Federal Payroll Taxes and Withholding

From: Staffing

Employers are cautioned not to interpret this information as the complete text on payroll taxes and withholding. Tax rates are subject to changes annually. Employers should consult the many Internal Revenue Service (IRS) documents, other available resources, or an applicable legal entity on this topic. For example, the IRS’ Circular E, Employer’s Tax Guide, outlines the rules and regulations for payroll deductions and deposits. Such forms may be obtained by contacting the IRS.

Who Is an Employee

Employees vs. Independent Contractors

Employers must be able to identify their taxable employees. Employers are required to withhold and pay taxes for those workers properly classified as employees. Employers with one employee will most likely be required to withhold federal income tax as well as Social Security tax from that employee’s wages. Employers may also be subject to federal unemployment tax. Once a worker is deemed an employee for tax purposes, the fact that the employee works only part time, on a temporary basis, or is a minor ordinarily will not remove the need to withhold and pay taxes on that employee’s wages.

Generally, an employee is an individual who performs services for an employer under the employer’s direct control of when, where, and how the work is done. For payroll tax purposes, the IRS and state tax agencies rely on common-law rules to determine who is an employee. Under the common-law definition, if an employer maintains the legal right to control worker’s activities, the workers are deemed employees. Although some workers may have discretion in determining their work performance, they are still legally considered employees. Employers must be aware that the actual employment relationship is most important in determining whether workers are employees. Should an employer-employee relationship exist, the labeling of the relationship has no value. Rather, the substance of the relationship governs the worker’s status, not the label.

The status of an individual as an independent contractor or an employee for purposes of the federal tax laws (and state income tax laws) is determined, with few exceptions, under the common-law tests for determining whether an employment relationship exists.

Common-Law Employee Status

The federal employment tax regulations (such as FICA, FUTA, and income tax withholding) provide that an individual is an employee if, under the usual common-law tests, the relationship between the individual and the person for whom an individual performs services is the legal relationship of employer and employee.

Such a relationship generally exists if the person for whom the services are performed has the right to control and direct the services, not only as to the result to be accomplished by the work, but also as to the details and means by which that result is accomplished. Specifically, an employee is subject to the will and control of the employer as to not only what shall be done but also, also how it shall be done.

The regulations state that the determination is to be based upon the particular facts in each case and warn that the designation or description of the relationship by the parties will not be determinative when facts prove otherwise.

The IRS has issued guidelines for conducting an independent contractor versus employee analysis, which focuses on evidence gathered in the following three primary categories:

Behavioral control.
Financial control.
Relationship of the parties.

A more detailed discussion of this analysis is provided in Working with Independent Contractors and Temporary Employees and Contingent Employment.

Taxes and Family Members

Employing family members may save payroll taxes, although if they are common-law employees they are subject to the same payroll taxes as any employee. In some situations, however, there may be savings in FICA taxes and unemployment taxes if the business is not run through a corporation or partnership (except for husband/wife partnerships).

Some basic rules apply to employing relatives as follows:

Employers are not required to withhold and pay Social Security and Medicare taxes for their children under age 18 who work for them if the trade or business is a sole proprietorship or a partnership in which each partner is the child’s parent. If the children’s services are for work other than in the parent’s home, taxes are not required to be paid until the child reaches 21.
Wages paid by a parent to a child under 21 are not subject to FUTA tax. However, the wages of a child may be subject to income tax withholding.
With exception, the wages for the services of a child or spouse are subject to income tax, Social Security, Medicare, and FUTA taxes when employed by a corporation, partnership, or estate of a parent or spouse.
Employers must pay income, Social Security, and Medicare taxes — but not FUTA taxes — for spouses they employ in a trade or business. No taxes are paid if the work is for other than a trade or business, such as domestic service in a private home.
The wages of parents employed by their children are subject to income tax withholding and Social Security and Medicare taxes. Social Security and Medicare taxes do not apply if the service is other than a trade or business unless it is for service caring for a child who lives with a son or daughter and who is under age 18 or that requires adult supervisor for more than four consecutive weeks in a calendar quarter due to a mental or physical condition. Wages paid to a parent who is employed by a child are never subject to FUTA taxes.

