Payroll taxes are the biggest tax problem that most small business owners face. In fact, more businesses are closed for non-payment of payroll taxes than income taxes.
When you pay employees, you must withhold federal income taxes, state and local income taxes (if your area has these taxes), social security, medicare, disability and/or unemployment taxes (in a few states only), and other non-tax deductions (medical, retirement, uniforms, etc.). You as an employer are responsible for paying the withheld taxes.
Restaurant and bar owners have a special problem with tip income. You are required to report all tips that your employees receive, and you must pay social security and medicare taxes on the tips. However, rarely will employees report the full amount they pick up, nor is there any practical way to find out all the tips unless they are put on credit cards. So in a tip audit, you can find yourself liable for amounts you cannot control, often based upon observations of agents who ate at your establishment and made notes for a day or so before they introduced themselves. Usually, the IRS will not question tips reported of 8% or more of wages. However, you should be aware that there is no “safe harbor” on tip reporting.
IRS Reporting
Most of the federal taxes are paid on a combined Form 941. This includes the federal withholding, social security and medicare taxes withheld from the employee, plus the company matching portion for social security and medicare. The 941 tax deposit is due monthly for most businesses on the 15th of the month following the month that the pay checks were issued. We recommend that you pay more frequently, every pay period. The payments will be smaller, and you can forget about the deadline if you deposit the taxes when you issue pay checks. This will make the tax deposits more manageable for your cash flow.
941 payments are made on blue coupons that come in a yellow booklet from the IRS. You can order an endless supply of Uncle Sam’s deposit slips at no charge by calling 1-800-824-1040. Mark the box called “941” and which quarter it applies to, and fill in the amount. Make the check payable to the BANK, not the IRS, and deposit it at your bank into Uncle Sam’s account. Be sure to get a deposit slip acknowledgment from the bank, since this is your only proof that you made your tax deposit if the IRS (or the bank) loses it. The canceled check is not proof of payment, since the IRS may argue that you might have been making a loan payment.
If your payroll tax deposits exceed $50,000 per year, you are required to deposit the taxes within 3 business days of each payroll, and must make tax deposits electronically (so the government can get its cash faster). When applying for electronic deposit, you should select the debit method (not the credit method) to give you more control over the payments and cut bank costs.
State Reporting
State withholding tax reports for states with income taxes are due either monthly or quarterly, depending on the amount of taxes required to be paid. Check with your state taxation department. Some states also let you pay electronically.
State unemployment tax returns are due quarterly. In most states this is a tax borne entirely by the employer.
Some states also have a quarterly workers compensation tax, although most states let employers purchase workers compensation insurance from private insurance companies.
State and local payroll tax returns are typically paid when the return is filed for most smaller businesses. Small businesses rarely have high enough state tax bills to require daily deposits.
State Unemployment
State unemployment tax rates fluctuate from year to year, and can be very confusing to business owners. The legislature sets a base rate. The state employment security commission either adds or subtracts from this rate based upon a complex formula that takes into account the “savings account” balance you have built with the government, potential or current withdrawals from that account by ex-employees, and the size of the payroll. The tax can soar for several years with only one or two claims. In some states, the lowest possible rate after several years is no tax at all.
To keep your tax bill low, you should look into the circumstances where you are allowed to deny a claim. For example, in many states you can deny an unemployment claim against your account when the employee quits, or is fired for violating the law.
Year End Reporting
The federal unemployment tax (called FUTA) is declared on Form 940, which is filed once a year by January 31st. However, you must make quarterly deposits if the cumulative liability exceeds $100. The quarterly deposits are made using the same coupons or electronic filing as your 941 payments, just checking the 940 box on the coupon.
At the year end, you need to file some annual reconciliations. The federal government requires you to file summaries of what you paid each employee and what you withheld from each of them on W-2 forms. In addition, you must include a W-3 form, which is like a “cover letter” summarizing all the W-2 forms. The W-3 and W-2s are sent to the Social Security Administration (not the IRS). States with an income tax also require an annual reconciliation along with copies of the W-2s. Some states also require proof of workers compensation coverage with the annual wage reconciliation. The employee copies are due to the employee by January 31st, while the government copies are due by February 28th.
The Social Security Administration shares the details with the IRS. The IRS matches the W-3 totals to the total of each of the withholdings and taxes reported on the quarterly 941 returns. The IRS, state taxation departments, and state employment security commissions all swap data to see if everything matches up. Any discrepancies will cost you penalties from somebody.
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