What Every Small Business Owner Needs to Know About Payroll Taxes

At one point, you probably put a great deal of time and thought into whether you wanted to start a business. Would it be fair to guess that payroll taxes were not the first thing you considered at that time? If so, that's fair. You had (and have) a ton on your plate. However, every small business owner must understand what payroll taxes are, how they work, and what happens if they're not paid.

What are payroll taxes?

As the name suggests, payroll taxes are deducted from an employee's paycheck. It's the employer who is responsible for making those deductions. Payroll taxes fund essential programs like Social Security and Medicare. Taxes deducted for Social Security (retirement benefits) and Medicare (disability benefits) are referred to as Federal Insurance Contributions Act taxes, or FICA.

The Federal Unemployment Tax Act (FUTA) requires American businesses to help fund programs and benefits for unemployed individuals. You do this by paying unemployment tax for each employee. Your payment goes toward funding your state's Unemployment Insurance (UI) trust fund.

For 2024, the FUTA tax rate is 6% on the first $7,000 from each employee's yearly wages. That means no employer should have to pay more than $420 annually per employee ($7,000 x 0.06).

The bottom line cost

Here's how much each party pays toward FICA:

• Payroll tax for Social Security: The employee pays 6.2% of their income and the employer contributes another 6.2%
• Payroll tax for Medicare: The employee pays 1.45% and the employer contributes an additional 1.45%
• In total, the total FICA contribution is 15.3% of an employee's annual income.

The contribution toward Social Security is required only on the first $168,600 of income. There is no wage limit for Medicare contributions. However, once annual wages and tips exceed $200,000, you must withhold a 0.9% additional Medicare tax. This additional tax is only imposed on the employee.

Is it difficult to figure payroll taxes?

Payroll software is certainly the fastest way to make the correct deductions, but the math is not difficult. Here's a quick breakdown of how it's done:

1. Find the employee's gross income for the pay period. Gross income is the amount they earned before any deductions are made. Put this number aside, because you won't need it again until step No. 5.
2. Now, work only with employee wages that are subject to payroll taxes. For example, contributions to most retirement plans and health benefits paid on behalf of an employee are not typically subject to payroll taxes. Let's say an employee earned $3,000 this pay period, but $100 went towards health benefits and another $300 went into their retirement plan. That would leave you with $2,600 of taxable income ($3,000﹣$400).
3. Based on that number, calculate how much should be deducted for Social Security and Medicare taxes. To make this calculation, multiply the employee's taxable income by 7.65%. For example, if an employee's taxable income is $2,600, multiply that amount by 7.65%. $198.90 is the employee's portion of FICA taxes.
4. Using an employee's W-4 information, figure out how much their federal income tax is. If your small business is in a state with an income tax, also figure out how much those taxes are. Taxes vary by state, so you'll need to find out how much state taxes are.
5. Subtract federal and state taxes, Social Security, and Medicare, employee health plan coverage, retirement plan contributions, and any other deductions from their gross income.

This is your employee's net pay.

If bookkeeping is not your jam, you may want to hire someone to take care of the time-consuming tasks for you, once you have the money in your business bank account to do so without straining your budget.

What happens if a business owner fails to pay payroll taxes?

If you're unable to pay employment taxes when they're due, it's likely that you'll receive a notice from the IRS with a monetary penalty attached. If the taxes due remain unpaid and the IRS determines that you're willfully withholding taxes due, it can place a lien on your business assets or file criminal charges.

Paying taxes on time takes discipline, but it's made easier by never commingling business and personal funds. That means you should have a checking account for business and a personal account. You need a savings account for your business and one for your everyday life.

Unless you're operating a charitable organization, there's nowhere to hide from taxes, payroll and otherwise. As long as you factor them into your business plan, though, you should be good to go.