How to Calculate Payroll Taxes for Your Employees

man using calculator for payroll taxes

If you’ve recently started a business, you may be in the process of hiring your first employee. While this is exciting news for you and the business, it also comes with a new headache in the form of payroll taxes. If you’ve never been responsible for payroll tax, you may be a bit mystified about how it works. It’s important to get right, however. Both you and the employee could be open to all manner of financial risks if it’s not done properly.

What is Payroll Tax?

While the name may seem to imply that payroll tax is a single tax, it’s actually a collection of different taxes paid on an employee’s wages. You’ll be responsible for deducting a portion of your employee’s wages to pay several different taxes on their behalf. In addition, you’ll need to pay payroll taxes from your business revenue for each employee.

There are two ways to calculate how much you should be withheld from employees’ pay. These include the Wage Bracket Method and the Percentage Method. The methodologies for both can be found in the IRS’ Federal Income Tax Withholding Methods publication.

Payroll Taxes Your Employees Pay

On behalf of your employees, you will need to collect both federal income taxes and state and local taxes. How much you collect for each employee will depend on how they have identified themselves on their Form W-4, which they prepared and signed upon hiring, as well as the employee’s gross pay.

Payroll Taxes That You Pay

There are two different types of payroll taxes that fall under this umbrella. These include:

FICA tax. FICA taxes are contributions to Social Security and healthcare programs such as Medicare. The costs for FICA taxes are shared by both you, as the employer, and your employees. Your business’ portion includes 6.2 percent for Social Security and 1.45 percent for Medicare. To effectively comply with FICA taxes, you will collect and remit the same amount from your workers. (So…6.2 percent times two equals 12.4 percent total). To calculate the necessary Medicare withholding, multiply your employee’s gross pay by the current Medicare tax rate of 1.45 percent. FICA is reported quarterly using Form 941 – Employer’s Quarterly Federal Tax Return.

FUTA tax. These taxes – Federal Unemployment Tax Act — are effectively contributions to unemployment insurance so the employee will be able to collect unemployment in the event he or she is laid off or furloughed. The total amount for FUTA tax is six percent. Many states, however, offer employers a 5.4 percent credit, leaving employers to pay only 0.6 percent. FUTA is reported on Form 940 – Employer’s Annual Federal Unemployment Tax Return at the end of the calendar year.

Consult a Tax Professional

To ensure that you don’t make any errors in calculating your employees’ federal and state tax withholding, it’s worth consulting with a tax professional.

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