Employee Rights and Obligations

Social Security Card

Employees, including resident and nonresident aliens, are required to have Social Security numbers for the purpose of completing Forms W-2. An employee must show an employer the card if it is available. Employees without a Social Security card may obtain one by completing Form SS-5, Application for a Social Security Card, available from a Social Security Administration office.

Once an employee receives a card, a corrected wage and tax statement (Form W-2c) should be submitted. Employees must ensure that the name is correct on the card.

Employers must record Social Security numbers for resident and nonresident aliens. Aliens who are not eligible for a Social Security card may request an individual taxpayer identification number (ITIN) for tax purposes, however employers cannot accept an ITIN in place of a Social Security number.

Form W-4

A newly hired employee must complete a Form W-4, notifying the employer how many withholding allowances to use when deducting federal income taxes. The more withholding exemptions an employee claims, the less taxes an employer will have to withhold. Employees may claim fewer exemptions than they are entitled to in an effort to reduce later tax obligations. Employees may also ask employers to take additional money from their wages in anticipation of a larger tax bill. The IRS provides Publication 505, Tax Withholding and Estimated Tax, and Publication 919, How Do I Adjust My Withholding, to help employees complete the form.

Employees may not claim more exemptions than those to which they are entitled. Employees may claim one for themselves (unless they can be claimed as a dependent by another taxpayer), one for their spouse (if the spouse is not claiming a personal exemption on a Form W-4), and one exemption for each child or other dependent claimed on their tax return. It is the employee’s responsibility to identify personal exemptions. Employees who submit a Form W-4 that results in less tax being withheld will owe tax when filing a return and may owe a penalty. However, employers are under no obligation to confirm the validity of an employee’s exemptions.

In the past, employers were required to submit all Forms W-4 to the IRS that claimed complete exemption from withholding (when $200 or more in weekly wages were regularly expected) or claimed more than 10 allowances. However, employers are no longer required to routinely submit Forms W-4 to the IRS and are only required to submit the Forms W-4 to the IRS if directed to do so by the agency via written notice or pursuant to specified criteria released by the agency.

If the IRS determines that an employee does not have enough withholding, it will notify the employer to increase the amount of withholding tax by issuing a “lock-in” letter that specifies the maximum number of withholding allowances permitted for the employee. A copy of the lock-in letter will also be included by the IRS and employers must provide it to current employees. An employer is not required to take action based on the lock-in letter if the employee is no longer employed by it. However, if the employee returns to work within 12 months, then the lock-in letter must be provided to him or her. For current and returning employees (within the aforementioned 12-month period), employers must withhold income tax from the employee’s wages based on the withholding rate stated in the IRS lock-in letter.

Note: The IRS provides additional guidance on lock-in letters and more on the Withholding Compliance Questions & Answers page on its website.

Tax Exempt

Some employees may qualify for a no-tax-liability exemption, thus relieving an employer from withholding federal income taxes (but not FICA taxes). An employee may claim an exemption from withholding for the current year only if both of the following apply:

For the prior year, the employee had a right to a refund of all federal income tax withheld because he or she had no tax liability.
For the current year, the employee expects a refund of all federal income tax withheld because he or she expects to have no tax liability.

An employee must provide his or her employer with a Form W-4 to claim that he or she is exempt from withholding. If the employee’s situation changes, so that he or she will be required to pay income tax, then the employee must file a new Form W-4 within 10 days after the change. Additionally, an employee who claims an exemption in 2018 but expects to owe income tax for 2019 must file a new Form W-4 by December 1, 2018 because an exemption is only valid for one year. Employers must be provided a new Form W-4 by February 15 each year to continue an exemption.

