Payroll Taxes You Need to Know

If it’s your first time running payroll, or it’s been a while since you’ve had an employee, it can feel daunting coming up to speed on all the payroll taxes out there. The good news is that there are only five federal and state payroll taxes you need to know to get started with the basics of payroll. Let’s dive in.

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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 estate tax. Taxable income in the U.S. comprises earned income (like salaries, wages, and tips) and unearned income (including interest, dividends, and profits from asset sales). Reducing taxable income is possible through contributions to retirement accounts such as 401(k)s and IRAs.

Federal income tax calculation is influenced by factors like tax brackets, which depend on taxable income and filing status. The U.S. tax system is progressive, meaning tax rates increase with higher income levels. For example, in 2020, the average tax rate on Adjusted Gross Income was 13.6%. Tax deductions are crucial for lowering taxable income.

Taxpayers can choose between the standard deduction and itemizing deductions. Common deductions include mortgage interest, state and local taxes, charitable donations, and certain medical expenses, with business owners able to deduct business expenses. Filing taxes is a yearly responsibility, typically due by April 15th for the previous year. This process involves preparing and submitting a tax return that accounts for various income types and deductions.

State Income Tax

In the United States, the approach to state income tax varies significantly from one state to another. A total of 41 states impose state income taxes, which are primarily structured in two distinct forms: flat rate and progressive rate systems. Under the flat rate system, taxpayers are required to pay a uniform percentage of their income as tax. For example, in 2023, states such as Arizona, Colorado, and Illinois employ this system, with tax rates that range from Arizona's 2.5% to Illinois's 4.95%. Conversely, the progressive rate system applies higher tax rates as an individual's income increases.

This system is employed by 30 states and Washington, D.C. The number of tax brackets and their corresponding rates vary widely among these states. For instance, Kansas implements three tax brackets, while California has ten, and Hawaii has twelve. Additionally, there are nine states that do not impose a general individual income tax, including Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.

Nevertheless, some of these states impose taxes on specific forms of income. For example, New Hampshire taxes investment income from dividends and interest, and Washington imposes a tax on certain capital gains. The tax obligations for individuals can differ based on several factors, such as remote work or relocating during a tax year. This might necessitate filing tax returns in more than one state, depending on where one lives and works.

The intricacies of these situations depend on the tax laws of the respective states. State-specific rules and deadlines for filing tax returns also exist, which may not align with the federal tax deadlines. Awareness of these state-specific requirements is critical for both individuals and businesses to ensure adherence to tax laws and avoid penalties.

FICA Payroll Taxes

The Federal Insurance Contributions Act (FICA) tax, a key source of funding for Social Security and Medicare, mandates contributions from both employers and employees. In 2024, the tax rate for Social Security remains at 6.2% for employers and employees alike. The Social Security taxable wage base has risen to $168,600, higher than the previous year. Consequently, the highest Social Security tax an employee might 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.

Regarding the Medicare tax in 2024, both employers and employees continue to pay a rate of 1.45%, with no maximum income limit. Additionally, there is an extra Medicare tax for those earning above certain amounts. In 2024, the additional tax of 0.9% applies to individual earners above $200,000 and married couples filing jointly over $250,000. For both employers and employees, awareness of these tax updates is crucial for accurate payroll processing and financial planning.

Employers must accurately withhold these taxes from wages and send them to the Internal Revenue Service (IRS). Employees benefit from understanding these changes for estimating their tax responsibilities and planning financially. Furthermore, FICA tax contributions are vital for supporting Social Security and Medicare programs, which offer retirement, disability benefits, and healthcare coverage to eligible individuals.

The benefits one receives from these programs are influenced by the contributions made during their working years. It is important for employers to comply with the latest FICA tax regulations. This ensures the continued support of these vital programs and avoids legal or financial issues related to payroll taxes.

FUTA Payroll Taxes

The Federal Unemployment Tax Act (FUTA) is responsible for funding unemployment benefits and involves a payroll tax. In 2024, employers are subject to a 6% FUTA tax on the initial $7,000 earned by each employee, capping the maximum FUTA tax at $420 per employee. Yet, most employers do not pay this amount in full due to a tax credit system. Employers who timely and fully pay state unemployment insurance taxes qualify 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 where the business is located. States with outstanding federal loans, like California and New York, offer lower FUTA credits. Consequently, employers in these states faced a 1.2% effective FUTA tax rate in 2023, as opposed to the more common 0.6% rate.

FUTA taxes are paid every quarter and reported annually via IRS Form 940. This form must be submitted by January 31 of the following year, with an additional 10 days allowed for those who file on time. In addition to FUTA taxes, businesses must pay State Unemployment Tax Act (SUTA) taxes, which are distinct and vary by state.

When states do not repay funds borrowed from the Federal Unemployment Trust Fund, they become FUTA credit reduction states. This results in a diminished FUTA tax credit for businesses in these states, leading to increased unemployment tax burdens per employee until the state settles its loan. Self-employed individuals are exempt from paying FUTA taxes and are not eligible for unemployment benefits provided under FUTA.

SUI

In the context of State Unemployment Insurance (SUI), it is observed that the tax rate is not uniform across all states. Variability in SUI tax rates can be attributed to factors such as the number of unemployment claims filed by a business's former employees, the promptness of a business's tax payments, and the length of time the business has been operational. SUI tax collection primarily serves the purpose of supporting unemployed individuals in their pursuit of new employment.

As a general rule, employers bear the responsibility for paying SUI taxes, but there are some exceptions. For example, in Alaska, New Jersey, and Pennsylvania, employees also contribute to the SUI tax. For new enterprises, the SUI tax often starts at a standard "new employer rate," which may be revised annually. This revision depends on factors like the frequency of unemployment claims associated with the employer.

This rate is typically in the range of 2% to 4%. On the other hand, more established businesses may experience changes in their SUI tax rates based on similar criteria. In conjunction with SUI, businesses also engage with the Federal Unemployment Tax Act (FUTA). Under FUTA, unemployment taxes are levied on the first $7,000 earned by each employee. The FUTA tax has a standard rate of 6%, but businesses often avail a reduced rate of 0.6%, credited for their contributions to SUI.

For tax purposes, both FUTA and SUI taxes are deductible expenses for businesses. Generally, these taxes are reported on line 23 of the Schedule C form in annual tax filings. It is advisable for businesses to stay informed about their SUI responsibilities to ensure they remain compliant and manage their finances effectively.

Other Payroll Taxes to Know

Once you have mastered these must-haves, it’s important to check if your business is subject to additional state or local payroll taxes. Some states, like California, have additional state disability taxes. Others, like Oregon and Pennsylvania, have local taxes based on zip codes. Federal, state, and local payroll taxes are all an essential part of running your payroll right. If you are looking for help, check out Homebase Payroll. Homebase offers an online payroll service that syncs automatically with your time tracking and scheduling, so you never have to enter hours manually and payroll is a breeze.