The moment you hire an employee for your business, you become responsible for payroll tax. It is important to remember that it is not a single tax but it is a term that is used to refer to all the taxes that are paid on the wages of employees. Hence, if you have employees, it is your responsibility to deduct a part of the employee wages and pay taxes on their behalf. Let us see how to calculate the tax and how much to remit to the government.
Difference between Income Tax and Payroll Tax
The income tax consists of Federal, State, and Local taxes. The Payroll tax consists of Medicare and Social Security.
Self employed professionals
Individuals who run a small business and do not have employees are still eligible for payroll taxes. This tax is for yourself. Also known as self-employment tax, it is basically Medicare and Social Security.
Types of payroll taxes
There are two types of payroll taxes- the one that will go out of your pocket and the one that you collect from the paycheck of the employees and then remit to the government. The taxes that are paid out of your pocket are FICA tax and FUTA tax.
- FICA Tax covers Medicare and social security. It is a tax that is shared by the employer and the employee.
- In contrast, the FUTA tax is unemployment insurance. The taxes that you collect and remit to the Government are Federal Income taxes and State and local taxes.
In order to estimate the amount of your employee’s income tax to withhold, it is important to have a copy of Form W-4 and the gross pay of the employee. You now need to estimate the method you wish to use to calculate withholding. There are two options-percentage method and the wage bracket method. The wage bracket percentage method is straightforward and easier to use.
Wage Bracket Method
- You will find tables marked “Wage Bracket Percentage Method Tables” in IRS Publication 15A. You can use it corresponding to the pay period of the employee.
- Now you need to go through the form W-4 to estimate if the employee filed income tax as single or married and the allowances they claim.
- Estimate the gross wage of the employee for the pay period in columns A and B. It should be more than the amount in column A and less than the amount in column B.
- Subtract the amount mentioned in Column C.
- Whatever result you get, multiply by the percentage found in Column D.
- Go through W-4 form again to see if the employee has requested an additional tax withholding from their paycheck. If the employee has, you need to add the amount to the final number.
- The result is the amount you have to withhold from the paycheck of the employee for the period.
Now that you know the amount to withhold from the paycheck of the employees’ you need to identify how much to withhold as per FICA.
Calculating the amount as per FICA
The Federal Insurance Contributions Act mentions a mandatory payroll tax deduction which is used for programs like Medicare and Social Security. In the case of FICA, the employee pays 50% from the paycheck and the employer pays 50% from their revenue. The employer needs to withhold the amount and pay the employee, and remit the fund on their behalf.
The tax rate for social security is 6.2% for the employer and employee. This makes it 12.4% in total. The current rate for Medicare is 1.45% for the employee and 1.42% for the employer. This makes it 2.9% in total.
When both are combined, the FICA tax rate will be 15.3% of the wages of the employees.
Steps to calculate FICA payroll tax
You can start by calculating the Social Security withholding. In order to do this, you will have to multiply the gross pay of the employee for the current period by the social security tax rate which is 6.2%. You need to deduct the amount from the paycheck of the employee and remit it with the payroll taxes.
To calculate the Medicare withholding, you need to multiply the gross pay of the employee with the Medicare tax rate, which is 1.45%, and deduct it from the paycheck of the employee.
The employer will match what the employees pay in FICA taxes.
Calculation the amount as per FUTA
The Federal Unemployment Tax is paid by the employer and it pays for the state unemployment agencies. The rate of tax is 6% on the first $7,000 paid to the employees in a year. Employers pay at the rate of 0.6% and every state receives a credit to cover the balance 5.4% of the payments.
FUTA is reported on Form 940 at the end of the year and FICA is reported quarterly on Form 941.
How to make payment
Once you make the calculation, the payment is easy and convenient. You only need to enroll in the Electronic Federal Tax Payment System and make an online payment.
It helps to have knowledge about the calculation of FICA and FUTA so as to withhold the right amount from the paycheck of the employees. Timely payment of dues to the Government is crucial and the payment should not be delayed in any case.