Payroll taxes are taxes withheld or paid by an employer, for or on behalf of employees. Payroll taxes include federal income tax withholding, state income tax withholding, social security and Medicare taxes, and federal and state unemployment taxes. Taxes paid are based on compensation, which includes all items paid to or on behalf of an employee such as wages and commissions (except for certain excludable amounts such as qualified reimbursed business expenses or nontaxable moving expenses).
Employee or Independent Contractor
Before you can determine how payment for your services will be treated in terms of payroll taxation, you must determine if you are an independent contractor or an employee for purposes of the work in question.
Independent contractors are people such as lawyers, accountants, architects, contractors, or subcontractors who follow an independent trade or profession in which they offer their services to the public. However, whether such people are actually employees or independent contractors depends on the facts of each particular case. Traditionally, anyone who performs services is an employee if the company or person paying for those services (the "payor") can control the details of how the services are to be performed. Facts indicative of the employment relationship include:
- Instructions as to when, where, and how to perform the work;
- Payor-provided training;
- Reimbursement of business expenses;
- Payment by the hour, week, or month; and
- Payment of employee-type benefits such as insurance, vacation, and retirement benefits.
Facts indicative of an independent contractor relationship include:
- Emphasis on results;
- Independent training;
- Unreimbursed business expenses;
- Investment by the worker in work facilities;
- Payment by the job rather than by time period; and
- Extent to which the worker can realize a profit or loss on the transaction.
Payroll Taxes for Employees
If an individual is an employee, the employer must withhold payroll taxes, including federal and state income taxes. The amount withheld depends on the amount of wages paid, the filing status (i.e. single or married), the number of pay periods, and the number of allowances claimed by the employee. Each employee is required to give the employer a signed Form W-4 that indicates the filing status and number of personal allowances claimed. The employee completes a worksheet provided with Form W-4, to assist with the computation of the correct number of personal allowances. An employee can claim fewer personal allowances but cannot claim more because the employee will be underpaid and subject to underpayment penalties.
Social Security Taxes
Both the employer and employee are required to pay social security taxes. The employer pays 6.2% of the taxable wage base and withholds 6.2% of a fixed taxable wage base from the employee. Both the employer and employee are also required to pay Medicare taxes. The employer pays 1.45% of wages and the employer withholds another 1.45% from the employee. Wages for social security purposes include 401(k) contributions and deferred compensation.
Employers also must pay federal and, where applicable, state unemployment taxes. The tax applies to the first $7,000 of wages paid to each employee. For state unemployment taxes, the rate of tax and wage base will differ from state to state. However, an employer can take a credit against federal unemployment for amounts paid to state unemployment funds up to fixed percentage of taxable wages.
Employers are required to provide each employee with a Form W2, which is an annual summary of wages paid, and taxes withheld. The employer also files Forms W2 with the Internal Revenue Service and state taxing departments. The form is due to the employee by January 31 of the year following that for which income taxes will be filed, so for employees filing income taxes for 2004, employers must provide a Form W2 by January 31, 2005.