Overview of Federal Payroll Taxes
If you run a business with employees, both the federal government and the state of New Jersey require that you withhold taxes for various purposes from the employees’ payroll, whether it’s done electronically or by check.
On the federal level, there is not only an income tax, which ranges from 10 percent to 37 percent depending on taxable wages, but there are also taxes for Social Security, Medicare, and unemployment benefits.
Social Security and Medicare taxes are known as FICA, after the Federal Insurance Contribution Act. Social Security taxes are capped at earnings of $142,800 a year in 2021, but Medicare taxes have no wage ceiling.
For Social Security, an employer must withhold 6.2 percent of each employee’s wages and match it as an employer contribution. Medicare is taxed at 1.45 percent until wages reach $200,000 when the rate jumps to 2.35 percent. The employer must match both Social Security and Medicare, which computes to 7.65 percent per employee until Social Security maxes out.
Unemployment benefits – known as FUTA for the Federal Unemployment Tax Act – are paid solely by the employer, and the rate is 6 percent of each employee’s first $7,000 of income.
In computing an employee’s gross wages, deductions can be made if they contribute to a 401(k), 403(b), or a Health Savings Account (HAS). Employees for 2021 can contribute $19,500 annually to a defined-contribution pension plan, with a $6,500 catch-up provision available for those 50 or older. The HSA limit is $3,600 for the employee only, and $7,200 for the employee and family.
State Payroll Taxes
The state of New Jersey also collects payroll taxes. It imposes a graduated income tax starting at 1.4 percent that reaches 11.8 percent for those earning more than $5 million. (The City of Newark also imposes a local tax of 1 percent.) The state’s unemployment tax ranges from 0.4 to 5.4 percent of the employee’s first $36,200 in wages, paid by both employee and employer. A new employer pays a flat rate of 2.68 percent.
The New Jersey Disability Insurance (DI) program has varied tax requirements, but new employers must pay 0.5 percent. Employees are taxed at 0.47 percent. The state’s Family Leave Insurance (FLI) program costs employees 0.28 percent of wages.
Employer Compliance Requirements
To pay all these taxes, which can change yearly, requires that employers keep accurate records of all employees’ earned income, plus any deductions they are entitled to for pension or health savings options. Employers must also utilize the exemptions for dependents claimed on each employee’s W-4 to determine income tax to be withheld.
Employers are then responsible for withholding the correct amount and transmitting taxes with required documentation to the proper agency responsible for the tax, generally the Internal Revenue Service (IRS) on the federal level and the Division of Taxation in New Jersey.
At the end of the year, the employer must supply each employee with a Form W-2 documenting wages paid and taxes withheld in all categories.
Common Payroll Tax Issues
Miscalculating taxes is always a possibility, as humans are prone to error and taxes can be complicated. It’s best to rely on a trusted third-party service. You also want to make sure you remit the taxes due promptly on time, accompanied by the proper form. Late payment can cost you in the long run. Nonpayment might sink your business.
Penalties for Non-Compliance
Struggling businesses are often tempted to retain funds withheld for taxes to use as a “rainy day” survival tool, but the penalties for nonpayment can be great. Even just miscalculating taxes due can lead to audits and fines. Nonpayment can open Pandora’s proverbial box.
If your business either fails to pay or fails to pay fully all taxes due, the responsible agency can demand repayment, along with interest penalties and even fines. Your business may also be audited and your reputation damaged among both employees and clients/customers. You could end up losing the commerce you depend on, or even going out of business.