Calculate Payroll Tax

Small business owners must be sure to pay their payroll taxes. Not paying these, or paying them late, is one of the surest ways to get in trouble with the IRS. Even the “corporate veil” can be pierced if a business owner ignores this responsibility.

Payroll taxes comprise three items: federal withholding, Social Security tax and Medicare tax. (Although the “payroll tax” often refers to Social Security and Medicare taxes.) For the first item, each employee should, at a minimum, fill out a W4 when they are hired and then again at the start of every calendar year. They can, however, fill out a new W4 at any time. This form tells the business owner how much federal tax to withhold from the employee’s paycheck. There is no cost to the business owner – this is taken directly from the employee’s paycheck.

The second step to calculate payroll tax is to determine Social Security tax. This tax is paid by both the business owner and the employee. They each pay 6.2% of the employee’s gross pay, or 12.4% total (NOTE: for 2011 the employee only pays 4.2% so the total is 10.4%). Once an employee’s gross wages for the year are more than a certain amount ($106,800 for 2011) Social Security tax is no longer due (from either the business owner or the employee), and does not figure into the calculations.

The third step to calculate payroll tax is to determine Medicare tax. This tax is also paid by both the business owner and the employee. They each pay 1.45% of the employee’s gross pay, or 2.9% total, and this is always paid regardless of the employee’s gross wages for the year.

One thing to note is that not all income counts towards an employee’s gross salary for Social Security and Medicare taxes. Income such as compensation for health care premiums and other fringe benefits is excluded. A complete list of what counts and what doesn’t count can be found in Publication 15 from the IRS (http://www.irs.gov/publications/p15/ar02.html) in sections 5 and 15. This publication can also further help to explain payroll taxes.

At this point add the federal withholding, Social Security tax and Medicare tax. This total is the amount of payroll tax due to the IRS. Again, remember, this must be paid on time and in full.