Change in Status

If an employee’s withholding allowances increase, then he or she may submit a new Form W-4 to his or her employer at any time. However, a new Form W-4 must be provided to an employer within 10 days of change in status if the allowance currently claimed exceeds that to which the employee is entitled.

Tips

Employees who make $20 or more in tips in any month are required to report all tips received to their employers. This must be in the form of a written report submitted by the 10th day of the following month. Employees who receive under $20 in tips in any month are not required to submit a report; however, they must include the tips on their tax return. Service charges added to bills are considered wages and not tips. Employers are responsible for withholding taxes on tips employees receive from customers.

Employees report the tips on Form 4070, Employee’s Report of Tips to Employer, or a similar statement showing their name, address, and Social Security number.

Employers must collect income tax, Social Security tax, and Medicare tax on the tips from either wages or other funds the employee makes available. Employers that operate large food or beverage establishment (more than 10 employees on a typical day and food or beverages consumed on the premises), are required to allocate tips if the total tips reported are less than 8 percent of gross sales. The allocated amount must be reported on the employee’s W-2 at the end of the year.

Wages

Employers have a considerably more complex responsibility in the tax process, beginning with exactly what constitutes wages for income tax purposes. Wages subject to federal employment taxes include all pay for services performed. This includes salaries and supplemental pay, such as vacation allowances, bonuses, commissions, and fringe benefits and may be paid in cash or in other forms.

Employer’s Supplemental Tax Guide, provides information on other forms of compensation that may or may not be taxable, such as the following:

Most awards and gifts are taxable unless clearly unrelated to employee performance (such as a wedding gift).
Christmas gifts or cash are taxable (turkeys are not).
Paid vacation time is considered taxable, as is any form of time-off pay.
Wages in the form of property are taxable and present the special problem of withholding the taxable amount.

Exemptions

Certain types of payments are exempt from withholding taxes as follows:

Business Expense Reimbursement. Employees who have incurred deductible expenses while performing services as an employee, have accounted to their employers for these expenses, and have been paid for their expenses are not subject to income tax withholding or payment of Social Security, Medicare, and FUTA taxes for the reimbursement — as long as they return any excess payment within a reasonable amount of time. Employees who are not required to account for and substantiate their expenses are subject to Social Security, Medicare, and Unemployment and Income Withholding taxes. Employees who are paid on a per-diem rate are considered to have accounted for their expenses if they have stayed within federal guidelines.
Noncash Payments. Noncash payments, otherwise known as “in kind” payments, for household work, agricultural labor, and service not in an employer’s trade or business are not subject to Social Security, Medicare, and FUTA taxes. Payment in kind for work done within an employer’s trade or business is taxable.
Moving Expenses. Employer payments or reimbursements in 2018 for employees’ moving expenses incurred prior to 2018 are excluded from the employee’s wages for income and employment tax purposes. (See Tax Reform Modifications)
Meals and Lodging. The value of meals is not taxable income if the meals are furnished for the employer’s convenience and on the employer’s premises. This is also true of the value of lodging furnished for the employer’s convenience, on the employer’s premises, and as a condition of employment.
Health Insurance Plans. Payments to employees’ accident or health insurance plans are not taxable as income unless the employee owns more than 2 percent of an S corporation and the S corporation is paying the cost of the insurance.
Medical Saving Accounts. Employer contributions to employees’ medical savings accounts are not taxable if there was expectation they would not be included in income. Employee contributions are, however, taxable.
Medical Care Reimbursements. Medical care reimbursements paid for under an employer’s self-insured medical reimbursement plan are not taxable. Sick pay remunerated to an employee unable to work because of illness or injury is subject to FICA and FUTA taxes for a period up to six months after the last calendar month the employee worked for the employer. After six months, sick pay is exempt from FICA and FUTA taxes.
Fringe Benefits. Ordinarily, fringe benefits (such as cars, company-provided air travel, service discounts, club memberships, and tickets) are taxable as income. However, services that do not cost the employer anything, minimal value fringes (such as local transportation benefits and parking) and services such as tuition reduction and the use of on-premise athletic facilities are not considered income. For tax years beginning in 2010, employee use of employer-provided cell phones and other similar telecommunications equipments (such as PDAs, BlackBerrys, and smart phones) and their related calling/data plans which are primarily for noncompensatory business purposes are treated as follows:
- Business use is excludable from the employee’s income as a working condition fringe benefit.
- Personal use is excludable as a minimal value fringe benefit. (Employer recordkeeping is not required for either the business or personal use of employer-provided cell phones.)
Casual Labor. Employers are not required to withhold federal taxes and most state income taxes or to pay federal and state unemployment taxes for cash payments of less than $50 in a calendar quarter if the employee was engaged in casual labor fewer than 24 different days during the quarter.

