Payroll Taxes and Employer Responsibilities
How to Calculate and Report Deductions
Employers report payroll by calculating gross monthly wage earnings and various payroll deductions to arrive at net pay. Although this seems simple enough on the surface, calculating various payroll deductions requires that you be detail-oriented and work with extreme accuracy.
Basic Formula for Net Pay:
Employee's gross pay (pay rate x hours worked)
minus Statutory payroll tax deductions
minus Voluntary payroll deductions
equals Net Pay.
Statutory Payroll Tax Deductions
The law requires that payroll taxes must be withheld from an employee's paycheck. Employers must then transmit these withholdings to various tax agencies. Payroll tax deductions include the following:
- Federal income tax withholding (based on withholding tables in Publication 15)
- Social Security tax withholding (6.2 percent up to the annual maximum taxable earnings of $127,200 as of 2017)
- Medicare tax withholding (1.45 percent)
- Additional Medicare tax withholding (0.9 percent) for employees earning over $200,000 (this is a new tax withholding requirement starting in the year 2013)
- State income tax withholding
- Various local tax withholdings (such as city, county or school district taxes, state disability or unemployment insurance).
Voluntary Payroll Deductions
Voluntary payroll deductions are withheld from an employee's paycheck only if the employee has agreed to the deduction. Voluntary deductions pay for or contribute toward various benefits which the employee has elected to participate in. Voluntary payroll deductions may include the following:
- Health insurance premiums (medical, dental, and eye care)
- Life insurance premiums
- Retirement plan contributions (such as a 401(k) plan)
- Employee stock purchase plans (ESPP and ESOP plans)
- Meals, uniforms, union dues and other job-related expenses
Voluntary deductions can be paid with pre-tax dollars or after-tax dollars, depending on the type of benefit that's being paid for. Some pre-tax deductions reduce wages subject to federal income tax, while other deductions reduce wages subject to Social Security and Medicare taxes as well. IRS Publications 15 and 15-B explain which benefits are pre-tax for various purposes, and professional grade payroll software will help you keep track of all tax-related payroll calculations.
Employer Payroll Tax Responsibilities
The responsibility for payroll taxes continues even after paychecks have been issued to employees. The company is responsible for:
- Paying the employer's share of payroll taxes
- For depositing tax dollars withheld from the employees' paychecks
- Preparing various reconciliation reports
- Accounting for the payroll expense through their financial reporting
- And filing payroll tax returns
Employer Payroll Taxes
Companies are responsible for paying their portion of payroll taxes as well. These payroll taxes are an added expense over and above the expense of an employee's gross pay. The employer portion of payroll taxes includes the following:
- Social Security taxes (6.2 percent up to the annual maximum)
- Medicare taxes (1.45 percent of wages)
- Federal unemployment taxes (FUTA)
- State unemployment taxes (SUTA)
FICA stands for the Federal Insurance Contributions Act. The FICA tax consists of both Social Security and Medicare taxes. Social Security and Medicare taxes are paid both by the employee and the employer. Each party pays half of these taxes. Together, both halves of the FICA taxes add up to 15.3 percent, broken down as follows:
- Social Security (employee pays 6.2%)
- Social Security (employer pays 6.2%)
- Medicare (employee pays 1.45%)
- Medicare (employer pays 1.45%)
As of 2013, an Additional Medicare tax is applied to employees who file taxes as head of household, single or as a qualifying widow(er) with a dependent child and whose Medicare wages exceed $200,000. The threshold is much lower for married individuals who file separate tax returns: $125,000. The Additional Medicare tax applies to income over $250,000 for married taxpayers who file joint returns.
This is an employee-only tax. There's no corresponding tax imposed on the employer.
The employee portion of Social Security has increased from the 4.2 percent it was set at in 2011 and 2012. That payroll tax holiday was legislated as part of the Tax Relief Act of 2010, which was then extended by HR 3765 and extended again by HR 3630. But the employee portion of Social Security reverted back to the full 6.2 percent in 2013.
Reporting Payroll Taxes
Employers are required to report their payroll tax obligations and to deposit payroll taxes in a timely manner. Reporting requirements include:
- Making federal tax deposits
- Annual federal unemployment tax return (Form 940 or 940EZ)
- Employer's quarterly payroll tax return (Form 941)
- Annual Return of Withheld Federal Income Tax (Form 945)
- Wage and Tax Statements (Form W-2)
Employers also have requirements to file reports with various state and local agencies. Employers can find links to state tax agencies through the American Payroll Association website.
Originally written by Diana Van Blaricom, a certified Professional in Human Resources (PHR). Edited and revised by Beverly Bird.