I had a client come to me and tell me they had an employee and were taking taxes out but didn’t know what to do next. I asked how long. Two years. She had an employee for two years and didn’t file any forms or pay any taxes. My heart sunk. This is the kind of trouble I can’t fix. She came to me because her employee was demanding a W2 (a year late) so he could get his tax refund. The problem is, once I filed the forms, the business owner had no idea she would owe many thousands of dollars in taxes, many thousands more in penalties and interest, and that they could come after her personally for it. That means they can take your house and seize your bank accounts. Payroll is serious business. Let’s break it down.
What are Payroll Taxes?
Payroll taxes are both the taxes you have to pay for your employees and the money you withhold from their check. Payroll taxes have been the law since 1943 and are not changing. Employers need to withhold the employee’s part of the taxes from their pay, send what you withheld to the government, and then pay your part of the taxes. Depending on the amount, you could be required to send it in every week.
Employee Withholding
When you promise to pay your employee $15 per hour, they don’t actually get all that when you pay them. You hold some back for their taxes. This is tax money they would have to pay, not you. Employers are required to take what the employee’s estimated tax would be and send it in to the government. How do you know what to withhold? The employee tells you that by filling out form W4. The government provides charts so you can do the math and withhold the correct amount.
You are required to withhold the employee’s federal and state income tax and their contributions for Social Security and Medicare. Social Security and Medicare are flat rate taxes. Everyone pays the same: about 7.5% of wages.
Employer Payroll Taxes
As an employer, you are required to match the employee’s contribution to Social Security and Medicare. You need to pay another 7.5% of wages into Social Security and Medicare for each employee.
Additionally, you need to pay into unemployment for the state and federal government. None of these taxes can be passed on to the employee. Altogether, your part of the payroll taxes is about 10% of total wages.
But Wait, There’s More
Some states require additional payroll taxes to be paid. New Jersey, for example, also requires Family Leave Insurance, Disability Insurance, Workforce Funds, and additional Unemployment to be paid. Your state may have additional requirements.
Can I Opt Out?
No. You cannot opt out of payroll taxes. They are strictly enforced and the penalties for not following the law are very high. There are specific guidelines as to who is an employee and who is not.
If you decide to treat an employee as a contractor in order to get out of paying payroll taxes, you can find yourself in a lot of trouble. First, if an employee is treated as a contractor, they will owe a lot in taxes. Then they can ask the IRS to decide if they were actually an employee. If the IRS sides with them, the IRS comes after you for the taxes that you should have paid, plus penalties and interest.
Paperwork – Lots of it
In addition to sending in all the money, you are required to file monthly, quarterly, and annual forms to report what was collected from each person and how much they earned. You can be fined for not filing the forms on time. If you want to learn more, the IRS prints Publication 15 with all their requirements.
What Should I Do?
Payroll laws are very complex. If you have employees, use a payroll provider or an online software that calculates the taxes and produces the necessary forms. Some of the worst IRS seizures I have worked have been due to my client not paying their payroll taxes. Once they bankrupt the company, they come after the assets of the company owners. The corporate veil does not protect anyone from payroll tax enforcement.
Summary
Payroll taxes are both the money you withhold from your employee’s wages and additional taxes that you need to pay.
Payroll laws are strictly enforced and you can be held personally responsible.
Use a payroll professional or software to keep track of payroll taxes and forms.
For more information on paychecks, click here.
For the next blog in this series – Franchise Tax – click here
