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Payroll Tax Withholding and Expenses in the United States

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Payroll Tax Withholding and Expenses in the United States
By Nancy E. Miller, PHR

Payroll taxes are administered by a variety of agencies in the United States, depending on where your employees work and live. In this article, you will learn about the main taxes that all employers must either withhold from their employees’ paychecks or which employers must themselves pay as a payroll expense. We will also introduce some of the more unusual taxes that appear at times from state to state or even city to city.

Payroll Tax Withholdings

Each employee must have the following types of payroll taxes withheld from their paycheck:
– Social security tax
– Medicare tax
– Federal withholding tax
– State withholding tax (in most states)
– Other miscellaneous taxes in some states or cities

Social security and Medicare taxes are administered and paid to the federal Department of the Treasury, Internal Revenue Service (IRS). These taxes are used to provide for a number of federally administered programs to help disabled, unemployed and retired citizens. The taxes are paid partially by the employees as a withholding tax and partially by the employer as a payroll tax expense.

For many years, Social Security tax was 12.4% of the employee’s wages up to a particular wage base for the current year (for 2012 the wage base is USD 110,110). Half of this was paid by the employee and half by the employer. However, in 2011, the federal government instituted a temporary tax cut for employees where the employee would only be required to pay 4.2% of their wages up to the wage base while the employer continued to pay 6.2%. This tax cut has been renewed by the government through December 31, 2012.

Medicare is also paid partially by the employee and partially by the employer. Currently the employee must pay 1.45% of all their taxable wages while the employer also pays 1.45% of the taxable wages.

Federal Withholding Tax is also administered by the IRS. Anyone who earns wages that are taxable by the federal government must file a tax return each year. The employer must be able to calculate the appropriate amount of Federal Withholding Tax to withhold from each employee’s check every payday. Therefore every new employee must complete a Form W-4, Employee’s Withholding Allowance, and turn it in to their employer. Current employees may complete a new Form W-4 at any time if necessary. If you are using a payroll service, you simply need to give them the information that is on the completed Form W-4 and the payroll service will access the tax tables provided by the IRS to calculate the appropriate amount.

Most states also have a State Withholding Tax which is similar to the Federal Withholding Tax. Each state has its own unique tax return, tax table, and method of payment. Some states even have their own withholding form similar to a Form W-4 that employees must complete in order to calculate the State Withholding Tax. We can help you determine your state’s requirements. Your payroll service can also be of great help in this area.

Some states, such as Pennsylvania, Ohio, Kentucky and Colorado, also have local taxes. Each of these types of taxes is unique. For example, in Pennsylvania the local tax is a municipality tax that is used to fund local school districts and emergency services. In Colorado, only a few cities have a local tax – this tax is called an Occupational Privilege Tax and is assessed on anyone who works in that city, but not on people who live in the city and work outside the city.

In addition to state and local withholding taxes, some states have additional special withholding requirements. For example, California employees must pay 1% of their taxable wages to the state-run Disability Insurance program. Three states (Pennsylvania, New Jersey and Alaska) require employees to pay part of the unemployment tax. Because each of these taxes is unique, it is very important to check with us or your payroll service when you hire an employee in a new state to avoid future penalties and interest.

Employer Tax Expenses

In addition to the withholding taxes, there are also a few taxes that the employer must pay:
– Social security
– Medicare
– Federal Unemployment Tax (FUTA)
– State Unemployment Tax (SUI)
As mentioned above, the employer pays part of the social security tax. Currently the employer portion is 6.2% of taxable wages for the first USD 110,110 that each employee earns in the year. The employer portion of Medicare is 1.45% of taxable wages.

FUTA tax is an employer tax of 0.08% that only applies to the first USD 7,000 that each employee earns in a calendar year. Sometimes at the end of the year you may be required to pay extra FUTA tax if your employees work in a state that has experienced a “credit reduction.” This is an extra tax levied against employers in states that have taken out loans from the FUTA program in order to fund their own SUI programs and not paid the loans back yet. Your payroll service will let you know if you are required to pay the extra credit reduction at the end of the year.

SUI tax is administered by each state in order to run their unemployment and worker training programs. Each state has its own wage base and each employer is assigned their own SUI rate, based on how many of their former employees have used the state unemployment system. Each state will send you your company’s new SUI rate before the beginning of each year. Be sure to forward this information on to your payroll service.

Most states have similar SUI agencies and refer to them as “Department of Labor” or “Department of Employment.” But other states are unique. For example, Washington has an “Employment Security Department” and California runs both their withholding and their SUI program under the same agency, the “Employment Development Department.” Another oddity is New Jersey, which bases its SUI rates on a fiscal year that runs from July through June instead of a calendar year and also requires employers to deduct a portion of the unemployment tax from their employees.

Tax Exemptions

Some types of companies are exempt from paying certain types of tax expenses. In addition, there are a few types of employees who do not have to pay certain types of withholding taxes. Plus, there are certain types of payments and deductions that can reduce an employees’ taxable wages.

Most employers are required to pay unemployment taxes, both federal (FUTA) and state (SUI). Charities and Non-Profit companies that are eligible under section 501(c)(3) of the Internal Revenue Code are exempt from paying these and other taxes. Please be sure to let your payroll service know if you believe that your company is exempt from payroll taxes.

Some of your employees may be exempt from having certain taxes withheld from their pay. Certain workers who are in the United States on a F-1, J-1, M-1, or Q-1/Q-2 nonimmigrant status visas may be exempt from paying social security and Medicare. In addition, the United States and Demark have entered into an Agreement providing an exemption to the payment of social security tax. This Agreement covers some Danish residents employed by Danish companies who are sent by their employer to work in the United States for a temporary period of time. It is very important that you speak with one of our attorneys regarding the applicability of these tax exemptions before asking the payroll service to stop withholding taxes!

Many employees take advantage of opportunities to lower their taxable wages through deferrals to a 401(k) retirement plan or health insurance-related deductions. These plans must be sponsored by the employer and should be administered by a provider who is familiar with the related tax laws. Retirement plans and health insurance programs are an excellent way to attract and keep the best employees. Please let us know if you would like to set up any of these programs and we will help you find an appropriate provider.

If you have any other questions about processing payroll in the United States, please feel free to email or call us at any time.