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Employers are required to withhold Income and FICA taxes from employees. In addition to withholding from the employee, the employer is also required to match the employee’s contribution of FICA taxes. Most employers are also required to pay Federal Unemployment Taxes.
Federal Income Tax
Federal Income Tax Withholding Explained:
Federal income tax is a tax levied by the federal government on all earnings which were generated in the United States or earned abroad by an individual or entity subject to United States income taxes. The earnings subject to this tax include all types of employee earnings such as regular pay, bonuses, commissions, etc.
The employer is required to withhold the income tax portion applicable to the earnings earned by the employee based upon the percentages the IRS is providing on an annual basis in Publication 15. The amount the employer is required to withhold is based on various factors unique to each employee as follows.
Federal income tax is calculated based on:
- The annualized amount earned.
- The employee’s marital status.
- The number of withholding allowances claimed.
- Additional amounts requested by the employee.
Upon hire, the employee completes a W4 form (Employee’s Withholding Allowance Certificate). In that form the employee is providing the necessary information for the employer to calculate the federal income taxes for each check the employee will be given.
When utilizing payroll software, all you generally need to do is setup the employee with the details the employee has provided in their W4 form. The software will automatically know how much tax to withhold on each check you pay the employee through the payroll software.
The Federal Insurance Contributions Act (FICA) is the federal law requiring employers to withhold Social Security and Medicare taxes from their employees’ wages. In addition to withholding these taxes from their employees’ wages, employers must also match their employee’s Social Security and Medicare tax contributions.
Social Security tax, commonly referred to as OASDI (Old-Age, Survivors, and Disability Insurance program), is subject to a wage base. That is, only up to a certain amount of the employee's earnings in a given year is subject to the tax. Any earnings in a given year above that wage base is not subject anymore to Social Security taxes. The wage base changes on an annual basis: In year 2018 the wage base is 128,400.
Medicare taxes do not have a wage base and all earnings are subject to Medicare taxes.
Social Security and Medicare Tax Rates used to change every few years, with the IRS and SSA advising of updated rates. However, they have remained the same since year 1990 with the following rates:
- Social Security: 6.2 percent
- Medicare: 1.45 percent
- 0.9 percent Medicare surtax for employees earning over $200,000 (Started in year 2013)
Unlike the 6.2 percent Social Security and the 1.45 percent Medicare taxes which employers are required to match and contribute, employers are not required to match the additional 0.9% Medicare tax withheld from employees earning over $200,000.
Federal Unemployment Tax
Federal Unemployment Tax Explained:
The Federal Unemployment Tax Act (FUTA) was enacted to help states fund their unemployment compensation programs. Most employers pay and report FUTA tax. This is an employer-paid tax; the tax may not be withheld from the employees. The FUTA rate is 6% of the first $7,000.00 of each employee’s taxable wages each year.
While the FUTA tax rate is 6 percent, employers can take a credit of up to 5.4% of the total FUTA tax if they make all the payments due to each state where they have taxable employment. This essentially means that when thinking about FUTA taxes the real rate is most of the time .6 percent of the first 7000.00 of the employee's annual earnings, and not 6 percent.
Employees can have certain contributions which are reducing their taxable income (provided of course that they are setup as outlined in the applicable federal statue) and thus they save on income taxes, Social Security and Medicare taxes. Some of these contributions are exempt of income taxes but not FICA taxes. Examples of contributions exempt of some or all 3 taxes are Retirement Contributions and Health Insurance Contributions. A full list of these items are outlined in IRS Publication 15-B.
Employees can be exempt from income taxes and can fill out the W4 form indicating that they are exempt. However, if they do so they need to submit a new W4 form to the employer on an annual basis to indicate that in the current year they are still exempt from income taxes.
We have covered three of the main federal payroll tax obligations employees and employers are required to pay. This overview is intended to provide a conceptual overview of the Federal Income Tax, FICA Taxes, and Federal Unemployment Tax levied, how they are calculated and paid.
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