Even as a skilled business owner, wading through the complex world of tax codes can be difficult. However, you are responsible for knowing your stuff, and payroll taxes are a big deal.
Many employers struggle to understand withholding taxes, but it doesn’t need to be you.
Once you understand the basics you’ll realize that they’re not that complicated, and you can feel confident in your newfound knowledge the next time tax season rolls around.
A major part of a successful business is having motivated employees who respect you. And properly handling their wages will certainly demonstrate your credibility as the boss.
The Basics
From the employer side, withholding taxes are pretty straightforward. You have income tax withholdings and FICA withholdings.
The easy one is income tax. Withhold for federal income tax according to the employee’s individual tax bracket, determined by their W-4. The amount will change slightly, depending on the allowances and exemptions claimed on the W-4. You also have to withhold state income tax, and local income tax, according to where your business is located and where your employees live.
Under FICA, there are two separate steps to make sure you cross off: the employee-paid taxes, and the employer-paid taxes.
- As the employer, you are responsible for withholding 6.2% of an employee’s compensation for Social Security, and 1.45% for Medicare tax (if the employee earns over $200,000, add 0.9% to the Medicare tax rate). Even though this money is coming from the employee’s pay, it is your job to make sure the withholding is in place.
- The employer-paid part of FICA dictates that you also “match” the tax payments, in a way. You pay 6.2% into Social Security, and 1.45% into Medicare. There is no additional Medicare surtax for the employer-paid portion. Further, if you have employees that earn tips, you may need to look into additional withholding policies.
Once you have paid your employee a certain amount of total wages (in 2017, this number was $127,200, but will likely be higher for 2018), you can stop paying and withholding for their Social Security tax. The Medicare tax has no wage cap, however, and your obligation to pay and withhold will continue for the duration of their employment.
The Contractors
Things might seem to get more complicated when you work with independent contractors, but really it’s just a little different. You do not need to withhold any income tax or FICA taxes from contractor wages, as they are independently responsible for paying these in accordance with where they live and conduct business. (This also means you don’t pay the employer-side of their FICA taxes.)
Depending on your company, you’ll either have contractors fill out a W-9 to get their TIN, or you’ll file a 1099-MISC at the end of the tax year. With 1099’s, you’re most likely going to encounter backup withholding at some point. So many people are exempt from backup withholding that it can be jarring if/when it does appear, but it’s really nothing to be afraid of. From your side as the employer, the IRS is just interested in making sure that the wages you reported paying the contractor match the amount claimed by the contractor.
The Exceptions
If you have employees that claim “Exempt” on their W-4, you do not withhold any income tax from their paycheck. You will still withhold for FICA taxes, regardless of exemption. However, beginning in the 2018 tax year, exemptions play no part in determining an employee’s taxable income. Be mindful of changes to W-4’s in the coming months and years.
If you’re classified as Self-Employed, you don’t have to worry about FICA taxes. Instead, you will pay the self-employment tax (SE). It’s basically just a blend of both the employer-paid portion and employee-paid portion of FICA. However, this can get sticky for public officials and government workers. While public officials are not considered to be practicing a “trade,” they are still considered employees in the eyes of the IRS and therefore don’t pay self-employment tax. However, officials that are paid based on fees, are considered self-employed and will pay the associated tax.
The important thing is to not stress about withholding taxes! For the vast majority of cases, things are fairly cut and dry. Take those W-4’s, income tax rates, FICA rates, and allowances then calculate the withholding taxes and sign the check. Things will add up just fine, and it never hurts to consult a tax professional or invest in some helpful tax software if you need a little extra help.
Contributor Post at SylvianeNuccio.com