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Overview of Employment Taxes

Withholding the right amount of federal and state taxes, and remitting the same to the respective agencies is one of the most important aspects of running a business. Many businesses fold each year from the pressure of payroll tax audits and the subsequent tax assessments. In recent years the auditors have become more aggressive, and the tax assessments have grown. Also, the IRS has become more inclined to disregard the business entity and personally assess the owners and officers of a business under the "responsible person" rules. Under these rules, the IRS can attack pensions, trust funds, homes and cabins for collection purposes.

The typical payroll tax assessment will include interest and penalties that in many cases will cause the company's tax bill to double. Unlike regular income tax assessments, you can almost never get penalties abated in payroll tax assessments. This is because payroll taxes are considered "trust taxes," much like sales taxes are, and the government considers that to mean the money was never yours in the first place.

The basic payroll taxes that employers are responsible for are as follows:

  1. Federal income tax withholding
  2. State income tax withholding
  3. Social Security tax (FICA) and Medicare
  4. Federal Unemployment Tax (FUTA), and
  5. State unemployment tax (SUTA)

Federal Income Tax Withholding

A person (or other business entity) is obligated to withhold income tax if that person meets the statutory definition of employer and has employees that are paid wages, unless the employee is exempt from withholding taxes. In such situations, employers must also withhold from payments to pensions, annuities, and distributions from deferred compensation plans. Also, payments for sick pay are subject to withholding.

All amounts withheld must be deposited with a federal depository or paid with the employer's quarterly FICA return. The percentage to be withheld depends on:

  1. The employer's payroll period;
  2. The method of withholding used;
  3. The number of exemptions and allowances the employee has claimed; and
  4. Whether the employer has an additional or voluntary withholding agreement with the employee.

State Income Tax Withholding

After an employee has determined the number of federal withholding allowances to claim, he/she must determine the number of Minnesota withholding allowances to claim. Employees may claim up to as many, but not more than, the allowances claimed on their federal W-4. State income tax withholding must be remitted to the state with form MW-5. The frequency is quarterly for most employers, and the due dates are the same as the federal deposit requirements, but for larger employers, the due dates can become more frequent.

Social Security Tax (FICA)

Federal Insurance Contribution's Act (FICA) imposes social security taxes on both the employer and employee. Employers must deduct the tax imposed on employees and pay it to the government along with the employer's share of the tax. These taxes provide the funds for two of the government's principal social security programs: old age, survivors and disability insurance (OASDI) and hospital insurance (Medicare).

The total tax rate for FICA is 7.65% (6.2% for OASDI and 1.45% for Medicare). OASDI is only withheld on the first $117,000 of an employee's wages (2014 wage base), while the Medicare is withheld on the entire amount of wages paid. So an employee who earns $117,000 will have to pay $8950.50 in FICA (.062 times $97,500 plus .0145 times $117,000).

Federal Unemployment Tax (FUTA)

The Federal Unemployment Tax Act (FUTA) imposes tax on most employers. This tax is in conjunction with state unemployment taxes and is used to provide benefits to unemployed persons under state law. The FUTA tax rate is 6.2% of taxable wages. The taxable wage base is the first $7,000 paid in wages to each employee during a calendar year. Employers who pay the state unemployment tax, on a timely basis, will receive an offset credit of up to 5.4% regardless of the rate of tax they pay the state. Therefore, the net federal tax rate is generally 0.8% (6.2% - 5.4%). This would equate to a maximum of $56.00 per employee, per year (.008 X $7,000. = $56.00) in federal tax. State tax rates are based on requirements of state law. Employers pay this tax annually by filing IRS Form 940.

State Unemployment Tax (SUTA)

SUTA is an employer paid tax not withheld from employee's pay. After you register your business with the Department of Employment and Economic Development, you will receive a rate notice. This rate notice will tell you how much SUTA you will have to pay. Employers who have a higher rate of laying off employees will see their rates go up, while more stabile employers will see their rates go down to less than 1%. This is called experience rating.

Conclusion

The distinction issues between employees and independent contractors only worsen the complexity of these laws. Also, wage hour laws, union fringe benefit plans, pension plans and tax deferred retirement plans, and leased employees make an employer's responsibilities more complex.

It is advisable to hire outside payroll processing company or accounting firm to handle all of these filings. There are several reasons for doing this. First, it saves a considerable amount of time on the part of the employer. Unless you have a full time accounting person, an employer with only 6-10 employees will find that the time commitment of payroll tax withholding, reporting, and depositing is tremendous. Secondly, these payroll professionals stay current on the law changes, and are in a better position to keep employers from underpaying or overpaying the taxes. In the event that the professional underpays, you should be able to have penalties abated under audit by saying you "reasonably relied on the advice of experts." This is the only situation short of a natural disaster where you will be able to claim such relief. Finally, employers who use professional payroll services are less likely to be audited.

The cost of such services is minimal, and the benefits of avoiding a payroll tax audit far outweigh these costs. Payroll taxes and the cost of withholding should be seen as a cost of doing business early on. As your business grows, you will come to accept these costs and you will appreciate the security that such services provides.

For more information, please visit us at www.haag-law.com.

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