Payroll 101

September 15, 2012 in , , , , ,

As an employer, you have many payroll-related obligations. If you have not handled payroll in the past, some terms and definitions can be confusing. The following basic payroll primer can give you a head start in understanding some of the terms and concepts you need to know.

Employee vs. Independent Contractor
An employee is defined differently under different regulations but is generally considered to be anyone who performs services for you where you have the right to control what will be done and how it will be done, even if the individual has been granted freedom of action.

An independent contractor is generally a business owner or contractor who provides services to other businesses and is considered self-employed. As the employer you will generally have the right to control or direct only the result of the independent contractor’s work and not how it will be done.

It is important to determine if individuals providing services for your business are employees or independent contractors. If you misclassify an employee as an independent contractor you may be held liable for employment taxes for that worker and possibly back overtime and benefits. For more information, refer to the IRS website: Independent Contractor (Self-Employed) or Employee? and the US Department of Labor Fact Sheet #13 Employment Relationships Under the Fair Labor Standards Act. (http://www.dol.gov/whd/regs/compliance/whdfs13.pdf)

Employee-Paid Taxes
If you have employees, you may be required to withhold specific employment taxes from their pay, including;

  • Federal Income Tax – The amount to withhold is based on IRS withholding tables, the employee’s taxable compensation and martial status, number of allowances, and exemptions that the employee reports on Form W-4.
  • Social Security and Medicare (FICA) – The Federal Insurance Contributions Act (FICA) provides a federal system for old-age, survivors, disability and hospital insurance. Employees are required to contribute a percentage of their wages to support the financing of this system, with employers generally making matching contributions. All of these benefits are supported by the social security portion of FICA, with the exception of the hospital benefits; this benefit is supported by the Medicare portion.
  • State and Local Income Tax – Businesses should withhold income tax from employees as specified by each state and locality where the business operates.
  • State Unemployment Insurance (SUI) – SUI is primarily an employer-paid tax; however, a few states require employees to contribute to the state’s unemployment compensation program as well.

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Employer-Paid Taxes
You may also be required to pay the following taxes:

  • Social Security and Medicare (FICA) – Along with your employees, you may be required to contribute to social security and Medicare. You are liable for the entire tax, regardless of the amount actually withheld from employees. After the total liability is calculated and the amount collected from employees is subtracted, you are responsible for paying the remaining portion. If you under-withhold this tax from your employees, you will be responsible for making up the difference.
  • Federal Unemployment Tax – The Federal Unemployment Tax Act (FUTA), in conjunction with state unemployment insurance programs, provides payments to workers who lose their jobs. FUTA tax is strictly to pay administrative costs and fund state programs as needed.
  • State Unemployment Insurance (SUI) – The SUI program pays the actual benefits to unemployed workers. Employers are responsible for paying SUI tax based on the number of employees in the business and a rate assigned by the state. If the state fund is depleted because of higher unemployment, the state may borrow from FUTA funds in the federal government.
  • State Disability – A few states require that an employer or employee contribute to a state-mandated disability program.

FLSA
The Fair Labor Standards Act (FLSA), the federal wage and hour law, establishes minimum wage, overtime pay, recordkeeping, and child labor standards affecting full-time and part-time workers in the private sector and in Federal, State, and local governments. For more information, see http://www.dol.gov/compliance/laws/comp-flsa.htm.

New Hire Reporting
The Personal Responsibility and Work Opportunity Reconciliation Act
(PRWORA) of 1996 requires employers to report any newly hired employees to the appropriate state agency, generally within 20 days from the date of hire. Some states may have even more stringent reporting requirements. This law was enacted to reinforce child support rulings, to locate parents, establish an order, or reinforce existing orders. Many states also use this information to help prevent fraudulent workers’ compensation and unemployment claims.

Tax Deposits
Employers are responsible for depositing employee-paid and employer-paid taxes on a schedule enforced by the federal, state, or local tax agency. Failure to pay taxes on time may result in a penalty assessed by the tax agency.

  • Federal liability includes federal income tax, employee social security and Medicare, and employer social security and Medicare. Payments are due to the IRS based on the amount of federal payment and how much liability the business incurred in a certain time period called the “lookback” period. These payments are sent to the IRS.
  • FUTA and SUI liability are normally paid quarterly. FUTA is paid to the IRS, and SUI is paid to the state agency where the business operates or the employee works.
  • State and local withholding is paid directly to the state or local agency based on a deposit schedule mandated by the tax agency.

Tax Returns
Tax returns are required to report wages and reconcile the tax deposits remitted; some tax payments can be sent when the return is filed.

Return Function Frequency
Form 941: Employer’s Quarterly Federal Tax Return Reports wages and taxes for federal income tax, employee social security and Medicare tax, and employer social security and Medicare tax. Quarterly
Form 940: Employer’s Annual Federal Unemployment Tax Return Reports wages and taxes for FUTA.
Although deposits are made quarterly – if over $500, the return is filed annually.
Quarterly deposits if over $500;
Annual filing
Form W-2: Wage and Tax Statement Reports individual employee wages and taxes. One copy given to employees; another copy filed with the Social Security Administration (SSA). Annual
Form W-3: Transmittal of Wage and Tax Statements Summarizes information reported on Forms W-2. Filed with the SSA along with a copy of Forms W-2. Annual
SUI Reports wages and SUI tax on state-specific form. Quarterly
Withholding Reports wages and taxes for state and local withholding. Varies by agency

Pay Frequency
The frequency of pay required (weekly, bi-weekly, semi-monthly, monthly) is generally determined by state statute.  Employers can generally establish the actual payday as long as they adhere to the applicable pay frequency law mandated by the state.  Where permitted, employers may also elect to pay employees using a mixed pay frequency, i.e., some employees could be paid weekly, and others paid monthly.

Wages and Other Compensation
Compensation includes all wages given to an employee for services performed. This compensation can be in cash or other forms and includes regular pay, overtime, vacation pay, sick pay, commissions, bonuses, and fringe benefits.
For more information, check http://www.irs.gov.

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