Before you hire your first employee, you might think, “Great, I hire someone for $30,000, give them a check once a month for $2,500, and away we go.”
If only things were that simple. As it turns out, that $30,000 employee is likely to cost you closer to $35,000, once everything is accounted for.
Today, we’re looking at one part of that increased expense—payroll taxes.
Someday, we’ll look at how much holidays, healthcare, retirement, and all the rest add to your cost base, but for now, it’s time to focus in on taxes.
What are payroll taxes?
“Payroll taxes” is a catchall term for the taxes paid by an employer or employee each pay period. Those taxes include income tax, Social Security, Medicare, and federal unemployment tax, or FUTA.
These are the federal requirements, but you may find additional state and local requirements, depending on where you operate.
Payroll taxes are so called because they’re associated with payroll.
Employment tax buckets and your responsibilities
There are two sorts of payments you, the intrepid employer, need to make: the ones that are based on the specific person you’re paying and their circumstances, and the ones that are simply based on the fact that you’re paying anyone at all
A slightly different division cuts between who is responsible for the payment of those taxes. While you’ll be deducting income, Social Security, and Medicare taxes from each paycheck, you’re not ultimately responsible for paying all of those taxes out of your own pocket.
Technically, all of the income tax and half of each of the other two are on the shoulders of your employees to pay. You might manage the process, but you’re only on the hook for half of the Social Security and Medicare payments.
On top of those halves, you do have to pay FUTA tax. FUTA is a percentage of your employee’s income, but it’s also capped: “The FUTA tax rate is 6.0%. The tax applies to the first $7,000 you paid to each employee as wages during the year.”
Now, let’s take a closer look at each bucket.
Federal income tax is broken into brackets, where employees pay a higher percentage of their income on higher earnings.
For instance, if you pay an employee $100,000, they’ll owe $20,984.75. That’s made up of:
- $932.50, equal to 10% of the first $9,325 in income, plus
- $4,293.75, equal to 15% of the income between $9,325 and $37,950, plus
- $13,487.50, equal to 25% of the income between $37,950 to $91,900, plus
- $2,268.00, equal to 28% of the income between $91,900 and $100,000
In 2017, the upper end of income tax hits 39.6%. (I have no idea why that 0.6% is in there. I imagine it’s a political thing, but it could also be a product of an intense, all-night, soda-fueled binge at the IRS.)
All of those numbers don’t actually mean much, though, because almost everyone claims some exemptions, which changes the math completely. And some folks don’t have any tax taken out, putting it all aside and making their payment when April rolls around.
Income taxes are on the employee. If John says he has 15 exemptions, well, you might want him to double check, but ultimately it’s his responsibility. You’re not legally required to check his math, though you do need to withhold the taxes he asks you to withhold.
Federal unemployment (FUTA) tax
FUTA lies at the other end of the spectrum: As an employer, you are 100% on the hook for this thing. FUTA taxes are paid on the last day of each quarter, but there’s a limit to your obligations.
For federal purposes, you pay 6% of each employee’s income, but that maxes out when their income reaches $7,000. That puts an effective $420 ceiling on your annual payments per employee. You may also have to pay state-level unemployment tax, but those state taxes can generate credits for your federal debt.
Social Security and Medicare taxes
Between you and your employee, the government will get the equivalent of 12.4% of your employees’ income. Half of that (6.2%) is taken from their paycheck with the other half paid by you, the employer.
The same setup goes for Medicare, though the rate is just 2.9%, or 1.45% from each party.
Social Security has a cap at $127,200 of income. At that point, everyone is off the hook. Medicare has no such cap, so you’ll just keep on paying and paying until your eyes bleed. At which point you may be eligible for coverage under Medicare.
Contractors and the self-employed
If you issue a 1099 at the end of the year to your contractors, you can ignore this stuff. Those folks are responsible for their own taxes from top to bottom.
As a bonus, if you’re a self-employed worker, you’ll need to pay both sides of Medicare and Social Security—you’re the employer and the employee. There are plenty of payroll services just for self-employed folks, though, so don’t worry about that too much.
Quick and dirty guide to payroll taxes
To sum everything up, here’s the super-quick guide to your financial responsibility as an employer versus what your employees’ when it comes to payroll taxes:
|Type of payroll tax||Employer responsibility||Employee responsibility|
|Federal Unemployment (FUTA)||100%||0%|
Payroll software to make your life easier
You can figure all this stuff out on your own, assuming you don’t mind a little Excel work. However, there are real penalties and fines for underpaying. You may also be staring down a roomful of furious employees if April rolls around and they discover that you’ve accidentally withheld too little, leaving them with a surprise tax bill.
Payroll software can alleviate some or all of the burden. Depending on what you’re looking for, you can get anything from a basic calculator to a full-service provider that calculates and cuts checks for you.
We compared a few payroll services last year, if you’re in the market.
Looking for Accounting software? Check out Capterra's list of the best Accounting software solutions.