All the Types of Employment Taxes
Income Taxes, FICA Taxes, Unemployment Taxes, Workers' Compensation
If you're an employer, the Internal Revenue Service (IRS) not only expects you to pay your business's share of taxes; you'll also have to withdraw the right taxes for your employees.
There are several types of employment taxes. You will need to withhold, file forms with the IRS, and remit to the IRS all of those taxes on behalf of your employees as part of your payroll taxes, and you will have to contribute toward some of them as well.
What Are Employment Taxes?
The IRS employment taxes are the taxes that you, your business, and your employees must pay to federal agencies. Self-employment tax, which includes Social Security and Medicare tax for self-employed business owners, is also considered an employment tax. You also may be responsible for paying various state taxes, including on income and for unemployment.
The source of the money for each of these taxes varies:
- Federal and state withholding is withheld from employee pay and turned over to the taxing authority.
- Federal Insurance Contributions Act (FICA) taxes must be taken from employee pay and also paid by the employer.
- Unemployment taxes and workers' compensation are the employer's responsibility. Employees don't contribute to these.
Trust Fund Taxes
Many of the taxes employers collect are held in a fund until they are paid to the IRS. These trust fund taxes are held and managed by the employer but don't actually belong to the employer. Keeping and using this money for anything other than paying taxes can get an employer into trouble with the IRS. There are penalties for failing to remit trust fund taxes, and if you don't pay the penalty, the IRS can place a federal tax lien against your personal assets or take other steps to seize them.
Federal Income Tax Withholding
All employers are required to withhold federal income tax from employees. The amount of tax is determined by the Form W-4 the employee fills out at hire or when the employee has changed status or wants to change the withholding amount. You may not pay employees without having a W-4 on file.
In 2020, the IRS released a new Form W-4 in an effort to make it easier to understand and increase transparency. As of 2020, employees aren't able to request adjustments to their withholdings using allowances. Instead, with the new W-4, employees can provide employers with amounts to increase or decrease tax withholdings and amounts to increase or decrease the amount of income subject to withholding.
Federal income tax withholding is calculated for each pay period for each employee. To calculate federal income tax withholding for an employee, you will need the employee's gross pay for the pay period, along with the information on the W-4. You will also need the most current Publication 15: Employer's Tax Guide from the IRS.
Using the tax guide, find the table that matches the employee's filing status. Then look down the list to the pay period type (weekly, monthly, etc.) and the employee's gross pay. Within that box, use the calculation to figure the amount of federal income tax withholding.
Most states collect an income tax and require employers to withhold the tax from employees. There are a handful of states that don't have any income tax, whereas there are some that don't collect tax on employment income but do collect tax on other types of income, such as stock dividends. Some states use the federal Form W-4, while other states have their own forms.
You will need to register with the state's taxing authority to collect and pay these taxes you have withheld from employees. Follow each state tax agency's procedure for calculating and remitting the amount of withheld income tax.
Along with income tax, some states also collect:
- State unemployment tax funds
- State disability funds
- State workers' compensation funds
All U.S. employers must deduct FICA taxes to fund Social Security and Medicare from the paychecks of all employees, and remit employer and employee portions of the tax to the IRS.
The Social Security deduction is 6.2% of gross pay for the employee and 6.2% for the employer, for a total of 12.4%. The annual maximum wage that was subject to the tax in 2020 was $137,700; in 2021, it is $142,800.
The Medicare portion for employees is 1.45% with no maximum wage, and 1.45% from the employer, for a total of 2.9%.
Along with regular FICA taxes, employers must also collect the Additional Medicare Tax if the employee's total annual income goes above $200,000. The additional tax amount is 0.9% of the employee's gross income.
The Additional Medicare Tax is assessed only on the employee. The employer does not contribute to this tax.
Employers are required to pay federal unemployment tax (FUTA) to provide benefits to employees who have lost their jobs. Employees do not contribute to this tax. Employers contribute based upon the gross payroll of their employees, considering each employee and the maximum earnings.
The federal unemployment tax rate is 6% on the first $7,000 of income (gross pay) for each employee, per pay period.
In addition to federal unemployment taxes, most states require you to participate in the state unemployment tax plan and to pay state unemployment taxes.
If your state has an unemployment tax, you may receive a credit of up to 5.4% against the federal tax. The effective rate works out to 0.6%.
Workers' Compensation Benefit Funds
Employers must pay into state-run funds that provide benefits for employees who incur illnesses or injuries because of their work. These benefits are governed by state workers' compensation laws and paid for by the employer contributions to state workers' compensation funds.
Check with your state's employment agency for more information on how its workers' compensation system is managed.
Self-employment taxes, sometimes called SECA taxes, are like FICA taxes in that they are Social Security and Medicare taxes for self-employed individuals. The Additional Medicare Tax is also required for self-employed individuals who surpass the $200,000 threshold.
Self-employment taxes are different from other employment taxes because they aren't withheld from employee pay or paid by an employer. This tax is calculated on the net income of a business and paid on the owner's personal tax return.
The self-employment tax rate is 12.4% for Social Security, until the annual maximum income is reached, plus 2.9% for Medicare, for a total of 15.3%.
If your self-employment income is more than $200,000 for the year as an individual filer—or more than $250,000 if you are married and jointly file your return—you will also have to pay the Additional Medicare Tax, at 0.9%.
While you are paying both the employee and employer portion of Social Security and Medicare taxes, the IRS does give you one break; you can deduct the employer half of your self-employment tax on your tax return. You will need to complete Schedule SE to calculate this deduction.