Congratulations! Your business is growing, and you now have . . . employees. Along with the much-needed help and growth potential comes a set of new responsibilities, including payroll taxes. Payroll taxes include:

  • The employee’s portion of payroll taxes:
    • Federal and state income taxes you withhold from the employees’ earnings;
    • Federal Insurance Contributions Act (FICA) has three separate taxes you withhold from the wages you pay your employees. FICA includes:
      • a 6.2 % Social Security tax;
      • a 1.45 % Medicare tax (the “regular” Medicare tax); and
      • a 0.9 % Medicare surtax when an employee earns over $200,000;
  • The employer’s portion of these taxes:
    • a 6.2 % Social Security tax; and
    • a 1.45 % Medicare tax (the “regular” Medicare tax); and
  • Federal Unemployment Tax Act (FUTA) is 6%, and states have their own unemployment taxes.

Because there are penalties involved (up to a $10,000 fine, imprisonment up to five years, or both, plus the cost of prosecution), you need to make sure you get the right information to collect and report everything correctly.

Here are some of the more common issues facing employers:

Misclassifying workers.

The IRS has been emphasizing the problem, and misclassifying workers is one of the frequent audit issue today. Since independent contractors pay all of the Social Security and Medicare taxes, there is an incentive to treat workers as independent contractors rather than employees. Instead of paying half the taxes due on wages, an employer only has to report the amount paid to an independent contractor if he or she pays them $600 or more.

However, classification as an employee or an independent contractor is based on how much control you, as the employer, have over the person you hire. Even if you have a written contract describing the person as an independent contractor and stating that you and the worker are not creating an employer-employee relationship, the IRS can still look at the control you exert over the hired person and determine if he or she is truly an employee or an independent contractor.

Find information about worker classification on the IRS website. If you are still in doubt, consult your tax advisor.

Not keeping payroll records.

You are required to keep timely and accurate payroll records and have them available for the IRS to inspect. These include time sheets for your employees, records of expense accounts and reimbursement, copies of W-2s and other payroll records. A general rule of thumb is to keep the information for at least four years.

You should also have copies of Form I-9. This shows an employee’s eligibility to work in the United States. Individual states may also have certain hiring forms that you should keep, such as E-verify forms (checking with the U.S. Citizen and Immigration Services database of eligible workers). More information is available from the U.S. Citizenship and Immigration Department.

Not monitoring payroll company activities.

You may choose to use an outside payroll company to handle the withholding calculations, the actual withholding, and the transferring funds to the U.S. Treasury for payroll taxes. However, some of these companies may not do their job, either by mistake or intentionally. It is your responsibility as an employer to correctly calculate, withhold and pay these taxes, even if you use an outside payroll company, and you remain responsible for payroll taxes.

It is in your best interest to monitor your tax account and make sure that funds are deposited on time and in the correct amount. If deposits are made electronically using EFTPS.gov, you can go on line and see the activity in your account, and you may want to print out the results for your payroll records.

Robbing Peter to Pay Paul – paying creditors before the IRS.

Small businesses inevitably run into cash crunches on occasion, even with the best of intentions. When a business gets into a cash crush, it is tempting to pay the rent, suppliers, utilities and employees before paying the IRS. Don’t do it. A business owner is a “responsible person” who remains 100% personally liable for payroll taxes. This is true even if your business is incorporated or a limited liability company. In addition, the IRS is aggressive about collecting the money, because it is tax that is already withheld, and is already ‘their’ money.

Set aside cash to cover payroll taxes so you do not use the money for any other purpose. To find out more information about the payroll tax recovery penalty, go to the IRS’s Employment Taxes and the Trust Fund Recovery Penalty (TFRP) website.

 

Stay on top of your employer responsibilities to avoid audits, complications and penalties by the IRS, the Department of Labor, Immigration or your state’s agencies.

These are some of the basics, and there are many additional rules if you have employees that receive tips, if you provide taxable fringe benefits, or have other types of compensation arrangements. For more information, check the IRS’s Publication 15, Employer’s Tax Guide.

Payroll Taxes