Among many other responsibilities, employers have to collect, report and pay payroll taxes, as required by federal and state laws. Managing payroll taxes can be a burdensome task. Adding to the burden are employment laws that are getting more complex, so businesses are finding it difficult to remain compliant.
Payroll taxes withheld by employers account for nearly 72% of all revenue collected by the Internal Revenue Service (IRS). Furthermore, 40% of small and medium-sized businesses are fined each year for failing to meet payroll tax regulations. Taking this into consideration, it is no surprise that the IRS has made enforcing payroll tax compliance one of its top priorities. Therefore, it is critical that employers take the necessary steps and follow the guidelines. Otherwise, they can face harsh payroll tax penalties.
Payroll Tax Requirements
The federal government levies payroll taxes on wages and uses most of the revenue to fund Social Security, Medicare, and other social insurance benefits. Federal income taxes are also used for funding areas such as defense and security.
There are typically four types of federal and state payroll taxes that businesses have to pay:
- Federal and state income taxes have to be withheld from employee pay and paid to the IRS and states as required by law.
- FICA taxes, including Social Security and Medicare taxes, have to be withheld from employee pay and matched by employers. FICA taxes should be paid either semi-weekly or monthly, depending on the size of a business, and reported quarterly on Form 941.
- Federal unemployment taxes need to be paid by an employer, based on the gross pay of all employees. These taxes are paid quarterly or annually and are reported on Form 940.
- State unemployment taxes have to be collected, reported and paid according to state laws. While not all states have payroll tax, some states may levy additional taxes, and some employees might be excluded from certain taxes.
Other payroll tax obligations include annual wage and tax reporting for employees on Form W-2 and for non-employees on Form 1099-MISC.
How to Calculate Payroll Tax
The IRS and state tax agencies publish annual tables to determine the amount of tax that has to be withheld from each paycheck depending on employees’ gross wages, filing status, number of withholding allowances and pay frequency.
Social Security and Medicare taxes have specific rates and thresholds. For 2019, the Social Security tax rate is 6.2% on the first $132,900 of wages paid. The Medicare tax rate is 1.45% on the first $200,000 of wages, plus an additional 0.9% for wages above $200,000.
Federal income tax is determined by the Form W-4 that an employee submits, showing their filing status and their number of exemptions. For state income tax withholding, a similar table is produced annually by each state to determine how much state income tax should be withheld from each employee’s paycheck.Find out what guidelines to follow when collecting, filing and remitting payroll taxes and ensure compliance with federal and state laws and regulations by following this detailed guide.
Payroll Tax Penalties
The three components that ensure correct filing of payroll taxes are paying them timely, in the correct amount and in the correct manner. Failure to comply with any of these components leads to severe payroll tax penalties. According to the IRS, employers who do not follow employment tax laws can be subject to civil and criminal sanctions.
In case of late deposits, payroll tax penalties rate depends on the number of calendar days a deposit is late starting from the due date of the deposit. For liability amounts not properly or timely deposited, the penalty rates are:
- 2 percent for deposits 1–5 days late,
- 5 percent for deposits 6–15 days late,
- 10 percent for deposits made more than 15 days late or within 10 days of first notice from the IRS, and
- 15 percent for all amounts still unpaid more than 10 days after the date of the first notice or the day on which the taxpayer received notice and demand for immediate payment, whichever is earlier.
One of the largest penalties charged by the IRS is the Trust Fund Recovery Penalty. Employers can face this penalty if they withhold payroll tax, Medicare, and Social Security payments from employees’ paychecks, but do not send the money to the IRS. The IRS levies this penalty on anyone who willfully fails to collect and pay trust fund taxes and it is equal to the amount of taxes that were unpaid.
Even if employers prove that failure to pay or report taxes was not willful, and avoid having to pay the Trust Fund Recovery Penalty, they can still face payroll tax penalties for late payments. Employers can ask for an abatement of the penalties if they have reasonable cause and did not fail to pay on time due to willful neglect. However, the IRS evaluates requests for abatement based on individual circumstances, so there is no specific list of problems that qualify as reasonable cause.
Mitigating the Risk
Apart from reporting wages, tips and other compensation paid to employees, employers have to report on taxes withheld. To do this properly and avoid payroll tax penalties, employers have to closely follow the IRS announcements and resources. In addition to this, each state has rules for depositing and reporting employment taxes at the state level. Thus, employers need to pay close attention to state payroll tax regulations in the states where their employees work.
Failing to pay payroll taxes on time can happen to any business owner due to different responsibilities they need to keep track of. To stay on top of payroll tax responsibilities and reduce risks, employers should outsource and rely on an electronic system to help them manage withholding and contributing payroll taxes more efficiently. This ensures correct calculation, collecting and remitting taxes to agencies on employers’ behalf. Automating payroll processes leaves employers with more time to work on other areas of their business, avoid payroll tax penalties, reduce costs and ensure employees are paid both accurately and on time.Automate payroll processes to save yourself from potential penalties and ensure accuracy of payment while getting your payroll taxes paid on time.