For entrepreneurs who are new to small business taxes, building a simple payroll tax system may seem like a fantasy. There are almost 10,000 federal, state and local tax jurisdictions across the United States. Most small businesses won’t have to comply with each of those jurisdictions, but it still points to the complexity of the laws with hundreds of new laws and regulations enacted each year.
So, where do you start? What are the basic elements for creating an accurate and compliant payroll tax system? This article will help you understand small business payroll taxes and the resources available to help you stay on track.
What’s included in small business payroll tax?
Payroll taxes are the taxes employers and employees pay based on how much the employee makes. There are three types of payroll taxes:
- Federal income taxes – taxes collected from any person or business that earns money during the year. There are broad and sweeping definitions of taxable income to include all property you receive, regardless of whether you earn it at work, through a business or from making good investments.
- FICA (Federal Insurance Contributions Act) taxes – Taxes collected to support Social Security and Medicare
- Federal unemployment taxes – Taxes to support federal unemployment.
Federal income and FICA taxes are sometimes referenced as “941 taxes” because they are included on the IRS Form 941, which is the quarterly wage and tax report.
State income taxes may be applicable in your state and should also be withheld from employee wages.
You don’t have to withhold income taxes or FICA taxes from the payments you make to independent contractors or non-employees, but you do have to file an annual report with the IRS for contractors.
How to process small business payroll tax
- Prepare a paycheck by calculating the gross pay for your employee(s). Then, deduct the federal income tax withholding, Social Security, Medicare deductions, and state tax if applicable. You should clearly itemize this on your employee paystub so it’s easy to understand before you distribute them. You’ll need to set aside all withholding to be paid later through payroll tax deposits.
- Calculate the amount you will owe for the employer portion of FICA taxes and set this aside with the employee portion of these taxes.
- Make payroll tax deposits either semi-weekly or monthly, depending on the size of your business. This includes your employee withholding for federal, state, Social Security, and Medicare taxes, and the taxes your business owes for Social Security and Medicare. You can make your payroll tax deposit payments using the IRS electronic federal tax payment system (EFTPS). If you don’t want to use EFTPS, you can arrange for your tax professional, financial institution, payroll service, or other trusted third party to make electronic deposits on your behalf.
- Submit your quarterly and annual tax reporting. Submit a quarterly report to the IRS on form 941 showing the amount of your payroll tax liability and the amounts you have paid on this liability during the previous quarter. Submit an annual unemployment tax report on Form 944 to the IRS showing the amount of your unemployment tax liability and the amounts you have paid.
When to make federal payroll tax payments
Your payroll tax deposit schedule will depend on the size of your payroll. There are two deposit schedules: monthly and semi-weekly. The deposit schedule you must use is based on the total tax liability you reported on Form 941 during what’s called a lookback period, a four-quarter period starting (for the calendar year 2018) July 1st, 2016 and ending June 30th, 2017:
- If you reported $50,000 or less in that period, you’re on a monthly schedule.
Under the monthly deposit schedule, deposit employment taxes on employee payments made by the 15th day of the following month.
- If you reported more than $50,000, you’re a semiweekly schedule depositor.
Under the semiweekly deposit schedule, deposit employment taxes for employee payments made on Wednesday, Thursday, and/or Friday are due by the following Wednesday. Deposit taxes for employee payments made on Saturday, Sunday, Monday, and/or Tuesday are due by the following Friday.
Note the terms “monthly schedule depositor” and “semiweekly schedule depositor” aren’t about how often you pay your employees. The terms identify which set of deposit rules you must follow when an employment tax liability arises. The deposit rules are based on the dates when wages are paid, not on when tax liabilities are accrued for accounting purposes.
How to set up a payroll tax calendar
If you fail to make a timely deposit, you may be subject to a failure-to-deposit penalty of up to 15 percent. It’s important to maintain an up-to-date and accurate calendar to avoid those kinds of costs. Your payroll calendar should include key dates for all payroll activity like pay dates, due dates for reporting employment taxes, and federal holidays, which sometimes will push your due date back.
Federal holidays are:
- New Years Day – January 1
- Dr. Martin Luther King Holiday Observation – mid-January (varies)
- Independence Day – July 4th (or the following Monday if it falls on a weekend)
- Memorial Day – First Monday in September
- Thanksgiving Day – Third Thursday in November
- Christmas Day – December 25th
There are also holidays that are local to your state that may impact due dates for state-level taxes. You can find more resources for information about specifics and exemptions on the IRS’ Small Business and Self-Employed Tax Center.
You can also subscribe to IRS-sponsored e-newsletters from IRS.gov like e-news for Payroll Professionals, e-news for Small Businesses, and IRS Guidewire for advance copies of tax guidance. The IRS website also includes resources for state payroll tax compliance.
Need help understanding payroll tax compliance? Virginia Dannelly has more advice in her blog post, Unscrambling payroll tax compliance regulation for small business.