Tax Reform Modifications

Employers are directly impacted by the Tax Cuts and Jobs Act. For example, the act disallows employer deductions for all of the following:

Activities generally considered to be entertainment, amusement, or recreation.
Membership dues for clubs organized for business, pleasure, recreation, or other social purposes.
A facility used in connection with the above items, even if the activity is related to the active conduct of trade or business.
Certain payments made in sexual harassment or sexual abuse cases (See Notice 2018-23).

The act also disallows deductions for expenses associated with transportation fringe benefits or expenses incurred providing transportation for commuting (except as necessary for employee safety).

The IRS offers resources on their Tax Reform Provisions that Affect Businesses web page, and provides the following information for employers:

Bicycle commuting reimbursements are no longer excluded from employees’ income but are still deductible by employers. Under the tax law, employers can deduct qualified bicycle commuting reimbursements as a business expense for 2018 through 2025. The new tax law suspends the exclusion of qualified bicycle commuting reimbursements from an employee’s income for 2018 through 2025. Employers must now include these reimbursements in the employee’s wages.
Employer payments or reimbursements in 2018 for employees’ moving expenses incurred prior to 2018 are excluded from the employee’s wages for income and employment tax purposes. Under Notice 2018-75, reimbursements an employer pays to an employee in 2018 for qualified moving expenses incurred in a prior year are not subject to federal income or employment taxes. The same is true if the employer pays a moving company in 2018 for qualified moving services provided to an employee prior to 2018. To qualify, reimbursements or payments must be for work-related moving expenses that would have been deductible by the employee if the employee had directly paid them prior to January 1, 2018. The employee must not have deducted them in 2017. For more information on the 2017 rules, see Form 3903 or Publication 521.
Employee achievement award — tangible personal property defined. Special rules allow an employee to exclude certain achievement awards from their wages if the awards are tangible personal property. An employer also may deduct awards that are tangible personal property, subject to certain deduction limits. The new law clarifies that tangible personal property does not include cash, cash equivalents, gift cards, gift coupons, certain gift certificates, tickets to theater or sporting events, vacations, meals, lodging, stocks, bonds, securities, and other similar items.

Withholding Period

Employers are required to withhold taxes for each payroll period that period of service for which wages are usually paid, even if an employee does not work for the full pay period. Employers without a payroll period should withhold the tax as if wages were paid for a daily or miscellaneous pay period.

For commissions paid on completion of a sale and other wages unrelated to a specific number of days, taxes are calculated based on the number of days back to the last payment or the date employment began (if during the same calendar year) or back to January 1 — whichever was most recent.

Applicable Taxes

Once employers know which workers require the collection and payment of taxes, on what income and how often these taxes must be collected, employers need to know exactly which taxes to collect.

Note: All tax rates are subject to changes annually. Employers should consult with the IRS or other applicable legal entity for current rates and scheduled changes.

Income Tax Withholding

Income tax must be withheld from an employee’s wages, as previously defined, for each payroll period. Income tax withholding is based on the Form W-4 filled out by each employee. The IRS Circular E provides valuable information for employers on handling Forms W-4. Basically, however, the amount of income tax withholding is based on an employee’s marital status and withholding allowances.

