $50,000, you are a semi-weekly depositor. You pay taxes three banking days after the end of any semi-weekly period in which you accrued a liability. The IRS divides the week into two periods: (1) Wednesday, Thursday, and Friday, and (2) Saturday, Sunday, Monday and Tuesday. Taxes accrued during the Wednesday–Friday period are due on the following Wednesday, and taxes accrued during the Saturday–Tuesday period are due on the following Friday.
In some cases, when a bank holiday (such as July 4th or Christmas) occurs during the week, semi-weekly depositors have an extra day to make their tax payment.
Exceptions to the Deposit Schedule Rules
There are three main exceptions to the monthly and semi-weekly tax deposit requirements, as follows.
Next-Day Deposit Rule: If you accrue $100,000 or more in federal tax liability at any point during a deposit period, you must remit taxes on the next banking day. This could result from a single payroll, or it could result from multiple payrolls within a single deposit period (month or semi-week). For example, if you are a monthly depositor and pay a one-time bonus to employees that results in more than $100,000 in liability on a single day, you must pay the amount due immediately. You also become a semi-weekly depositor until your lookback liability falls below the $50,000 threshold again.
Quarterly exemption: If you owe less than $2,500 in federal taxes for a quarter, you can choose to pay when you file your taxes at the end of the quarter (instead of making deposits during the quarter). If you’re not sure how much your business will grow, you should make more frequent deposits: the IRS will assess penalties if you owe more than $2500 at the end of a quarter and have not made tax deposits.
If you choose to make quarterly tax deposits but have $2500 or more due in a quarter, we automatically update your deposit schedule to be monthly.
Annual exemption: If the IRS has notified you in writing that you are a 944 filer, and your total annual federal tax liability is less than $2500, you can make your federal tax deposits annually. The 944 filing status is for very small employers who typically pay $4000 or less in annual wages.
Paying FUTA and SUI
Unlike other federal taxes, FUTA (federal unemployment tax) is paid on the last day of the month following the end of each quarter:
- April 30 (for Q1)
- July 31 (for Q2)
- October 31 (for Q3)
- January 31 (for Q4)
If you accrue less than $500 of FUTA liability in a quarter, you do not need to make a deposit until the following quarter.
Like FUTA, SUI is also paid once per quarter to your state.
State Withholding Schedules
Like the IRS, states have established deposit schedules for paying income tax you’ve withheld from your employees’ paychecks. When you register with the state revenue agency they notify you of your state deposit schedule.
State Unemployment Insurance
Like FUTA, state unemployment insurance (SUI) taxes are remitted once a quarter, regardless of the employer’s size. In addition, other taxes administered by the state’s unemployment commission, such as Arizona’s Job Training Tax or New York’s Re-employment tax, tend to be paid jointly with the SUI tax on a quarterly schedule. In states such as Florida and Nevada, where there are no state taxes withheld from employees’ wages, SUI is the only payroll tax employers pay, so all employers pay taxes quarterly.
Now that you’ve given all your employees accurate paychecks and paid all the payroll taxes you owe, you’ve got one more responsibility: filing tax forms. This section provides an overview of the types of form filings required of all employers.
Form 941. Most employers file this tax form every quarter with the IRS. It compares federal payroll taxes owed with taxes paid during the quarter to determine whether your payments were timely and whether you have a balance due.
Form 944. Employers who have received written notice from the IRS may file Form 944 annually instead of Form 941 each quarter. Like Form 941, it reports wages and calculates federal payroll tax liability. Most 944 filers also pay taxes once a year.
Form 940. All employers who pay FUTA file this tax form at year end with the IRS. Like Form 941, it compares FUTA tax liability with FUTA tax payments to determine whether your deposits were timely and whether you have a balance due.
Form W-2. All employers provide Form W-2 to each employee at year end as an earnings record for income tax filing purposes. You are also responsible for filing Form W-2 with the Social Security Administration.
Wage Reports report wages paid to each employee for a given quarter. They are sometimes combined with a quarterly contribution report that calculates SUI tax owed and is typically accompanied by the SUI payment at quarter end. Most states require both a wage report and a contribution report each quarter, either as separate forms or as a combined form. (California is one exception; only a wage report is filed each quarter.) Many states also require a quarterly reconciliation for state income tax.
Annual Reconciliations. Some states require filing an annual reconciliation for income tax at the end of the year. This may or may not be accompanied by copies of employees’ W-2’s.
Cities, counties, or school districts that assess tax may also require quarterly or annual forms and may require copies of W-2’s. Check with each agency to which you pay tax.
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