How To Calculate Payroll Taxes for Small Businesses

Payroll taxes

Many small business owners prefer to have their payroll needs handled by an outside source. By hiring a payroll service to prepare payroll and handle payroll taxes, business owners are able to focus their attention on the income producing aspects of the business. A large number of employers outsource their payroll tasks simply because they are unsure of how to correctly figure taxes and deductions from their employees’ earnings.  Businesses with the need to cut costs often find that by completing these tasks in-house they can save money.

Each year the IRS publishes Circular E, The Employers Tax Guide. This publication contains all of the information that an employer needs in order to deduct the correct amounts from their employees’ earnings, as well as the amounts as the employer must contribute for payroll taxes. Employers who do not have a current copy of this handbook can access the IRS website to download the most current version in a PDF file.

Payroll taxes are figured based on the gross earnings of an employee. FICA (Federal Insurance Contributions Act) consists of both Social Security and Medicare taxes. The rates for these taxes are announced by the IRS before January 1st each year. The current rate is not expected to change in the upcoming year. The current rate is 7.65%. This amount must be withheld from employee earnings and matched by the employer. This percentage consists of 6.2% for Social Security and 1.45% for Medicare.   To figure this portion of your payroll taxes, multiply the employee’s gross earnings by 7.65% and deduct this amount.  Social Security tax is withheld on the first $106,800 in gross earnings. This amount is subject to change each year. Refer to Circular E for the correct rates each year.

Federal Income Tax must also be withheld from employees’ gross earnings. The amount withheld is based on the information provided by the employee on form W-4.  Using the information provided by the employee, refer to IRS publication Circular E to determine the correct amount of withholding for Federal Income Tax. It is possible that federal withholding amount will be zero.  This amount is also subtracted from the gross earnings. Many states have State Income Taxes in addition to the aforementioned taxes. These rates vary from state to state and must be withheld in accordance with state law. State Income tax withholding is deducted from the gross earnings of an employee’s paycheck and submitted directly to the state in which you are doing business.

Depending on the size and type of your small business, the IRS may require you to submit payroll taxes semi-weekly, monthly, quarterly, or yearly. The IRS determines the frequency based on dollar amount and other contributing factors. You will be notified by the IRS of your filing requirements. Quarterly filing is most common and requires the use of IRS form 941. This form is used to calculate the amount of payroll taxes due for the prior quarter.  Payroll taxes can be paid at many local bank branches using a payment book provided by the IRS. These taxes can also be paid online using the EFTPS payment system. Contact the IRS for enrollment in the online payment option.

In addition to FICA and Federal Withholding, employers must also pay unemployment taxes. FUTA (Federal Unemployment Tax Act) and SUTA (State Unemployment Tax Act) are taxes paid solely by the employer with no amounts being withheld from employees’ paychecks. FUTA and SUTA are both paid quarterly. FUTA is paid to the IRS in the same manner as FICA and Federal Withholding, while SUTA is paid directly to the state in which you are doing business.  The current FUTA rate is 0.8% of the first $7000 in earnings for each employee. This rate is subject to change before January 1 each year and will be announced by the IRS. This information is located in the IRS publication Circular E. SUTA rates vary by state.  When applying for a SUTA account with your state, you will be provided a tax rate along with the maximum taxable earnings.  At the end of each quarter, you will receive forms which allow you to figure the amount of payroll tax due for each type of unemployment tax.


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