Some employees may claim an exemption from withholding based on having no income tax liability last year and on the expectation of having none for this year. However, this employee’s wages are still subject to Social Security and Medicare taxes.

Employers are also required to withhold income tax from the wages of nonresident aliens. However, IRS Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Corporations, and IRS Publication 519, U.S. Tax Guide for Aliens, present exceptions to this requirement.

Employers must withhold income tax from each pay period. The IRS provides wage-bracket tables to help employers calculate withholding tax. These are easy-to-use tax tables similar to those used to calculate taxes owed on the standard Form 1040. The IRS also supplies percentage-method tables based on the particular pay period an employer uses (such as weekly and biweekly), which are slightly more complicated to use. Employers that wish to use a method other than the wage-bracket or the percentage method should consult a tax specialist. Whatever method is used, employers may not withhold less than the prescribed amount.

Note: Part-time and temporary workers are treated the same as full-time employees for purposes of income tax withholding.

Advanced Earned Income Credit Payment

An employee who is eligible for the earned income credit (EIC) and has a qualifying child is entitled to receive EIC payments with pay during the year. To receive these payments, the employee must submit a completed Form W-5 to the employer.

Employers are required to make advance EIC payment to employees who provide them with a completed and signed Form W-5. Unless revoked by the employee, the Form W-5 remains in effect until the end of the calendar year.

Social Security and Medicare Taxes

The Federal Insurance Contribution Act (FICA) is intended to provide a system of old age, survivor, disability (OASDI), and hospital insurance. The first three of these are financed by the Social Security tax, and the hospital insurance is financed by Medicare tax. The taxes are reported separately.

Both employees and employers are responsible for paying these taxes. Employers withhold and pay the employees’ share and pay a matching amount. The wage base limit is adjusted annually; the rate for 2018 is $128,400 and increases to $132,900 in 2019. For 2018 and 2019 the employee’s withholding rate is 6.2 percent, and employers must pay a tax of 6.2 percent on the first $128,400 in 2018 (the first $132,900 in 2019) of an employee’s salary, for a total of 12.4 percent. For Medicare’s Hospital Insurance Program (HI), after 1993 there has been no limitation on HI-taxable earnings. Tax rates under the HI program are 1.45 percent for employees and employers, each, and 2.9 percent for self-employed persons.

Part-time employees, temporary employees, and employees with more than one job are all treated the same as full-time employees for purposes of Social Security and Medicare taxes. IRS publication 15-A explains the part-year-employment method of figuring taxes or the same method as used for full-time workers may be used.

Federal Unemployment Tax Act

The Federal Unemployment Tax Act (FUTA), with state unemployment systems, provides for payments of unemployment compensation to workers who have lost their jobs. The funds from the FUTA tax create the Federal Unemployment Trust Fund, administered by the U.S. Department of Labor. Most employers pay both a federal and state unemployment tax. However, only the employer pays FUTA, and it is not deducted from an employee’s wages.

Employers with one or more employees — other than farm or household workers or their own children — are subject to FUTA if the wages total $1,500 or more in any calendar quarter in the current or previous tax year or if they employ workers for at least one day in each of 20 calendar weeks, regardless of whether the calendar weeks were consecutive. However, some state laws differ from the federal law and employers should contact their state workforce agencies to learn the exact requirements.

Employers of domestic employees must pay state and federal unemployment taxes if they pay cash wages to household workers totaling $1,000 or more in any calendar quarter of the current or preceding year. A household employee is an employee who performs household work in a private home, local college, or local fraternity or sorority chapter.

Employers that paid more than $20,000 in cash wages to farm workers during any calendar quarter of the current or previous tax year or who employed 10 or more farm workers during at least part of a day during any 20 or more weeks in either the current or previous tax year are also subject to FUTA. The 20 weeks need not be consecutive weeks, nor must they be the same 10 employees, nor must all employees be working at the same time of the day.

