Unscrambling payroll tax compliance regulation for small business

Published · 4 min read

How familiar are you with your local payroll tax compliance regulation?

Understanding and maintaining compliance can be tedious with any level of prior experience, but especially for those who are new to the task. It can be difficult to keep up with changes in legislation each year, implement them into your payroll process, and identify checkpoints to make sure you are consistently accurate. To help eliminate some of the mystery of getting it right every time, here’s a breakdown of the basics and advice on how to make management easier.

What is payroll tax compliance?

Basically, it’s the process of fulfilling requirements from governing authorities. Payroll tax is one of the most regulated business functions in that it must meet federal, state, and local jurisdiction requirements. Employers must report payroll taxes to the appropriate taxing jurisdiction in the manner each jurisdiction provides. Quarterly reporting of aggregate income tax withholding and Social Security taxes is required in most jurisdictions. Employers must file reports of aggregate unemployment tax quarterly and annually with each applicable state, and annually at the Federal level.

Payroll taxes are imposed on employers and their employees, and are usually calculated as a percentage of the salaries that employers pay their staff. Some states do not have state income tax (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) do not have state income tax at all, while New Hampshire and Tennessee only tax income from interest and dividends.

Payroll taxes (generally) fall into two categories:

Deductions from an employee’s wages

Also known as withholding tax, pay-as-you-earn (PAYE) tax, or pay-as-you-go (PAYG) tax. This often covers advance payment of income tax, social security contributions, and various insurances (e.g., unemployment and disability).

Taxes paid by the employer based on the employee’s wages

Directly related to employing a worker. These can consist of fixed charges or be proportionally linked to an employee’s pay. The charges paid by the employer usually cover the employer’s funding of the social security system, Medicare, and other insurance programs. The economic burden of the payroll tax falls almost entirely on the worker, regardless of whether the tax is remitted by the employer or the employee, as the employers’ share of payroll taxes is passed on to employees in the form of lower wages than would otherwise be paid.

Common payroll tax compliance challenges

Misclassifying employees and contractors

Understanding worker classification and getting it right is important because it impacts income and employment tax. It also impacts whether the worker is entitled to applicable benefits and how their compensation should be reported.

Late payments

Deadlines are another complexity of payroll tax— specifically payment due dates. And, depending on your organization, there’s much more to consider than traditional tax season. It’s important to keep a calendar that outlines important dates, so nothing slips through the cracks. Failure to timely and properly pay federal payroll taxes results in an automatic penalty of 2% to 10%. Similar state and local penalties apply. Failure to properly file monthly or quarterly returns may result in additional penalties. Failure to file Forms W-2 results in an automatic penalty of up to $50 per form not timely filed. State and level penalties vary by jurisdiction.

No audit controls

If you’re not keeping up with local legislation and don’t have a system in place to regularly check for compliance, your organization is vulnerable to discovering inconsistencies when it’s too late. Businesses that implement processes to control compliance are more prepared in case of an audit, and can catch costly inconsistencies in advance.

Data inaccuracies

Businesses that use outdated tools like spreadsheets to manage payroll data inherently need to spend more time double-checking their figures because of the higher margin of human error.

Today’s solutions for payroll tax compliance

Consider outsourcing

Outsourcing payroll is an option for small businesses looking to totally remove the hassle completely. For some, the easiest way to keep compliant is to have experts handling tasks like collecting employee time records, processing the payroll, printing the checks, submitting direct deposit, and even filing with the proper authorities. Even if your payroll is outsourced you still can keep your employees engaged through various options for employee self-service portals. They can keep your workforce up on the latest releases, policies and procedures.

Implement automation with software

Using software is a very popular avenue for managing payroll—and this has been a growth area in recent years with cloud software providing many benefits. Often the payroll software will be built from the ground with consideration for regulatory requirements like local tax laws, making it more difficult to make a mistake.

You’ll find that most payroll software includes technology stacks that can automatically adjust to all the compliance and regulations twists and turns and other traditionally manual processes. In most cases they can take them off your plate and allow you to manage your business more closely.

Following tax reform

The IRS website has an extensive resource section that covers topics specific to payroll professionals, like employment taxes for business and considerations for businesses with employees. 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.

To protect your company from costly fines and possible litigation, you need to stay informed about employment laws, reporting rules, and other factors of compliance:

  • Inaccuracies in payroll means spending work hours checking and double-checking data.
  • Sage research shows that one in three small businesses are penalized for incorrect payroll.
  • The 2015 IRS Databook shows employer payroll tax issues cost U.S. small businesses $6billion in civil penalties.

Both software technology and outsourcing have vast advantages over using an outdated spreadsheet system. Both save your business time with improved efficiency, and money with improved accuracy.

If you’re new to employing staff, Keir Thomas-Bryant has shared expert advice for running payroll.

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