All the Types of Employment Taxes

Income Taxes, FICA Taxes, Unemployment Taxes, Workers Compensation

Before you set up your payroll system and hire your first employee, you need to know about the different types of employment taxes. 

What are Employment Taxes? 

Employment taxes are the taxes that you, your business, and your employees must pay to federal, state, and local agencies. Self-employment tax (Social Security and Medicare tax for self-employed business owners) is also considered an employment tax. 

Some taxes, like federal and state withholding, you just withhold from employee pay and turn over to the taxing authority

Other types of employment taxes, like FICA taxes (for Social Security and Medicare), must be taken from employee pay and also paid by you, the employer.  And still others, like unemployment taxes and workers compensation, are your responsibility as an employer, but employees don't contribute to these.

Here's the IRS list of employment taxes, which includes only federal employment taxes. I've included state employment taxes in this article. 

Some Employment Taxes are Trust Fund Taxes

Trust fund taxes are taxes withheld from employee paychecks and owed by employees and employers to the IRS and state and local tax authorities. These funds go into your business accounting, but your business doesn't own them.

You must periodically make payments for these taxes to the appropriate federal, state, and local taxing agencies. Keeping and using this money is a common mistake business owners make, and it can get you into trouble with the IRS, especially. 

 

01
Federal Income Tax Withholding

UPDATE: With the tax law that went into effect beginning in 2018, many employees may need to re-calculate their federal income tax withholding to adjust for lower taxes. 

All employers are required to withhold federal income tax from employees. The amount of tax is determined by the W-4 form the employee fills out at hire or when the employee has changed status or wants to change the withholding amount.  You may not pay employees without having a W-4 form on file. 

Federal income tax withholding is calculated for each pay period for each employee. To calculate federal income tax withholding for an employee, you will need the employee's gross pay for the pay period, along with the information on the W-4 form. You will also need the most current Publication 15: Employer's Tax Guide from the IRS.

Using the tax guide, find the table that matches the employee's marital status. Then look down the list to the pay period type (weekly, monthly, etc.) and the employee's gross pay. Within that box, use the calculation to figure the amount of federal income tax withholding. 

02
State Income Tax Withholding

States which have state income taxes require employers to withhold those taxes from employees.  Some states use the federal W-4 form, while other states have their own forms. 

To collect income taxes in a state, you will need to register with the state's taxing authority to collect and pay these taxes you have withheld from employees. Find out their procedure for calculating state income tax withholding. You will a

 

03
Social Security and Medicare (FICA Taxes)

All U.S. employers must deduct FICA (Social Security and Medicare) tax amounts from paychecks of all employees, and pay employer and employee portions of this tax.

The Social Security employee deduction is 6.2 percent of gross pay up to the annual maximum. The Medicare portion for employees is 1.45 percent with no maximum.

You must also begin to tax employees for an additional Medicare tax if their total annual income goes above $200,000. The additional tax amount is 0.9 percent of the employee's gross income. So, once the employee's income reaches $200,000, you must collect 2.35% from the employee for each pay period for the rest of the year. 

You as the employer are also required to pay FICA taxes.

  • You must match the 6.2 percent for the Social Security portion, with no maximum, and 
  • You must match the 1.45% for the Medicare portion. You don't have to contribute to the additional Medicare tax.

 

04
Federal and State Unemployment Taxes

Employers are required to pay federal unemployment taxes to provide benefits to employees who have lost their jobs. Employees do not contribute to this tax. Employers contribute based upon the gross payroll of their employees, considering each employee and the maximum earnings. 

In addition to federal unemployment taxes, most states require you to participate in the state unemployment tax plan and to pay state unemployment taxes.

The federal unemployment tax rate is 6.0 percent on the first $7,000 of income (gross pay) for each employee, per pay period. 

If your state has an unemployment tax, you may receive a credit of up to 5.4 percent against the federal tax. The effective rate works out to 0.6 percent.

05
Workers Compensation Benefit Funds

Employers must pay into state-run funds which provide benefits for employees who incur illnesses or injuries because of their work. These benefits are governed ​by state worker's compensation laws and paid for by employer contributions to state worker's compensation funds.

Check with your state's employment agency for more information on how its worker's compensation system is managed. 

06
Self-employment Taxes

The IRS considers self-employment taxes in the category of employment taxes. That's because self-employment taxes (sometimes called SECA taxes) are like FICA taxes; they are Social Security and Medicare taxes for self-employed individuals. 

The additional Medicare tax is also required for self-employed individuals. 

Self-employment tax is different from other employment taxes because it isn't withheld from employee pay or paid by an employer. This tax is calculated on the net income of a business and paid by the owner on his or her personal tax return. 

The current self-employment tax rate is 12.4% for Social Security, up to the annual maximum plus 2.9% for Medicare. In other words, you as a self-employed person are paying both the employee and employer portion of Social Security and Medicare taxes. if your self-employed income is $200,000 or over for the year, you will also have to pay the additional Medicare tax at 0.9%. 

The IRS does give you one break: You can deduct up to half of the amount you paid for self-employment tax, on the first page of your tax return, to calculate your adjusted gross income. You will need to complete Schedule SE to calculate this deduction.