PAYROLL TAXES: FEDERAL

Back in the day, employers didn’t have to spend the time and energy taking out taxes from your paycheck.  Employees would just have to pay their full amount of taxes come tax day, but these employees were irresponsible and never set enough money aside to pay their taxes.  They spent it all.  So now employers are required to take a chunk out of your paycheck and send your share to the government.  Employees no longer have that extra money for investing and employers no longer have free time.  Good work, everybody! 

Let's take a look at all the federal payroll taxes:

- Federal Income Tax (FIT)

- Federal Insurance Contributions Act (FICA)

                                  - Social Security Tax

                                  - Medicare Tax

- Federal Unemployment Tax Act (FUTA)

Federal Income Tax (FIT)

The Federal Income Tax is levied by the Internal Revenue Service (IRS).  This money is used by the government to pay for the growth and upkeep of the country.  They spend the money on infrastructure, police, education, and all other public facilities and services.  Your federal tax is basically your fee to use all these resources.  This is the largest source of revenue for the federal government.  Income Tax is taken from an employee’s wage, it is not matched by the employer.

 

Use the information gathered from your employee’s W4 in tandem with the withholding tables located on the Federal Income Tax Withholding Methods (Publication 15-T) to determine what percentage must go to income taxes.  Several factors influence the amount of income tax withheld, including your filing status (single, married, etc.) and how many dependents (people you financial support) you have.

 

As an employee, you and your dependents each represent an “allowance” on your W-4.  The more allowances you claim, the less tax you pay upfront and the more money you’ll see in your paycheck.

 

The goal is to be accurate.  You don’t want your employer to withhold too little money, because then you’ll have to make up the difference with a large lump sum come tax day.  But if the employer withholds too much money, you might get a nice refund come tax day, but you will have had to survive the entire year on less money.

 

The United States has a progressive tax system, which means that as you move up the pay scale, you also move up the tax scale.  As of 2020, there are seven tax brackets:

10%                        $0                                to             $9,875

12%                        $9,876                        to            $40,125

22%                        $40,126                      to            $85,525

24%                        $85,526                      to            $163,300

32%                        $163,301                   to            $207,350

35%                        $207,351                   to            $518,400

37%.                       $518,401 or more

You’re income is taxed as it works its way up the scale.  So your first $9,875 will be taxed 10%.  The next batch of income will be taxed 12% until you cross $40,125.  Then the next batch of income will be taxed 22% and so on.

 

 

Federal Insurance Contributions Act (FICA)

There are two parts to FICA: Social Security and Medicare.  Each of these taxes is reported separately.  

 

Social Security is the common and now standard term for the Old-Age, Survivors, and Disability Insurance program (OASDI).  Social Security is basically your government-run retirement fund.  You pay into this fund throughout your life (via taxes on your paycheck) and then collect your monthly benefit payout when you retire.

 

The Social Security Tax is paid by the employee and then matched by the employer.  The tax amount is based off the employee’s wage.  There is also a wage limit.  Anything beyond this limit is not taxed.  As of 2020:

Employee Pays:            6.2%            on the first $137,700

Employer Pays:            6.2%            on the first $137,700

Medicare is the common and now standard term for your federal Hospital Insurance and Medical Insurance.  Medicare provides health coverage for people sixty-five and over.  This program also covers people under sixty-five who have a disability.  Whether or not you fit those descriptions, you still pay into the program.

 

The Medicare Tax is paid by the employee and then matched by the employer.  The tax amount is based off the employee’s wage.  There is also the Additional Medicare Tax that only applies to employees who make a certain wage.  Employers do not match the Additional Medicare Tax.  As of 2020:

Employee Pays:            1.45%            on the first $200,000

Employee Pays:            2.35%            on anything over $200,000

Employer Pays:            1.45%            on all wages

The Additional Medicare Tax is 0.9%.  This tax is only applied to income over $200,000.   This tax is in addition to the standard rate of 1.45%, which brings your total to 2.35%.

 

 

Federal Unemployment Tax Act (FUTA)

FUTA provides unemployment compensation to workers who have lost their jobs.

The federal government collects unemployment funds and pays into the state unemployment funds, known as State Unemployment Tax (SUTA).  The federal funds help to supplement what the states collect through their own unemployment taxes.  Only the employer contributes to FUTA taxes.  The tax amount is based off the employee’s wage (but not taken out of their wage).

 

If your state is in good standing with the IRS (meaning your state didn’t borrow a bunch of federal funds to pay for unemployment compensation), then you receive a tax credit (the amount varies).  Mostly all states are currently in good standing.  You must also submit any state unemployment taxes on time to receive the credit.

 

As of 2020, the FUTA tax rate is 6%.  But if you receive the maximum tax credit (which most states do), then you can remove 5.4%, leaving a FUTA tax rate of just 0.6%.  The FUTA tax rate also only applies to the first $7,000 of income.

Employer Pays:              0.6%             on the first $7,000 of employee’s wage

Deposits and Paperwork

There is a lot of paperwork that needs to be filed and a lot of money that needs to be deposited when doing payroll taxes.  You’ll first need to learn how to deposit all the taxes you’ve been collecting.

 

For FICA (Social Security & Medicare) and FIT (Income Tax), you will have a set schedule of when you must deposit the withheld taxes.  You will deposit both at the same time.  There are two deposit schedules: monthly and semiweekly.  