The standard FUTA tax rate is 6.0 percent on the first $7,000 of wages subject to FUTA. Generally, employers may receive a credit of 5.4 percent when they file their Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, to result in a net FUTA tax rate of 0.6 percent (6.0 percent – 5.4 percent = 0.6 percent). Some states take Federal Unemployment Trust Fund loans from the federal government if they lack the funds to pay UI benefits for residents of their states. If a state has outstanding loan balances on January 1 for two consecutive years, and does not repay the full amount of its loans by November 10 of the second year, the FUTA credit rate for employers in that state will be reduced until the loan is repaid. The reduction schedule is 0.3 percent for the first year the state is a credit reduction state, another 0.3 percent for the second year, and an additional 0.3 percent for each year thereafter that the state has not repaid its loan in full. Additional offset credit reductions may apply to a state beginning with the third and fifth taxable years if a loan balance is still outstanding and certain criteria are not met.

State Income Taxes

Most states, but not all, impose a personal income tax. Employers conducting business in those states must withhold that tax along with the federal taxes.

Employers can usually use the same methods to calculate state income taxes that they used to calculate federal ones. Most states have their own equivalent to the federal Form W-4.

In some cities, employers may have to withhold local income taxes in addition to federal and state income taxes. Multistate employers may have to withhold taxes for several states when employees live and work in different states. The services of a tax specialist are highly recommended as these situations become more complex.

Military Spouses Residency Relief Act

The federal Military Spouses Residency Relief Act allows a military spouse who moves out of a state with their service member under military orders to have the option to claim the same state of domicile as their active duty spouse, regardless of where they are stationed. Service members themselves have long had such an option and spouses did not, thereby resulting in split residencies for many families.

The act is effective for tax years after 2008 and amends the Servicemembers Civil Relief Act to prohibit all of the following solely because the person is absent from a state because they are accompanying their spouse who is absent from the state in compliance with military or naval orders:

Losing a residence or domicile in a state.
Acquiring a residence or domicile in any other state.
Becoming a resident in or of any other state.

The act also prohibits both of the following:

A service member’s spouse from either losing or acquiring a residence or domicile for purposes of taxation because of being absent or present in any U.S. tax jurisdiction solely to be with the service member in compliance with the service member’s military orders if the residence or domicile is the same for the service member and the spouse.
A spouse’s income from being considered income earned in a tax jurisdiction if the spouse is not a resident or domiciliary of such jurisdiction when the spouse is in that jurisdiction solely to be with a service member serving under military orders.

State Unemployment Taxes

Most states require employers to pay part of the first $7,000 to a state unemployment fund to provide the benefits for former employees terminated without cause after working for at least 20 weeks. A company’s liability is based on the prior year’s claims experience. Companies are required to register with the state and file quarterly tax returns. The state unemployment tax rate will be adjusted to ensure that the company maintains a minimum balance relative to its experience rating.

Note: State unemployment tax rates are subject to changes annually. Employers should consult with the IRS or other applicable legal entity for current rates and scheduled changes.

Paying the Taxes

Employers should keep in mind a few of the following important issues to ensure accurate withholding and timely payment of various taxes:

Failure to pay over taxes withheld may subject business owners to an obligation for the tax withheld plus interest and penalties. Individuals responsible for payroll are liable for the taxes withheld portion of payroll taxes due, and bankruptcy does not protect someone from this obligation.
Deposits of less than the required amounts may subject employers to penalties unless the shortage is less than the greater of $100 or 2 percent of the required amount and the shortage was paid or deposited by the by the shortfall makeup dates specified in Circular E.
Failure to deposit income tax and FICA by the due date results in a 2-percent penalty for deposits 1 to 5 days late, a 5-percent late-payment penalty for deposits made 6 to 15 days late, and up to a 15-percent penalty for deposits unpaid more than 10 days after an IRS notification.
Employers must submit federal payroll taxes with the appropriate financial institution at least monthly.
State tax payments must be sent to the administering agency quarterly.
Employers must notify employees of payroll taxes withheld.

