Posted in Payroll | by: Danielle Grant

Where Does the Money Go? A Payroll Tax Primer for Small Businesses

Every time you pay your team, there’s an alphabet soup of tax terms staring back at you. What do they all mean? Why do you have to pay them all? And who exactly is this FUTA person anyway? Well, we’re here to clear up the confusion. This post will break down all the different payroll taxes out there, so you can have a more solid understanding of where exactly your money goes.

At a glance

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Taxes you and your team have to pay

Social Security

Let’s secure our Social Security knowledge. In 1935, President Roosevelt signed the Social Security Act to provide a cushion for people when they hit retirement age. Why is this so important? Because today, two out of three senior citizens rely on Social Security for supplemental income.

To make the program work, you and your team contribute to it every paycheck, which comes out to 6.2 percent of your employees’ gross (total) income.

Medicare

Similar to Social Security, Medicare is a system that was created in 1966 to provide health insurance for people 65 and older, along with those who have certain disabilities. In 2010, around 48 million Americans benefitted from health insurance under the program.

So how do we take care of Medicare? Sustaining it means that both you and your employee are required to pay 1.45 percent of their total income to the program, while people who make over $200,000 need to contribute an additional 0.9 percent.

Taxes only you have to pay

Federal unemployment taxes (FUTA)

FUTA — one of the coolest-sounding terms you’ll see on payday. The Federal Unemployment Tax Act, or FUTA for short, is there to provide a buffer for people who have recently lost their jobs.

Being on time pays off here. While it’s true that employers have to pay 6 percent toward FUTA, companies who pay their state unemployment taxes on time receive a 5.4 percent credit reduction. After all is said and done, the FUTA tax rate equals 0.6 percent of all taxable wages — up to the first $7,000 earned for each employee. You can expect it to be in the ballpark of $42 per worker, per year.

State unemployment taxes

Just like FUTA, state unemployment insurance (SUI) is another safety net for people who are looking for a new gig. Nearly every state has a different tax rate, which is usually determined by the type of business you have and your history with unemployment claims. Head over to the US Department of Labor’s state law website to learn more about your particular rate.

Taxes only your employees have to pay

Federal income tax

Say hello to the most hotly debated tax today: the federal income tax. This tax is paid by employees only and is calculated off of their total income, filing status, and personal exemptions. Excluding any deductions, the minimum federal tax rate is 10 percent and the maximum federal tax rate is 39.6 percent for any income over $415,050 (for single filers) or $466,950 (for married joint filers). Take a peek at the estimated 2016 federal income tax brackets right here.

State income tax

Most states collect income tax too. Looking at the average US household income of $53,657, the states with the highest income tax for a single filer (after the standard deduction and exemption) are:

  • Oregon (8.17 percent)
  • Hawaii (6.34 percent)
  • Tennessee (5.86 percent)
  • Iowa (5.56 percent)
  • Idaho (5.52 percent)

And at the other end of the spectrum? Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming are totally tax-free. Click here to browse through a list of 2015 state income tax brackets.

 

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Extra credit: Other taxes, deductions, and contributions

Local/county taxes

There are also a grab bag of taxes out there that are based on the city, county, or municipality that you work in. Keep in mind that these often need to be processed along with your federal and state payroll taxes. Wondering how you can keep track of them all? Many services can take care of this for you automatically.

Typically, most companies are only required to withhold taxes for counties where there’s a work location, like a cafe, office, or construction site. So if an employee lives in a county that’s different from where they work, companies may choose to lend them a hand by withholding their local residential taxes as well.

Employee deductions

Deductions are amounts that are subtracted pre- or post-tax from employee paychecks and then kept in the company’s bank account. This money doesn’t go to the government, and is instead used for things like health or life insurance, retirement, or government mandated wage garnishments. And you have a bunch of options here. You can either specify a percentage of income or a dollar amount that can apply to every payroll. In fact, you can also deduct for one-time occurrences too.

Deduction trivia: Ever eat at a cafeteria and see rows of food laid out before you? Well, there’s actually a tax equivalent. Section 125 plans, deliciously nicknamed “cafeteria plans,” enable employees to pay for a range of services before taxes are taken out. These services include things like health insurance, adoption assistance, disability insurance, and more.

Employer contributions

Contributions are the opposite of deductions. These are post-tax amounts that you add to your employees’ paychecks for benefits like retirement funds and profit-sharing plans.

Who knew your payroll taxes could have such a dramatic impact on the world? The programs you support every time you pay your team are quite special, and were set up to protect people who are sick, looking for work, or embarking on the next stage of their life. Now, the next time you see all those acronyms swimming around, you can take some pride in knowing exactly why each one is where it is.

About Danielle Grant

Danielle Grant is on the customer experience team at Gusto. She currently empowers the onboarding team that serves customers through payroll setup. You can get in touch with Danielle here.