 

Your schedule is determined by your Lookback Period.  The Lookback Period starts July 1st and extends one full year to June 30th.  So for 2020, you’re Lookback Period would be July 1st, 2018 through June 30th, 2019.

 

If you reported payroll taxes under $50,000 during your Lookback Period, then you’ll deposit monthly.  Over $50,000, you deposit semiweekly.  New employers with no Lookback Period are by default on a monthly schedule.

 

If you’re on a monthly schedule, you have until the 15th of the following month to deposit your FICA and FIT taxes.

 

If you’re on the semiweekly schedule, and pay your employees on either Wednesday/Thursday/Friday, then you must deposit FICA and FIT taxes by the following Wednesday.

 

If you’re on the semiweekly schedule, and pay your employees on either Saturday/Sunday/Monday/Tuesday, then you must deposit FICA and FIT taxes by the following Friday.

By the way, the IRS should not call it semiweekly.  Semi would imply you are making a deposit every half week.  You’re only making a deposit after you’ve had payday.  So if you’re employee gets paid every two weeks, you’d make a deposit every two weeks.  It should be called the Payday Deposit Schedule.  Get it together, IRS. 

 

Whether you are a monthly or semiweekly depositor, if you accumulate over $100,000 in taxes on any day during a deposit period, you must deposit the tax by the next business day.  This is called the $100,000 Next-Day Deposit Rule, and if it happens, you automatically become a semiweekly depositor for the rest of the year and the following year.

 

The Electronic Federal Tax Payment System (EFTPS) is a free service where you can pay any tax due to the Internal Revenue Service.  You’ll need to enroll through their website (www.eftps.gov/eftps/).  You must use this service to make all federal tax deposits.

 

Now for the paperwork.  You will need to file Employer’s Quarterly Federal Tax Return (Form 941).  You file this every quarter.  This is basically a summary of all the FICA and FIT taxes you submitted during that quarter.

 

Form 941 is due by the last day of the month that follows the end of the quarter:

1st Quarter (Jan, Feb, Mar)                           April 30th

2nd Quarter (Apr, May, Jun)                        July 31st

3rd Quarter (Jul, Aug, Sep)                          October 31st

4th Quarter (Oct, Nov, Dec)                        January 31st

You can file online (IRS.gov/EmploymentEfile) but the IRS requires you use approved commercial tax preparation software.  Otherwise you’ll need to mail the form into your specific district (https://www.irs.gov/filing/where-to-file-your-taxes-for-form-941).

 

And now for your FUTA (Unemployment) taxes...

 

FUTA taxes are deposited through the Electronic Federal Tax Payment System (EFTPS) just like FICA and FIT taxes.  This deposit is not done monthly or semiweekly, this deposit is done quarterly.  And the deposit is due by the last day of the month that follows the end of the quarter:

1st Quarter (Jan, Feb, Mar)                           April 30th

2nd Quarter (Apr, May, Jun)                        July 31st

3rd Quarter (Jul, Aug, Sep)                          October 31st

4th Quarter (Oct, Nov, Dec)                        January 31st

If the tax collected for the quarter is under $500, you don’t have to make a deposit.  Instead, you will carry that amount forward into the next quarter.  Once your accumulated tax is over $500 for the quarter, you must then make your deposit.

 

And now for the paperwork.  You will need to file Employer’s Annual Federal Unemployment Tax Return (Form 940).  It summarizes what FUTA taxes you paid during the year.  This form is filed annually and due by January 31st.

 

You can file online (IRS.gov/EmploymentEfile) but the IRS requires you use approved commercial tax preparation software.  Otherwise you’ll need to mail the form into your specific district (https://www.irs.gov/filing/where-to-file-your-taxes-for-form-940).  Sound familiar?

 

Self-Employment Tax (SE Tax)

If you’re the owner of a business, you’re not considered an employee and your paycheck wouldn’t be subject to all these payroll taxes.  But just because you’re self-employed, doesn’t mean the government will let you not pay any taxes.

 

So the government created the Self-Employment Tax.  This tax is simply based off the FICA (Social Security & Medicare) rates and rules.  For an employee, you would withhold their FICA taxes and then match that amount.  But for yourself, you just pay the combined total.  As of 2020:

Self-Employed Pays:         12.4%                      on the first $137,000           

                                                2.9%                        on the first $200,000

                                                3.8%                        on anything over $200,000

You will make your tax deposits using The Electronic Federal Tax Payment System (EFTPS).

 

For some reason, the IRS just doesn’t say: “Hey, pay your fair share of the FICA taxes.”  They had to relabel the entire process as a Self-Employment Tax.  Which means there is a different document that needs to be submitted: Estimated Tax For Individuals (Form 1040-ES).  This form is submitted quarterly:

1st Quarter (Jan, Feb, Mar)                         April 15th

2nd Quarter (Apr, May, Jun)                      July 15th

3rd Quarter (Jul, Aug, Sep)                        October 15th

4th Quarter (Oct, Nov, Dec)                       January 15th

You must still pay FIT (income) taxes, which you will withhold and remit with your quarterly Self-Employment Tax.

 

Self-employed individuals don’t pay FUTA (unemployment) taxes. 

 

If you’re the owner of an S-Corp, Self-Employment Taxes do not apply to you.