Most the taxes paid are through paychecks, so a large part of payroll accounting is properly accounting for all taxes.
Most people are familiar with their annual personal tax return, but payroll tax filing works a bit differently. Payroll is run weekly, bi-weekly, monthly, or even semi-monthly, so for each pay cycle, taxes need to be calculated and reported. All tax payments need to be calculated for each pay cycle, then filed once per quarter.
Paying Taxes vs Withholding Taxes
When paying payroll taxes, there is a distinction between the taxes paid by the employer, and taxes withheld by the employer. In a nutshell, companies need to pay certain payroll taxes to the government, but they also withhold all the taxes that employees need to pay the government too.
Think of it this way – the government charges some taxes directly to employers, so companies need to pay these directly and it does not have any impact on the employee’s take-home pay. These are taxes employers pay the government. These are employer taxes.
The government also charges taxes on the employee’s income, so these are the taxes employees actually see on their paycheck (like the state income tax), and so impact take-home pay. These taxes are withheld from each paycheck and also sent directly to the government. At the end of the year, each employee gets a statement showing how many taxes were withheld throughout the year, which is used to file personal income tax returns (to get some of that withheld cash back, if possible).
When doing payroll, both employer taxes and employee taxes need to be calculated.
When running payroll, the first concern is calculating the taxes owed for each employee in each pay period. The main payroll tax categories that are paid by employers are FICA and Unemployment taxes.
FICA – Federal Insurance Contributions Act
FICA refers mainly to two large programs managed by the Federal Government – Social Security and Medicare, which support supplemental income and healthcare for the elderly and disabled. FICA taxes are shared between employers and employees – both sides pay the same amount into the program.
This tax supports retirement supplemental income and disability benefits for workers. The Social Security part of the FICA tax is 6.2% of the base salary.
Employer’s Social Security Tax = Employer Social Security Tax Rate x Base Salary
For example, if an employee earns $40,000 per year, the calculation would be:
Employer’s Social Security Tax = 6.2% x $40,000 = $2,460
There is a cap on the maximum amount companies need to pay for each employee – Social Security Tax is only charged on the first $127,200 of income (which is $7,886.40 in total tax paid). Even if the employee earns $150,000 per year, the employer still only needs to pay $7,886.40 (as of 2017).
The Medicare program supports healthcare for the elderly, and is the other half of FICA. The Medicare part of the FICA tax is currently 1.45% of base salary.
Employer’s Medicare Tax = Employer’s Medicare Tax Rate x Base Salary
For the sample employee earning $40,000 per year, the total Medicare tax paid by the employer is:
Employer’s Medicare Tax = 1.45% x $40,000 = $580
Unlike the Social Security tax, there is no income cap for Medicare taxes. For the high-earner example, the calculation would be:
Employer’s Medicare Tax = 1.45% x $150,000 = $2,175
The second major type of payroll tax employers pay is Unemployment. Unemployment taxes are used to fund unemployment insurance programs and job placement programs run by states. Like FICA, there are two different pieces of unemployment taxes paid by employers – FUTA and SUI.
FUTA – Federal Unemployment Taxes
The FUTA taxes are federal taxes, so it will be the same regardless of where you like (like FICA). This tax funds unemployment insurance, and is distributed to state governments to fund other unemployment programs. The FUTA tax rate is 6% of base salary.
Federal Unemployment Tax = FUTA Tax Rate x Base Salary
Like Social Security, FUTA has a cap on the maximum amount that needs to be paid – FUTA is only charged on the first $7,000 of base pay. Consider three employees – our $40,000 and $150,000 earners from before, but also a temp worker who only earned $5,000.
FUTA ($150,000 Earner) = 6% x $7,000 = $420
FUTA ($40,000 Earner) = 6% x $7,000 = $420
FUTA ($5,000 Earner) = 6% x $5,000 = $300
SUI – State Unemployment Insurance
The other half of unemployment taxes come at the state level. State unemployment taxes vary quite a lot from state to state, and can be complex to calculate even within a single state. For example, in Texas the state unemployment tax rate can vary between 0.59% and 8.21% (as of 2017), but averages 1.64% for most employers.
The state unemployment taxes also have a cap, which again varies by state. In Texas, the cap is $9,000.
Using our three example employees from before, we can calculate the expected SUI taxes due in Texas:
SUI ($150,000 Earner) = 1.64% x $9,000 = $147.60
SUI ($40,000 Earner) = 1.64% x $9,000 = $147.60
SUI ($5,000 Earner) = 1.64% x $5,000 = $82.00
Calculating Employer Tax Owed
Once we have all four of the employer taxes calculated, simply add them together to get the total tax the employer owes for each employee.
Employer Tax = FICA + Unemployment
Employer Tax = (Social Security + Medicare) + (FUTA + SUI)
For each of the example employees, the totals would be:
Employer Tax ($150,000 Earner) = $7,886.40 + $2,175 + $420 + $147.60 = $10,629
Employer Tax ($40,000 Earner) = $2,460 + $580 + $420 + $146.60 = $3,606.60
Employer Tax ($5,000 Earner) = $310 + $72.50 + $300 + $82 = $754.50
Note that for the lowest earner, the employer needs to pay almost the same in unemployment taxes as FICA.
All of the calculated taxes above are paid strictly by the employer, so they would not appear on an employee’s paycheck or impact their take-home pay. However, employers are also required to withhold the employee’s income taxes as well and file it with the IRS. These income tax withholdings do appear on an employee’s paycheck – employees can subtract these withholdings from their Base Salary to find their Net (after-tax) pay.
FICA taxes are charged to employees too – employees need to pay the same amount as employers, both for Social Security.
Employee’s Social Security Tax = Employee Social Security Tax Rate x Base Salary
Employee’s Medicare Tax = Employee Medicare Tax Rate x Base Salary
The FICA taxes paid by the employee follow the same rules as the FICA taxes paid by the employer – same cap rules, and almost always the same rate. Currently, employees also pay 6.2% Social Security tax and 1.45% Medicare tax. For the three example employees, the FICA taxes are:
FICA ($150,000 Earner) = Social Security + Medicare = $7,886.40 + $2,175 = $10,061.40
FICA ($40,000 Earner) = Social Security + Medicare = $2,460 + 580 = $3,040
FICA ($5,000 Earner) = Social Security + Medicare = $310 + $72.50 = $382.50
Income taxes are also withheld by employers and remitted to the IRS. There are two types of income tax – Federal and State. The actual calculation for both income taxes can be more complex, as the tax rates change for different levels of income at the federal level.
States also use different income tax rules – some states (like Texas and Alaska) do not have any state-level income tax at all.
Filing Payroll Tax Returns
Once employers calculate the total taxes owed and the total taxes withheld for each employee, they must file Form 941 with the IRS. Unlike personal income tax returns, the Form 941 is filed quarterly, not annually. This form reports all the income earned, pays the employer’s FICA taxes, and remits all the employee side income taxes withheld. Most employers use payroll software, and most payroll software will automatically generate the Form 941, which can be electronically filed with the IRS automatically.
Just like with personal income taxes, it is possible for employers to get a tax return when filing the Form 941. This happens most often if there was an error in the previous report – employers need to manually file a Form 941-X for any amendments or corrections.