Essential Payroll Tax Facts Every Employer Should Know

If you're doing payroll for the first time or haven't employed an employee in a while, it can be daunting to learn all the payroll taxes that are out there. The good news is that there are only five federal and state taxes you need to know to get started with payroll basics. Let's dive in.

Federal income tax

The federal income tax system in the United States, overseen by the Internal Revenue Service (IRS), includes not only income tax but also various other taxes such as capital gains tax, social security tax, Medicare tax, self-employment tax, gift tax and inheritance tax.

Taxable income in the U.S. is made up of earned income (such as salaries, wages, and tips) and unearned income (including interest, dividends, and gains from the sale of assets). Reducing taxable income is possible through contributions to retirement accounts such as 401(k)s and IRAs.

Federal income tax calculations are influenced by factors such as tax brackets, which depend on taxable income and filing status. The US tax system is progressive, meaning H. tax rates increase with higher income. For example, in 2020, the average tax rate on adjusted gross income was 13.6%.

Tax deductions are crucial for reducing taxable income. Taxpayers can choose between the standard deduction and the itemized deduction. Common deductions include mortgage interest, state and local taxes, charitable contributions and certain medical expenses, although business owners can deduct their business expenses.

The tax return is an annual obligation that is usually due by April 15th for the previous year. This includes preparing and filing a tax return that takes into account various types of income and deductions.

State income tax

In the United States, income tax is handled very differently in each state. A total of 41 states levy state income taxes, which are structured primarily in two different forms: flat rates and progressive rates.

The flat tax system requires taxpayers to pay a uniform percentage of their income as tax. For example, in 2023, states such as Arizona, Colorado and Illinois will adopt this system, with tax rates ranging from 2.5% in Arizona to 4.95% in Illinois.

In contrast, the progressive tax system applies higher tax rates as income increases. This system is used in 30 states and Washington, D.C. applied. The number of tax brackets and the corresponding tax rates vary greatly between these states. There are three tax brackets in Kansas, ten in California and twelve in Hawaii.

Additionally, there are nine states that do not impose a general income tax on individuals, including Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. However, some of these states impose taxes on certain types of income. For example, New Hampshire taxes capital gains from dividends and interest, and Washington imposes a tax on certain capital gains.

Tax obligations for individuals may differ based on various factors, such as: B. if they work somewhere else or move during a tax year. This may result in having to file tax returns in more than one state, depending on where you live and work. The intricacies of these situations depend on each state's tax laws.
There are also federal rules and deadlines for filing tax returns that may not correspond to federal tax deadlines. Understanding these federal requirements is critical for both individuals and businesses to ensure compliance with tax laws and avoid penalties.

FICA payroll tax

The Federal Insurance Contributions Act (FICA) tax, a major source of funding for Social Security and Medicare, requires contributions from both employers and employees.

In 2024, the Social Security tax rate remains 6.2% for employers and employees alike. The assessment base for social security rose to $168,600, which is higher than in the previous year. Consequently, the highest Social Security tax a worker could pay in 2024 is $10,453.20, calculated as 6.2% of $168,600. This increase in the wage base reflects changes in the national wage index.

As for the Medicare tax in 2024, both employers and employees will continue to pay a rate of 1.45%, with no income cap. Additionally, there is an additional Medicare tax for those who earn more than certain amounts. In 2024, the additional 0.9% tax applies to single filers earning more than $200,000 and married couples filing jointly more than $250,000.

For both employers and employees, knowing these tax updates is critical for accurate payroll and financial planning. Employers must withhold these taxes from wages and submit them to the Internal Revenue Service (IRS). It is beneficial for employees to be aware of these changes in order to assess their tax obligations and plan their finances.

Additionally, FICA tax contributions are critical to supporting the Social Security and Medicare programs, which provide retirement, disability and health benefits to eligible individuals. The benefits you receive from these programs depend on the contributions you have made during your working years.

It is important for employers to comply with the latest FICA tax regulations. This ensures continued support for these vital programs and avoids legal or financial issues related to payroll taxes.

FUTA payroll tax

The Federal Unemployment Tax Act (FUTA) is responsible for funding unemployment benefits and includes a payroll tax. In 2024, employers must pay a FUTA tax of 6% on the first $7,000 earned by each employee, with a maximum amount of FUTA tax capped at $420 per employee. However, most employers do not pay this amount in full due to a tax credit system.

Employers who remit state unemployment insurance tax on time and in full are eligible for a FUTA tax credit of up to 5.4%. This credit reduces the FUTA rate to 0.6% for many employers. The availability of this credit depends on the state in which the business is located. States with outstanding federal loans, such as California and New York, offer lower FUTA credits. As a result, employers in these states will face an effective FUTA tax rate of 1.2% in 2023, as opposed to the usual rate of 0.6%.

FUTA taxes are paid quarterly and reported annually using IRS Form 940. This form must be submitted by January 31 of the following year, with an additional 10 days' grace for those who submit it on time.

In addition to FUTA taxes, companies must also pay State Unemployment Tax Act (SUTA) taxes, which vary from state to state.

If states fail to repay funds borrowed from the Federal Unemployment Trust Fund, they become states that reduce their FUTA balances. This results in a smaller FUTA tax credit for businesses in these states, resulting in a higher unemployment tax burden per worker until the state pays back its loan.

Self-employed individuals are exempt from paying FUTA taxes and are not eligible for unemployment benefits under FUTA.

SUI

When it comes to State Unemployment Insurance (SUI), it should be noted that the tax rate is not uniform in all states. The variability in SUI tax rates can be attributed to factors such as the number of unemployment claims filed by a company's former employees, the timeliness of a company's tax payments, and the length of time the company has been in business.

The primary purpose of collecting the SUI tax is to support the unemployed in finding new employment. Typically, employers are responsible for paying SUI taxes, but there are some exceptions. In Alaska, New Jersey and Pennsylvania, for example, employees also contribute to the SUI tax.

For new businesses, the SUI tax often starts with a standard new employer rate, which can be adjusted annually. This adjustment depends on factors such as the frequency of unemployment claims associated with the employer. This rate is usually between 2% and 4%. However, for more established companies, SUI tax rates may change based on similar criteria.

In conjunction with the SUI, companies also face the Federal Unemployment Tax Act (FUTA). Under FUTA, unemployment tax is levied on the first $7,000 earned by each worker. The FUTA tax has a standard rate of 6%, but companies often claim a reduced rate of 0.6%, which is credited towards their SUI contributions.

For tax purposes, both FUTA and SUI taxes are deductible expenses for businesses. Generally, these taxes are reported on line 23 of Form Schedule C on the annual tax return. It is advisable for businesses to educate themselves about their SUI obligations to ensure they remain compliant and manage their finances effectively.

Other payroll taxes to consider

Once you've mastered these "must-haves," it's important to consider whether your business is subject to additional state or local payroll taxes. Some states, such as California, have additional state taxes on disability. Others, like Oregon and Pennsylvania, levy local taxes based on ZIP codes. Federal, state and local payroll taxes are an essential part of proper payroll accounting.

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Mastering payroll taxes is vital for businesses. Simplify the process with IceHrm's online payroll service.