Hiring your first employee (or finally giving the founders an actual paycheck) is an exciting step in a business. While many businesses think long and hard about whether they can afford to take on employees, they may not realize how big their employment tax responsibilities are.
If you don't properly withhold, report and pay payroll taxes, your business could be at risk of being shut down by the government. Here's what you need to do when you're ready to put your first employee on payroll.
What Employment Taxes You Need to Collect
Employers must collect all federal and local taxes from their employees, including the following.
Federal Income Taxes
Withhold federal income taxes based on each employee's annualized income. Use the IRS withholding tables to determine how much to withhold.
Social Security and Medicare Taxes
Employers and employees share responsibility for Social Security and Medicare taxes. You withhold roughly half of the taxes from the employee's wages and pay the remainder of the tax from your own funds.
Use Publication 15 to determine the exact amounts due.
Federal Unemployment Tax
You must also pay a Federal Unemployment Tax (FUTA) from your own funds. The rate for 2016 is 6 percent of the first $7,000 of each employee's wages.
Workers compensation is technically an insurance program, not a tax, but your payments are usually tied to your payroll. Each state sets workers compensation laws, so the requirements vary by state.
In general, you need to purchase a private insurance policy, enroll in a state-sponsored plan or prove that your business has the financial means to self-insure.
State Income Taxes
State income tax withholding is similar to federal income tax withholding but paid and reported to the state. For example, California handles its payroll taxes through the Employment Development Department.
Report income taxes to the state where the employee physically worked, regardless of their home address. Employees who live in another state are responsible for filing income tax returns in their own state and requesting any refund owed from your state.
What You Need From Your Employees
When you hire an employee, you must collect a completed IRS Form W-4. Your state may also require you to collect a similar form for state income taxes.
The W-4 tells you the employee's marital status, number of withholding allowance, and if they request additional withholding. Use this information when calculating how much to withhold from each paycheck.
If an employee's wages change, you do not need a new W-4. Use the information on the original W-4 when you recalculate their withholding.
Employees are responsible for notifying you of any changes in their allowances, marital status or withholding by providing a revised W-4. You must adjust their withholding within 30 days of receiving the completed form.
What to Do With Withheld Employment Taxes
You must deposit withheld federal employment taxes using the Electronic Federal Tax Payment System. Make monthly deposits if your tax liability for the preceding four quarters was $50,000 or less. Make semi-weekly deposits if your tax liability was greater.
You must also file a quarterly Form 941 detailing the income taxes, Social Security, Medicare and FUTA taxes you withheld. If you use online bookkeeping services, you should be able to quickly generate a report that lets you easily fill out this form.
If you withheld taxes for one or more states, each state will have a similar process. Using a professional payroll services company in conjuction with outsourced bookkeeping services can help alleviate the burden on you to stay on the right side of all of this record keeping and processing.
*This blog post is not tax or legal advice. Please consult your CPA or tax attorney to find out which taxes your business is responsible for paying.