Employer Identification Number

To file the various tax returns, employers need a federal Employer Identification Number (EIN). Other than a sole proprietor with no employees, every employer needs an EIN. Employers must use an EIN on all items sent to the IRS and Social Security Administration. Employers may obtain their EIN by filing Form SS-4, available at most Social Security Administration and IRS offices. Additionally, the number may be obtained by mail, fax, or by phone.

Note: If the organization or ownership of a business changes, an employer may have to apply for a new EIN.

Federal Taxes

Income Tax and FICA Tax

Withheld income taxes, Social Security, and Medicare taxes (less any advance earned income credits) must be deposited by mailing or delivering a check, money order, or cash to an authorized financial institution or Federal Reserve Bank. These deposits are usually made monthly (by the 15th of the following month) or semiweekly (within the next week), as the IRS determines for the individual employer.

The frequency of deposits is based on an employer’s total taxes, as reported on Form 941 in a four-quarter look-back period beginning July 1 and ending June 30. Taxes of less than $50,000 are usually deposited monthly. Taxes of over $50,000 are deposited semiweekly.

New employers deposit taxes monthly for their first calendar year, although there is an exception to this — the $100,000 Next-Day Deposit Rule — explained in Circular E. Employers who incur a tax liability of $100,000 or more on any day during a deposit period must deposit the tax by the next banking day, whether they are on a monthly or semiweekly depositing schedule. Taxes of less than $2,500 for a quarter may be paid directly with the quarterly return rather than being deposited.

Note: Income tax and FICA tax rates are subject to changes annually. Employers should consult with the IRS or other applicable legal entity.

FUTA Taxes

Federal unemployment tax is usually deposited quarterly, on the last day of the month that follows the end of each quarter. Thus, payments are due by April 30, July 31, October 31, and January 31. Employers with a FUTA liability of less than $500 are not required to deposit the tax. Rather, such employers may carry the tax forward and add it to the liability of the next quarter to determine whether a deposit must be made. Form 8109, Federal Tax Deposit Coupon, which the IRS supplies with the EIN, must accompany deposits of federal payroll taxes. The deposit coupon is how the IRS credits an employer’s tax account. The authorized financial institution or Federal Reserve Bank cannot accept payment without a deposit coupon.

Note: FUTA tax rates are subject to changes annually. Employers should consult with the IRS or other applicable legal entity.

Electronic Transfer of Funds

Employers with FUTA tax liability over $500, including any FUTA tax carried forward from an earlier quarter must, deposit the FUTA tax by an electronic funds transfer or in an authorized financial institution using Form 8109, Federal Tax Deposit Coupon.

Additionally, employers must electronically deposit all depository taxes (employment tax, excise tax, and corporate income tax) using the Electronic Federal Tax Payment System (EFTPS) if either of the following applies:

The total deposits of such taxes in the previous tax year were more than $200,000.
An employer was previously required to use EFTPS.

Penalties

Employers that are required to use EFTPS and fail to do so are subject to a 10 percent penalty. Employers that are not required to use the system may do so voluntarily.

State Taxes

State income taxes withheld and employer payments for state unemployment taxes must be submitted to the appropriate state agency at least quarterly, although some states, notably California, have special requirements.

Note: State tax rates are subject to changes annually. Employers should consult with the IRS or other applicable legal entity.

Record keeping

Employers’ tax responsibility does not end once the taxes are withheld and deposited. They must also comply with elaborate recordkeeping requirements.

