Deconstructing Payroll Taxes for Your Small Business

If your small business employs people, no matter how few, you’re required to withhold payroll taxes from their paychecks and pay federal, state, and local taxes (this is one of the reasons small and especially micro businesses may opt to use independent contractors, to whom they don’t pay benefits and who pay their own taxes).

Usually, withheld taxes are comprised of FICA (Medicare and Social Security taxes) plus federal, state, and local income taxes where applicable. Additional withholding obligations are the Federal Unemployment Tax (FUTA) and in some states you must withhold disability insurance tax — check your state’s tax laws to make sure your bases are covered.

Before you launch your small business, make sure your accounting system is solidly in place. If you don’t pay your taxes or if you miss a payment you could end up with unwanted fines or penalties, so understanding your obligations is critical.

In order to calculate payroll taxes, you need to figure out three things:

Who are my taxable workers?
What are their taxable wages?
How much do I need to withhold?

Taxable workers can be employees or independent contractors, the difference being that employees are subject to payroll taxes. Since sometimes the lines between employees and contractors can be a bit blurry, the IRS has behavioral, financial, and relationship tests to determine who’s who.

The IRS considers a taxable worker to be someone whose work an employer has the right to direct and control, not just the results of that work. A taxable worker doesn’t have control over the supplies used for the work being done, and is tied to one company, unlike an independent contractor who can advertise and work for several companies at the same time. In terms of the relationship, if there’s no timeline for employment, like the completion of a project, then the person is a taxable worker.

Taxable wages are payments for services and could include bonuses or gifts, as well as salaried wages. Generally speaking, reimbursed expenses for travel or meals do not fall into this bucket, but need to be verified by saved receipts that are reflected on expense reports.

Now that you know how many taxable employees you have and which wages are taxable, you now have to figure out how much to withhold for federal, state, and local taxes, as well as FICA and FUTA.

By law you must withhold federal income taxes from each paycheck issued for the applicable period. To calculate the amounts, use the wage bracket and percentage tables provided by the IRS. Remember you don’t need to withhold state taxes if there is no state tax on income, like in Alaska and Florida.

The Federal Insurance Contributions Act (FICA) requires employers to withhold Social Security and Medicare taxes from wages paid to employees. In this case, the employer and employee each pay half of the tax. Unemployment taxes, or FUTA, are paid only by the employer.

Calculating payroll taxes can be complex, so give yourself plenty of time to understand the particulars of your obligation, make deadlines, and ensure you have the resources you need at hand.

If you need legal help, don’t hesitate to contact me at the Law Office of E.C. Lewis, P.C., home of your Denver Small Business Attorney. Phone: 720-258-6647. Email:

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