Payroll can be one of the biggest expenses for your business so doing it right is important. By paying employees the correct amount on the correct day not only makes your employees happy, but it keeps you in compliance with the IRS and other tax-collection entities.
With so many laws and regulations constantly changing, it’s difficult to be sure you’re in compliance. Here are some important factors to consider before recording and filing your payroll taxes.
Federal taxes you’re legally obligated to collect
First, you need to determine who is an employee and who is an independent contractor. You are only responsible for payroll taxes for employees. The IRS has very specific rules about the differences so make sure you classify your workers carefully. Improper classification can put up a red flag for the IRS.
Once you know who fits the guidelines, you need to determine which taxes you’re collecting. Like all other business owners, you have to collect federal payroll taxes for:
- Federal income tax withholding
- Social Security
Federal income tax varies from employee to employee and is based on how many exemptions each one claims on his or her federal W-4 form. Since rarely are two employees’ incomes and exemptions equal, you must make careful calculations for each employee you have.
Both Social Security and Medicare are funded by the Federal Insurance Contributions Act (FICA) tax. These funds provide benefits for the disabled, children of deceased workers, retirees and their survivors, and hospital insurance for the elderly. FICA is based on a specific amount of gross wages. (For example in 2013, that amount is $113,700.)
Other taxes that may come into play
You also have to pay federal unemployment taxes (FUTA), and depending on your state, state unemployment taxes, though these are employer-paid and not deducted from employees’ salaries.
Your employees, however, may also be responsible for taxes other than federal — such as state, school district, county and/or municipal taxes — and it’s your responsibility to collect them.
More than 40 states currently have state income tax. If you have employees who live in different areas or different states, then your employees’ taxes may differ from person to person.
But beware of sudden changes
Unfortunately, even if you understand your responsibilities in collecting taxes, those taxes may change. New legislation, lapsing or temporary tax breaks, and newly instituted rules can mean sudden changes that will force you to adjust your payroll – sometimes with little warning.
“Legislative changes to the tax code often happen in the 11th hour — with little time to make the changes before your next payroll needs to go out,” says John Kennedy, president of payroll services at Insperity. “It’s important that you or your payroll provider is able to update tax changes in an instant.”
If tax rules change and your payroll is due, you may have to scramble to adjust your calculations and ensure that your new figures are accurate. You may also need to make sure that your employees understand why their paychecks have changed.
The penalties of payroll mistakes
Though complicated, the process of accurately collecting payroll taxes is imperative for your business. Taxes that are incorrectly collected or reported can result in fines and escalating interest fees.
Improperly paid payroll taxes for the federal taxes alone can result in an automatic penalty of two to ten percent with the percentage increasing the longer the delay. Failing to prepare a W-2 or submitting an incorrect one results in a $50 penalty for each statement. The compounding costs can end up crippling a business.
Of course the best way to avoid penalties and the attention of the IRS or other tax authorities is to pay taxes correctly and on time in the first place. It keeps your employees happy; it keeps tax agencies happy and most of all; it keeps your business running smoothly. And isn’t that what you’re aiming for?
We are, too. For help keeping in compliance with the complicated world of tax information while getting your payroll out on time, check out Insperity® Workforce Acceleration.