General Employment Tax Records

Employers are required to keep the following employment tax records for at least four years from the due dates of the relevant returns or from the dates the taxes were paid:

Amounts and dates of wages paid and tips reported.
The fair market value of noncash wages.
The names, addresses, Social Security numbers, and job titles of all employees.
The dates of all employees’ employment.
The rate of pay of each employee.
Copies of Form W-4 showing each employee’s withholding allowances.
Duplicate copies of Forms 940 and 941 filed.
The dates and amounts of all tax deposits.
Periods for which employees and recipients were paid while absent due to sickness or injury and the amount and weekly rate of payments made by the employer or third party.
Canceled checks or check stubs for all wages paid and deposits made.
Undeliverable Forms W-2.

Note: These records must be kept in such a way as to allow them to be easily accessed by the IRS or by state authorities.

Form 941

All employers, who are not farmers, who pay wages subject to income tax withholding or Social Security or Medicare taxes, must file Form 941, Employer’s Quarterly Federal Income Tax Return. Agricultural employers file an annual return, Form 943.

Employers with more than one location or division must only file one Form 941 per quarter — January – March, April – June, July – September, and October – December. The form is due by the last day of the month following the end of the quarter. Employers that qualify may file the form by phone or electronically in the cases of reporting agents filing for groups of taxpayers. A final Form 941 is required for employers who go out of business. Form 941 reports the following:

Wages paid, including, any tips employees have received.
Federal income tax withheld.
Social Security and Medicare taxes withheld and the employer’s share of Social Security and Medicare taxes.
Advance earned income credit payments.

An adjustment line is available to correct the Social Security and Medicare taxes employers were unable to collect on employees’ tips or for Social Security and Medicare taxes withheld from employees’ sick pay from a third party, such as an insurance company. The income tax withheld is added to the Social Security and Medicare taxes on the form and any advance earned income credit payments are subtracted. The remainder is the amount of employment taxes owed for the quarter. Employers with a tax liability of more than $2,500 must complete a special portion of Form 941 or Schedule B (Form 941).

Employers are required to resolve discrepancies between Form 941 filed with the IRS and the Forms W-2 and W-3 filed with the Social Security Administration. Employers should reconcile all amounts entered on the forms, comparing the Forms W-3 with the quarterly Form 941. Employers must use an adjusted Form 941 to resolve these discrepancies.

Form 940

Employers may also have to file a federal unemployment tax return Form 940 by January 31 of each year if they paid $1,500 or more in wages in any calendar quarter in the current or previous tax year or had at least one employee work for some part of a day in any 20 different weeks the current or previous tax year. This includes regular, temporary, and part-time workers.

Note: As of the 2008 tax period, the IRS is no longer using or accepting Form 940-EZ. Employers who would have filed a 940-EZ form must now use the simplified Form 940.

Agricultural Occupations

Agricultural employers will have to file Form 940 or 940-EZ if they paid cash wages of $20,000 or more to farm workers in the current or previous tax year or employed 10 or more farm workers for at least part of a day during any 20 or more different weeks in the current or previous tax year.

Schedule H

Employers who do not report employment taxes for household employees on Form 941 or 943 must report FUTA taxes for those employees on Schedule H of Form 1040.

Form W-2

Employers required to file a Form 941 must inform their employees how much has been withheld from the employees’ wages for federal and state income taxes and FICA taxes. This reporting is done by supplying each employee with a Form W-2, Wage and Tax Statement, by January 31 of the month following the reporting year. Copies of Forms W-2 must be filed with the Social Security Administration by the end of February.

Termination

Employees who were terminated before the end of the year may request the Form W-2 earlier, and the form must be furnished within 30 days of the request.

Form 1099-Misc.

Independent contractors who have been paid at least $600 for their services receive a copy of the federal information return form (Form 1099-Misc.) that employers must file with the IRS. The independent contractor must receive the form by January 31, and the IRS must receive the form by February 28.

Caution

The material provided here is intended solely as an introduction to a very complex topic. Employers are urged to read IRS publications, consult additional publications, and confer with a tax professional to assist with a thorough understanding of this complicated subject.