What Are Employment Taxes? What Small Businesses Should Know

Employment taxes are federal and state taxes paid for employee wages. Employers have to submit these taxes to federal, state, and sometimes local governments, usually on a quarterly basis.

Complying with the relevant federal, state, and local laws can be complicated, but failing to do so can result in heavy fines and penalties. Below are brief details of the major types of employment taxes that employers and employees need to pay.

Income tax

Employers withhold federal and sometimes state and local income taxes from employee paychecks to help cover what the employee will owe for the tax year.

Employers base income tax withholding on the employee's Form W-4, Employee's Withholding Certificate.

Social Security and Medicare tax (FICA)

Both employees and employers are responsible for paying Social Security and Medicare taxes.

The FICA tax rate is 15.3%. That rate includes:

• 6.2% of employee wages for the employee's portion of Social Security tax
• 6.2% of employee wages for the employer's portion of Social Security tax
• 1.45% of employee wages for the employee's share of Medicare tax
• 1.45% of employee wages for the employer's share of Medicare tax

However, the Social Security portion is subject to a wage base limit. The Social Security Administration sets the wage base limit, and it changes annually.

Employers also have to withhold an Additional Medicare Tax of 0.9% on any individual wages over $200,000 in a calendar year. The employer doesn't have to pay a matching rate on the Additional Medicare Tax.

Businesses use the Treasury Department's online tax payment portal (EFTPS) to deposit federal income taxes and FICA taxes on either a monthly or semi-weekly basis.

At the end of the quarter, the employer files Form 941, Employer's Quarterly Federal Tax Return, to report total employee compensation for the quarter and reconcile deposits with their actual tax liability.

Federal Unemployment Tax Act (FUTA)

In the U.S., the federal government doesn't pay unemployment benefits, but it does collect a Federal Unemployment Tax (FUTA) to assist states with administering and paying unemployment benefits.

The FUTA rate is 6.0% of the first $7,000 paid to each employee during the calendar year. However, companies that pay their state unemployment taxes on time may be eligible for a FUTA tax credit of up to 5.4%, bringing their FUTA tax liability to just 0.6% of the first $7,000 of each employee's wages.

At the end of each quarter, employers must calculate the FUTA tax they owe and make a payment using the EFTPS portal if they owe at least $500. At the end of each year, employers file Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return and reconcile the amount paid each quarter to the amount of FUTA tax owed for the year.

State unemployment tax

States also assess their own unemployment taxes to provide unemployment benefits to displaced workers.

State unemployment taxes (SUTA) may also be known as state unemployment insurance (SUI) or reemployment tax.

In most states, only the employer pays SUTA. However, employees in a handful of states may also be responsible for paying SUTA, and their employers withhold it from the employee's paychecks.

State unemployment tax rates and the amount of wages subject to tax vary by state. The rate the employer pays is usually based on their claims experience. Companies that lay off employees frequently pay higher SUTA tax rates than those with fewer unemployment claims against them. Each year, states inform businesses of the tax rate they have to use to calculate SUTA taxes.

Understanding the various employment tax responsibilities, rates, and due dates can be overwhelming. To ensure you do things correctly and avoid penalties, consider outsourcing payroll to your accountant or a payroll service provider.