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Payroll Taxes: Introduction

In election years, we often hear about politicians either wanting to increase the payroll tax or decrease it. While it may be an effective talking point for sparring political parties, it is a reality for small business owners everywhere. But what is a payroll tax and who is responsible for it? Is it mandatory or can some employers opt-out? Below, you will find the answers to your payroll tax questions and much more.

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Withholding Taxes

Employers are responsible for withholding taxes from employees' paychecks, sending them to the proper government agencies, and other employer tax obligations. The major employer-paid taxes (FICA, federal unemployment, and state unemployment taxes) will be explained below.

Social Security and Medicare Taxes

The Federal Insurance Contributions Act (FICA) provides for a federal system of old-age, survivor, disability, and hospital insurance. The first three are financed by the social security tax, while hospital insurance is financed by the Medicare tax. The five major benefits covered by Social Security taxes are

  1. Retirement, 
  2. Disability, 
  3. Family benefits, 
  4. Survivors  
  5. Medicare.

Employers must withhold social security and Medicare taxes from employees' wages, and pay a matching amount. These taxes have different rates, and only the social security tax has a wage base limit. There is no wage base limit for Medicare tax; all covered wages are subject to Medicare tax.

Federal Unemployment Tax

The Federal Unemployment Tax Act (FUTA), together with state unemployment systems, provides for payments of unemployment compensation to workers who have lost their jobs. Most employers pay both a federal and a state unemployment tax. Only the employer pays FUTA tax; it is not deducted from the employee's wages. Generally, employers can take a credit against FUTA tax for amounts paid into state unemployment funds. This credit cannot be more than 5.4 percent of taxable wages. Those entitled to the maximum 5.4percent credit have an effective FUTA tax rate of 0.8 percent after the credit.

State Unemployment Tax

State unemployment taxes are also paid by the employer and are not deducted from the employee's wages. Each state has a different rate and different wage limits from which the taxes are calculated.

Payroll Services

Generally, hiring a payroll service is a good idea for businesses in which payroll isn't the same from pay period to pay period. Businesses with hourly employees or employees earning commissions can save time and money by using a payroll service. One of the chief benefits is avoiding costly mistakes in payroll processing like failing to remit payroll taxes in a timely manner. Payroll companies calculate the amount of each paycheck and the tax obligations for each employee; print the checks; and provide payroll reports.

Legal Advice on Payroll Taxes

Now that you've had a primer on payroll taxes, consider speaking to a qualified attorney in your area to make sure you are complying with important laws and regulations. A business and commercial law attorneyy can answer your legal questions and provide an explanation of the laws.

For more information, see FindLaw's Small Business section page.

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Contact a qualified business attorney to help you navigate your business's taxes.

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