Starting a business is no easy feat. In addition to the permits and paperwork involved, business owners have far more tax responsibilities than the average employee. It becomes your job to ensure that employment taxes are adequately withheld from your employees’ wages, even if your only employee is yourself. Furthermore, you need to pitch in your employer’s share of employment taxes on each employee from the company’s revenue and beware of the differences in California payroll tax reporting, calculating, and paying.
Understanding California Payroll Tax Responsibilities
Payroll taxes are the taxes levied on wages and compensation paid to your employees, including yourself, if you are self-employed. While payroll taxes are sometimes referred to in the singular (e.g., “California payroll tax”), they constitute several different employment taxes on both the federal and state levels, including:
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- Federal income tax
- FICA (Social Security and Medicare) tax
- FUTA (federal unemployment insurance) tax
- State disability insurance tax
- State income tax
Not all states have an additional income tax. When it comes to California payroll tax, for example, businesses and employees must pay state disability insurance taxes and state income taxes. On the other hand, Florida levies no income tax and no state disability insurance at all, meaning taxpayers in Florida only pay federal income taxes and Social Security/Medicare.
FICA and FUTA Taxes
Federal and state income taxes come entirely out of employee paychecks. On the other hand, FICA and FUTA are either shared between employers and employees (FICA) or wholly paid by the employer (FUTA).
FICA Taxes
For 2021, any given paycheck must pay 6.2 percent of its value in Social Security contributions and 1.45 percent of its value in Medicare contributions. This means FICA taxes are 7.65 percent of an employee’s pay. Employers must match these individual contributions out of their business’ revenue.
FUTA Taxes
The FUTA tax for the Unemployment Trust Fund (UTF) also comes out of your business’ revenue. It is equal to 6 percent of the first $7,000 of an employee’s eligible contributions/pay, which is capped at $420 per paycheck. FUTA comes entirely out of your pocket as a business owner, so it doesn’t appear on an employee’s paycheck. Most states, including California, offer a credit of 5.4 percent, reducing a business’ contribution per paycheck to 0.6 percent (or a maximum of about $42) once they file their Annual Federal Unemployment Tax Return. However, suppose a state fails to make all its due payments for FUTA loans taken from the federal government. In that case, businesses in that state may suffer a credit reduction of:
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- 0.3 percent in the first year of a due balance.
- 0.6 percent in the second year.
- 0.9 percent in the third year.
- And additional potential credit reductions afterward.
If you are self-employed, you pay Self Employment Tax and your income taxes. Self-employment taxes are Social Security and Medicare contributions equal to the tax paid by any other employee. You take all 15.3 percent of it out of your net business income (i.e., both halves of 7.65 percent).
State Disability Insurance Taxes
Businesses in California can either use a private disability/unemployment insurance plan or use the state’s program. In 2022, California’s state disability insurance taxes equal 1.1 percent of the first $145,600 of an eligible employee’s annual wages. Businesses must also pay the assessment rate to the California Employment Development Department, which is 14 percent of the SDI tax rate (i.e., 14 percent of 1.1 percent in 2022, or 0.154 percent). Unlike FUTA and FICA taxes, federal and state income taxes are calculated, withheld, and remitted to the government every quarter. While FUTA and FICA contributions are set in stone, things become more complicated when calculating federal and state income taxes.
Calculating Federal Payroll Tax Withholding
This is crucial. The first thing you will need is each of your employee’s respective Forms W-4, which contain the information you need to calculate their withheld taxes. With this Form, you can choose to calculate income taxes either through the wage bracket method or the percentage method. Use the IRS 2022 Publication 15-T to guide you through the calculation process, as the wage bracket method differs for Forms W-4 created in 2019 or earlier and Forms W-4 made in 2020 or later.
Wage Bracket Method Tables for Manual Payroll Systems
Forms W-4 From 2019 or Earlier
Navigate to the Employer’s Withholding Worksheet 3 and follow the steps below:
Step 1: Figure the tentative withholding amount.
1a. Enter the employee’s total taxable wages this payroll period.
1b. Use the amount on line 1a to look up the tentative amount to withhold in the appropriate Wage Bracket Method table in this section for your pay frequency, given the employee’s marital status (line 3 of Form W-4) and number of allowances claimed. This is the Tentative Withholding Amount.
Step 2: Figure the final amount to withhold.
2a. Enter the additional amount to withhold from line 6 of the employee’s Form W-4.
2b. Add lines 1b and 2a. This is the amount to withhold from the employee’s wages this pay period.
Forms W-4 From 2020 or Later
Navigate to the Employer’s Withholding Worksheet 2 and follow the steps below:
Step 1: Adjust the employee’s wage amount.
1a. Enter the employee’s total taxable wages this payroll period.
1b. Enter the number of pay periods you have per year (see Table 5).
1c. Enter the amount from Step 4a of the employee’s Form W-4.
1d. Divide the amount on line 1c by the number of pay periods on line 1b.
1e. Add lines 1a and 1d.
1f. Enter the amount from Step 4b of the employee’s Form W-4.
1g. Divide the amount on line 1f by the number of pay periods on line 1b.
1h. Subtract line 1g from line 1e. If zero or less, enter -0-. This is the Adjusted Wage Amount.
Step 2: Figure the Tentative Withholding Amount.
2a. Use the amount on line 1h to look up the tentative amount to withhold in the appropriate Wage Bracket Method table in this section for your pay frequency, given the employee’s filing status and whether the employee has checked the box in Step 2 of Form W-4. This is the Tentative Withholding Amount.
Step 3: Account for tax credits.
3a. Enter the amount from Step 3 of the employee’s Form W-4.
3b. Divide the amount on line 3a by the number of pay periods on line 1b.
3c. Subtract line 3b from line 2a. If zero or less, enter -0-.
Step 4: Figure the final amount to withhold.
4a. Enter the additional amount to withhold from Step 4c of the employee’s Form W-4.
4b. Add lines 3c and 4a. This is the amount to withhold from the employee’s wages this pay period.
The percentage method is even more complicated and is thoroughly explained through IRS Publication 15-T. As for your state taxes, the California Franchise Tax Board offers a comprehensive income tax calculator for each respective tax year, with the respective tax tables.
Working With a Tax Professional
Calculating and properly withholding wages for tax purposes is complicated. And risky. The consequences for failing to calculate the payroll tax you owe the government are steep, with up to 15 percent penalties on unpaid payroll taxes. Even 24 hours behind your payroll taxes can cost you a 2 percent penalty on the amount due. You can save yourself the headache and financial woes of federal and state tax trouble by contacting a payroll tax expert to manage your taxes and ensure that you’re paying your employees and the federal and state government what they’re owed.
Many companies and tax services offer tax suites to businesses, including payroll tax calculation and management for each of their employees and new hires, often at lower costs than what you might owe the government if you make a few essential clerical errors. Anything and everything can go sideways when setting up a business. Keep payroll taxes from being yet another hurdle on your path to success by working with our tax professionals at Rush Tax Resolution.