All the Types of Employment Taxes
Income Taxes, FICA Taxes, Unemployment Taxes, Workers Compensation
Nothing is certain except death and taxes. When it comes to taxes, the Internal Revenue Service (IRS) not only expects you to pay your share, but also if you're an employer, you need to make sure you pay your business's share, as well as help collect for your employees.
There are several types of employment taxes, and some you have to contribute to whereas others you simply need to withhold, file, and remit on behalf of your employees as part of your payroll taxes.
What are Employment Taxes?
The IRS employment taxes are the taxes that you, your business, and your employees must pay to federal, state, and local agencies. Self-employment tax, which includes Social Security and Medicare tax for self-employed business owners, is also considered an employment tax.
The source of the money for each of these taxes varies:
- Federal and state withholding is withheld from employee pay and turn over to the taxing authority.
- Federal Insurance Contributions Act (FICA) taxes must be taken from employee pay and also paid by the employer.
- Unemployment taxes and workers' compensation are the employer's responsibility. Employees don't contribute to these.
If you hire contractors or freelancers, you don't have to withhold taxes; however, you are required to obtain Form W-9 from the worker, and then submit Form 1099-MISC to the worker and the IRS reporting the amount you paid the worker if it is $600 or more.
Trust Fund Taxes
Many of the taxes employers collect are held in a fund, called trust fund taxes, until paid to the IRS. These funds are held and managed by the employer but don't actually belong to the employer. Keeping and using this money for other than paying taxes can get an employer into trouble with the IRS.
Penalty for Using Trust Fund Taxes
According to the IRS, there are penalties for failing to remit trust fund taxes, and if you don't pay the penalty, the IRS can take collection action against your personal assets, such as filing a tax lien or taking levy or seizure action.
Here's the IRS list of employment taxes, which includes only federal employment taxes. I've included state employment taxes in this article.
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.
In 2020, the IRS released a new W-4 in an effort to make it easier to understand and increase transparency. As of 2020, employees won't be able to request adjustments to their withholdings using allowances. Instead, with the new Form W-4, employees can provide employers with amounts to increase or decrease tax withholdings and amounts to increase or decrease the amount of income subject to withholding.
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.
Most states collect income taxes and require employers to withhold those taxes from employees. There are a handful of states that don't have any income tax, whereas there are some that don't collect tax on employment income but do collect tax on other types of income such as dividends. 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.
Along with income tax, some states also collect:
- State unemployment tax funds
- State disability funds
- State worker's compensation funds
Contact your state's tax agency for information on collecting, reporting, and remitting state 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% of gross pay for the employee and 6.2% for the employer for a total of 12.4%. The annual maximum wage that's subject to the tax 2020 is $137,700.
The Medicare portion for employees is 1.45% with no maximum wage, and 1.45% from the employer, for a total of 2.9%.
Along with regular FICA, employers must also collect additional Medicare tax if the employee's total annual income goes above $200,000. The additional tax amount is 0.9% of the employee's gross income. So, once the employee's income reaches $200,000, you must collect 2.35% from the employee on the excess over that amount for each pay period for the rest of the year.
Additional Medicare Tax is withheld only from the employee. The employer does not contribute to this tax.
Employers are required to pay federal unemployment taxes IFUTA) 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.
The federal unemployment tax rate is 6% on the first $7,000 of income (gross pay) for each employee, per pay period.
In addition to federal unemployment taxes, most states require you to participate in the state unemployment tax plan and to pay state unemployment taxes.
If your state has an unemployment tax, you may receive a credit of up to 5.4% against the federal tax. The effective rate works out to 0.6%.
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 workers' 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 workers' compensation system is managed.
Self-employment taxes, sometimes called SECA taxes, are like FICA taxes in that they are Social Security and Medicare taxes for self-employed individuals. The additional Medicare tax is also required for self-employed individuals who meet the $200,000 threshold.
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 on the owner's 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, for a total of 15.3%. For 2019, the annual maximum is $132,900 of all earnings subject to Social Security. For 2020, that annual maximum is $137,700.
If your self-employment income is $200,000 or over for the year, you will also have to pay the additional Medicare tax at 0.9%.
While you are paying both the employee and employer portion of Social Security and Medicare taxes, the IRS does give you one break, in that you can deduct the employer-half of your self-employment tax on your tax return. You will need to complete Schedule SE to calculate this deduction.