Taxation

Employment Taxes for Small Businesses

If you own a small business, you have many more tax matters to be concerned about than the average taxpayer. Whether you have workers on the payroll or if you work for yourself, you have obligations for federal employment taxes.

If you don't live up to your responsibilities, you face stiff fines and penalties by the IRS. So it pays to have a good understanding of your employment taxes.

Employers

If you have employees, you have responsibilities for income, Social Security and Medicare, and federal unemployment taxes.

Income Taxes

You have to withhold federal income taxes from each of your employees' wages. You have to make the withholding essentially at the same time they earn their wages, so withholdings usually are made from each paycheck.

How much do you withhold? Each employee must give you a completed W-4 Form. It estimates the employee's income taxes based on personal exemptions and withholding status - married or single. The number of exemptions claimed sets how much tax is withheld.

If a worker doesn't give you a W-4, the IRS requires you to treat the worker as a single person who's claiming no withholding exemptions, and withhold the necessary taxes.

Social Security and Medicare Taxes

You have to withhold Social Security and Medicare taxes, or Federal Insurance Contributions Act (FICA), from each employee's wages. Social Security taxes pay for your employees' retirement, survivors, and disability insurance. Medicare taxes pay for hospital insurance.

Again, you typically withhold them from each paycheck.

In addition to withholding each employee's share, you have to pay a share of FICA taxes, too.

How much? For 2010, the amount you have to withhold from each employee's wages for Social Security is 6.2 percent. For 2011, it's 4.2 percent. For both 2010 and 2011, the withholding applies only to the first $106,800 of each employee's wages. This is called a wage base limit. Wages above that amount aren't taxed for Social Security.

As for how much you pay in Social Security taxes, for 2010 and 2011, it's 6.2 percent on to the first $106,800 of each employee's wages.

As for Medicare, for both 2010 and 2011, you have to withhold 1.45 percent from each employee's wages, and you pay a matching amount. There's no wage base limit for Medicare tax, however.

Federal Unemployment Tax (FUTA)

FUTA provides unemployment compensation payments to workers who lose their jobs. You, and only you, pay FUTA taxes. It's not withheld from your employees' wages. Employers who have to pay FUTA are those who, during the current or last year (2010 or 2011, for example):

  • Paid wages of $1,500 or more during any calendar quarter
  • Employed at least one employee for at least some part of a day in any 20 or more different calendar weeks

For all of 2010 and up to June 30, 2011, you have to pay 6.2 percent on the first $7,000 of each employee's wages. On and after July 1, 2011, your payment drops to 6 percent.

Reporting & Paying

You report income, Social Security and Medicare taxes to the IRS on Form 941 if you file income tax returns quarterly, and on Form 944 if you file annually. You report FUTA taxes on Form 940.

You pay employment taxes by depositing electronically; mailing, or delivering a check, money order or cash to an authorized financial institution; or using the Electronic Federal Tax Payment System (EFTPS).

Penalties

If don't withhold these taxes you'll have to pay them out of pocket. If an employee eventually pays the tax, you may still be liable for interest or penalties. The penalty is equal to 100 percent of the income, FICA, and FUTA taxes that weren't withheld. The penalty doesn't apply to your share of FICA or FUTA taxes.

More Taxes

In addition to these federal taxes, you're probably responsible for:

Taxes and Self-Employment

If you're self-employed, such as an independent contractor, then you have to pay self-employment tax (SE). Essentially, this tax covers the same things as the Social Security and Medicare taxes paid by most other employees. However, because you're both the employer and the employee, you have to pay both shares of the tax.

  • For 2010, your tax is 15.3 percent of your first $106,800 - 12.4 percent for Social Security and 2.9 percent for Medicare
  • For 2011, it's 13.3 percent of your first $106,800 - 10.4 percent for Social Security and 2.9 percent for Medicare.

You report SE tax on Schedule SE, which you attach to your 1040 tax return. You can arrange to have employment taxes withheld, but it's usually difficult to do because most self-employed workers don't know exactly when and how much they'll get paid. So, most self-employed workers pay estimated tax, where you pay taxes, both employment and income taxes, in installments, based upon what you expect to earn in the year.

Questions for Your Attorney

  • How do I calculate my 2010 taxes if I was self-employed for several months and then started working full-time for someone else?
  • I'm an independent contractor, but I work almost exclusively for one company. Doesn't that make me the company's employee, so shouldn't it be paying and/or withholding my employment taxes?
  • I made a mistake in withholding taxes for my workers. Can I file an amended return? Should I?

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