Every business wants to be profitable, but not every business is great at calculating its expenses. Without a complete picture of monthly expenditures, it’s nearly impossible to predict profitability. Although most business owners have a handle on factoring in office space, utilities, cost of supplies and other static costs, they often struggle with figuring out just how much their employees cost.
This is understandable. Employee costs can fluctuate significantly and there are a lot of hidden expenses when it comes to paying people in your business. The one area that catches most people off guard is taxes. Employee taxes can make up nearly a third of your overall operating budget, so you want to ensure you’re factoring in everything.
Let’s take a look at four of the most important employee taxes (and tax credits) you should know as a business owner.
- Unemployment Taxes
These taxes are often deducted in a pretty straightforward manner, but where businesses can get in trouble if they don’t account for both types of unemployment taxes. Every business is required to take the Federal Unemployment Tax Act (FUTA) tax, which is 6% on the first $7,000 of wages. However, some states also require employers to take an unemployment tax.
It’s important to know if your state requires separate unemployment taxes to be withheld by employers. If you don’t comply with this, you could have a huge bill come tax season. Make sure you check with your state’s workforce commission to determine if you have a state unemployment tax and at what rate you need to withhold.
- Social Security and FICA
These are two other common tax credits that most employers know about but might struggle to determine how much they need to withhold. Social security and FICA taxes are unique in that the employer is only responsible for part of it.
The total rate for these two taxes is 15.3% but the employer only has to pay half. So you can withhold 7.65% from payroll and the employee will pay the other 7.65% when they file their year-end taxes. Keep in mind this is only for your W-2 employees. If you have contractors on your payroll, then you do not have to withhold these taxes. They will be responsible for paying the full amount.
- Income Tax
This is one of the most basic taxes you’ll take directly out of payroll, but also the most important. Retaining income tax for your employees is another type of withholding that will affect at both the federal and state level. Similar to FUTA, the two rates will be different.
Federal income taxes are divided into brackets. People earning within certain ranges will be responsible for paying a specific percentage of their wages in taxes. Most low to middle-range employees will fall within the 22% federal tax bracket. However, they may request you withhold more or less depending on how they like to file their taxes.
State income tax can vary widely, and some states don’t even require it. This is another instance where you need to ensure you know your state laws and are withholding the correct amount for your employees.
- Tax Credits
That sounds like a lot of money coming out of your pocket, but there are some tax benefits to being a business owner. For example, there are a variety of tax credits you can claim based on how many employees you have and how long they stay with your business.
The Employee Retention Tax Credit was a product of the CARES Act during COVID-19 and allowed businesses to claim part of their employees’ wages if they stayed with the company for the entire year. This can have a major positive impact on a business’s bottom line.
With this tax credit, businesses could be credited up to $5,000 per employee in 2020 and up to $21,000 in 2021. The ERC is being discontinued in 2022, but there’s still a chance to claim some credits. The government is allowing businesses to claim 50% of an employee’s first $10,000 in 2021 on their 2022 taxes.
Figuring out employee taxes and payroll can be complicated, but it’s necessary to get it right so you can ensure your profitability.