- How do you calculate payroll taxes?
We're going to talk all about it in this video.
Hi everyone, I'm Hector Garcia.
I'm a CPA, QuickBooks consultant and business owner.
I'm a big fan of Intuit QuickBooks, and I'm partnering
with them to produce this video series about payroll.
In fact, I have an entire YouTube channel,
where I have tons of videos
about QuickBooks, accounting, tax,
and a bunch of important smart business topics.
Hit the like button, if you're interested
in seeing more videos of these topics.
Today I'm gonna talk about how to calculate payroll taxes.
Now it's important to acknowledge
that most small business owners, use payroll software
or outsource their payroll.
So they don't actually see
or have to deal with these calculations
in order to generate a proper paycheck.
However, it behooves every small business owner
to understand what is happening behind the scenes
of the payroll software or service,
and understand how their wage expenses are distributed
and essentially,
how their employees net paychecks are calculated.
We're going to split tax calculation into two groups.
We're gonna have federal and state and local.
Additionally, you will hear me talk
about employee versus employer taxes,
because both parties actually incur tax
in one way or the other.
When I mention employees taxes, these are the ones
that you can actually see in their paychecks
as a reduction towards their net pay.
While the employer taxes are accrued
by the employer simultaneously
and they're not seen on the paychecks.
Both of these are remitted by the employer
as part of the responsibility.
Let's start with federal taxes, AKA the IRS.
Employees will see in their paychecks
three types of federal taxes.
First, they're gonna see federal withholding,
which is typically tied to the tax bracket of the employee
depending on their income level and marital status.
There's a publication
by the IRS called Publication 15-T,
that has information about all of these tax tables.
There's also Social Security withholding,
which is actually split between employee and employer.
So the employee sees the 50%
of the total amount in their paycheck.
As of 2021, the total rate of employee wages
towards Social Security is 12.4,
which half is paid by the employer and half by the employee.
The Social Security withholding limit
is to the first $142,800 of their wages,
and after that, there's no more Social Security withholding.
Beyond 2021. you can expect
that limit to increase every year
by 3 to 5% as it has done in the past.
This number is announced and published by both the IRS
and the Social Security Administration every year.
Next, is Medicare withholding.
This is also split between employers and employees
and the total amount is 2.9% of those gross wages.
Medicare doesn't have a limit
or a cap like Social Security,
so it's applied at all income levels.
The combined tax of Social Security and Medicare
is often referred to as FICA,
which is a total of 15.3% of the wages
that is paid 7.65 by the employee
and 7.65 by the employer.
Beyond the matching of the FICA tax that we mention here,
the employer also has additional taxes.
We have the federal unemployment tax
often referred to as FUTA,
this tax in 2021 could be as slow as 0.6%
to as high as 6% of the first $7,000 worth of wages.
Depending on the state that you're in and whether or not
they will get a special credit of 5.4% reduction
if you have actually paid
the state version of the unemployment taxes,
check with your state to see
if the rate reduction applies in your state.
Let's move into state and local tax.
Unfortunately, this is literally different
across 50 states and numerous cities across the US.
I will mention the typical taxes that we expect to see here.
First, we have state income tax withholding.
This is similar to federal tax withholding
but it's a flat or tiered percentage in several states.
However, some states have an actual withholding tax table
just like the IRS.
Also, in some cases you will see a local tax levied
by cities, municipalities or counties
charged to the employees as an additional income tax.
This is most typically seen in larger metropolitan areas
such as New York City or San Francisco.
For example, if an employee lives in San Francisco,
they will also pay an additional flat
1.5% city tax on their income.
Both of those I just described are at the employee level.
So they will see this tax in their pay stubs
as a reduction of the net pay.
But there's also
some typical state taxes paid by the employer.
For example, we have the state unemployment tax,
often referred to as SUTA,
employees will not see this on their paychecks.
Also states charge additional state level taxes to employers
to fund employee benefiting programs such as training
or retraining programs for unemployed individuals.
All that being said, it is important to point out
that most payroll software connects digitally
to the taxing authorities
and receives updates regarding tax rate changes.
This will update the payroll system in real time,
so your payroll taxes get calculated accurately.
All these taxes I mention,
whether they're being paid by the employee
through a reduction of their net paycheck
or incurred by the employer
need to be remitted by the employer
in a proper and timely matter.
I'll also throw one last curve ball at you.
Not all gross wages are subject to tax.
For example, an employee can elect to have
their health insurance paid by the employer,
but their portion paid through payroll.
So that portion of health insurance paid by the employee
is actually not subject to payroll taxes.
A little bit more complex is a 401-k retirement plan,
because all contributions to your 401-k
are not subject to federal tax, but are subject to FICA.
So as you can tell, every payroll item
needs to be looked at individually
to determine which tax is applied to each one.
I strongly recommend my clients to use QuickBooks
for their accounting with QuickBooks payroll
to make all these calculations seamlessly
and concentrate on doing what they love to do.
There are hefty penalties for employers that do not pay,
pay late, or make mistakes paying these payroll taxes.
So it's important to have a process in place
to make sure these payments are made accurately and timely.
Let's do a simple example.
Let's say we have an employee in Florida,
which doesn't charge state income tax or even local taxes,
meaning that you will not see tax withholding
at the state level in the employee's cheque.
This employee makes $1000 a week,
so let's break it down.
Mike is single and works for a Florida-based company.
His gross wages are $1000 a week.
In the further withholding tax table
according to publication 15-T,
his federal withholding would be $87.
Then you can have Social Security tax for $62
which is 6.2% of the gross wages,
then you will see Medicare, which is $14.50,
which is 1.45% of the wages,
and finally, a net paycheck
of $836.50.
Now, let's see how the employer
is going to accrue their portion of tax.
You're gonna see the same Social Security for $62
and Medicare, $14.50 amount
as a matching portion of the FICA tax.
In addition, you gonna see the federal unemployment tax
or the FUTA out for $6,
which is 0.6% of the first $7,000.
You're gonna see the state unemployment tax,
which happens to be 2.7% of the first $7,000,
so that will be $27.
So the employer paid in cash $836 in the paycheck,
paid $240 to the IRS
as a combination of federal withholding and FICA tax,
paid $6 to the IRS in connection to FUTA,
paid $27 to the state in connection to SUTA,
and that's a total of $273 in taxes
remitted to the government.
If you add up the net paycheck and the taxes paid,
that is $1,109.50,
which is a total cash outlay by the employer,
which is about 10% above the actual wages.
This percent will vary greatly state by state.
So it safe to estimate that the tax overhead
for being an employer could vary between 8 and 15%.
So if you are in a traditionally employer tax friendly state
like Wyoming or South Dakota,
your tax burden as an employer will vary greatly
compared to states with much higher tax burdens
like California or New York.
For example, in California
you will need to add the following.
State disability tax, which is 1.2%
of their first $128,000 in 2021
and state income tax on the employee's paycheck calculation
based on their individual income tax table.
The employer also needs to pay a training tax
which is 0.1% of the first $7,000.
In conclusion, payroll taxes are not a walk in the park
if you need to manage this manually,
but if you use payroll software like QuickBooks Payroll
it would feel like it is.
If you have any questions or comments,
leave a comment below.
And as always remember to click the like button
if you have found this video helpful,
and be sure to subscribe to the QuickBooks YouTube channel,
so you don't miss out on future videos like this.
I'm Hector Garcia, thanks for joining me
and I'll see you next time.
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