Congratulations! Your business is growing and you need employees. However, that joy and excitement can turn to stress and anxiety if you don't understand the in's and out's of payroll.
As a small business with a payroll, here’s a sobering thought: you are in a very real sense a de facto agent of the IRS. You collect and hold onto the funds until it comes time to file your quarterly (or annual) Employer’s Federal Tax Return, whereupon you are required to make a payment to the IRS.
You undoubtedly know that along with the income tax withholding, there are employment taxes that include Social Security and Medicare. What most small business owners don't realize is that as an employer you also foot the bill for the federal and state unemployment fund (FUTA) and must file an annual tax return for FUTA.
Keeping up is the Challenge
For the average business owner, it is more than a matter of trying to adhere to the 10,000-page federal tax code. In addition to making sure that employees’ payroll income taxes are withheld and reported, there are also those FICA deductions and the employer’s share to pay.
Employers deduct FICA payments and contribute matching funds as follows:
• Social Security tax – 6.2 percent
• Medicare tax – 1.45 percent (Beginning with tax year 2013, employees earning over $200,000 pay an additional 0.09 percent, but the employer does not have to match the surtax.)
When the employer does everything required by the IRS, the employee’s Social Security, Medicare and other retirement accounts accumulate for retirement. Again, it is the employee’s money that is entrusted into the care of the employer and is a responsibility that should not be taken lightly.
Employees Share in the Responsibility
The employee, of course, has an important role when it comes to paying income taxes. The system is essentially pay as you go. The employee must pay the income taxes as the money is earned, rather than just wait until the end of the year to catch up. It is the employee’s responsibility to make sure sufficient income tax is being deducted each pay period.
In most cases, if the employee owes more than $1,000 at the end of the tax year, the IRS will assess an additional underpayment penalty. If the underpayment does not involve fraud, the employee could be facing a 20 percent penalty assessment on the amount of the additional taxes owed. Add fraud into the mix, and things can get quite painful as the IRS can apply heavy civil and criminal sanctions for willful tax evasion.For the honest employee who wants to avoid underpayment, the IRS provides an online withholding calculator. This tool is especially useful for anyone who has additional outside income and needs to have more than just the standard amount deducted from a regular paycheck.
Here are 10 steps to help you set up a payroll system for your small business:
1. Obtain an Employer Identification Number (EIN)
2. Check Whether You Need State/Local IDs
3. Understand Independent Contractor vs. Employee
4. Take Care of Employee Paperwork (W-4 vs. W-9)
5. Determine a Pay Period
6. Carefully Document Your Employee Compensation Terms
7. Choosing a Payroll System
8. Run a Payroll
9. Keep Proper Records
10. Report Payroll Taxes
Whether you have one employee or 100, setting up a payroll system not only streamlines your ability to stay on top of your legal and regulatory responsibilities as an employer, but it can also save you time and help protect you from incurring costly Internal Revenue Service (IRS) penalties.