Payroll Tax Basics for New Employers

Hiring your first employee is an exciting milestone, but it comes with significant payroll tax responsibilities. Failing to withhold, deposit, and report payroll taxes correctly can result in substantial IRS penalties. Understanding the basics is essential for every new employer.

Federal Payroll Tax Obligations

As an employer, you are responsible for several federal payroll taxes:

• Federal income tax withholding: Based on the employee's W-4 form and IRS withholding tables
• Social Security tax: 6.2 percent of wages up to the annual wage base, matched by the employer
• Medicare tax: 1.45 percent of all wages, matched by the employer (employees earning above $200,000 pay an additional 0.9 percent, which the employer does not match)
• Federal unemployment tax (FUTA): 6.0 percent on the first $7,000 of each employee's wages, with a credit of up to 5.4 percent for state unemployment taxes paid

You must also obtain an Employer Identification Number (EIN) from the IRS by filing Form SS-4 before making your first payroll tax deposit.

Depositing Payroll Taxes

The IRS requires electronic deposit of payroll taxes through the Electronic Federal Tax Payment System (EFTPS). Your deposit schedule depends on your tax liability:

• Monthly depositors: Employers with a tax liability of $50,000 or less during the lookback period deposit by the 15th of the following month
• Semi-weekly depositors: Employers with a liability exceeding $50,000 deposit on Wednesday or Friday depending on payday
• Next-day deposit: If your accumulated tax liability reaches $100,000 or more on any day, you must deposit by the next business day

New employers without a lookback period are generally monthly depositors.

Reporting Requirements

Employers must file several tax forms:

• Form 941: Quarterly report of federal income tax, Social Security, and Medicare taxes (filed by April 30, July 31, October 31, and January 31)
• Form 940: Annual FUTA tax return (filed by January 31)
• Form W-2: Annual wage and tax statement for each employee (furnished to employees by January 31, filed with SSA by January 31)
• Form W-3: Transmittal of W-2 forms to the Social Security Administration

State Tax Obligations

In addition to federal requirements, most states impose:

• State income tax withholding: Rules vary by state; some states have no income tax
• State unemployment insurance (SUI): Rates vary based on your industry and experience rating
• State disability insurance: Required in a few states including California, New Jersey, New York, Hawaii, and Rhode Island
• Local taxes: Some cities and counties impose additional payroll taxes

Register with your state's tax and employment agencies before making your first hire.

Avoiding Common Mistakes

New employers frequently make these payroll tax errors:

• Missing deposit deadlines, which triggers automatic penalties
• Failing to account for the employer's matching share of Social Security and Medicare
• Not registering with state agencies before hiring
• Misclassifying employees as independent contractors to avoid payroll taxes
• Using payroll tax funds for other business expenses (this is a trust fund obligation, and the IRS can hold business owners personally liable for unpaid trust fund taxes under the Trust Fund Recovery Penalty)

Consider using a reputable payroll service to handle calculations, deposits, and filings, especially when starting out. The cost is modest compared to the potential penalties for errors.