If you are the sole owner of a corporation and pay yourself a salary, you are in the unique position of being your own boss--and your own employee.
As an employee of your corporation, you must have payroll taxes withheld from your earnings: federal and state income taxes, as well as FICA (Federal Insurance Contributions Act, to be explained in detail below). As the employer of your corporation, you must pay a matching amount of FICA tax and remit this tax, along with the federal income tax withheld, to the IRS. Any state and local income taxes withheld must be paid to the state department of revenue. Employers must also pay federal and state unemployment taxes on behalf of their employees.
If you are a self-employed entrepreneur who files a Schedule C (Profit or Loss from Business) with your federal Form 1040, you'll avoid the hassles of payroll taxes, as long as you hire no employees. Unlike your corporate counterparts, you calculate payroll taxes once a year, on April 15th. You use Schedule C to figure your income taxes, and Schedule SE to determine the self-employed's version of FICA.
But your payroll responsibilities begin the day you hire your first employee. While you continue to file Schedules C and SE, your new employee must have payroll taxes withheld like any corporate employee.
While it could take years--if ever--for the IRS to audit your corporate income tax return or individual return with Schedules C and SE, if you miss even one payroll tax deposit, you could hear from the IRS in a matter of months. The IRS makes no allowances for start-up businesses; a deposit or return late by one day could generate a penalty.
"New businesses get in trouble with payroll taxes faster than with income taxes," says Marion Penrod, owner of Penrod Tax Service in South Bend, Indiana. "If they're smart, they'll get help."
Whether you get help or go it alone, you need to understand the basics of payroll taxes. Here is a checklist of payroll tax requirements for start-up businesses:
1. Federal identification number. Any business with an employee must file Form SS-4 with the IRS to receive an Employer Identification Number (EIN). This number is used to track your business income tax returns and your payroll tax returns. Corporations and partnerships must have an EIN regardless of whether they have employees or not. Sole proprietors only need an EIN if they have a Keogh retirement plan or hire an employee.
2. Federal income tax withholding. To determine how much federal income tax to withhold from an employee's earnings, you must have the employee fill out a Form W-4 (Employee's Withholding Allowance Certificate). Once you know the employee's salary, marital status and number of exemptions being claimed on their Form W-4, you can determine the federal taxes that must be withheld from each paycheck from the IRS Publication 15, Employer's Tax Guide. Also known as Circular E, this publication contains tables that show how to calculate the withholding and when deposits must be made with the IRS. To order a free copy, call (800) TAX-FORM.
3. FICA withholding. When you worked for someone else, you could just complain about FICA. As an employer, you now have to calculate it.
FICA is actually two separate taxes: Social Security and Medicare. The Medicare tax of 1.45 percent must be withheld on an employee's entire salary. Social Security tax of 6.2 percent is withheld on only the first $62,700 of salary (the limit in 1996). Even if you are a long way from meeting the $62,700 limit, the quarterly Form 941 Payroll Tax Return will require you to account for the Social Security and Medicare taxes separately. In addition to withholding these FICA taxes from your employee, employers are required to pay to the IRS a matching amount.
4. FICA and federal deposits. If your combined employer and employee FICA and federal taxes for all employees total less than $500 in a quarter, you can pay the entire amount when you file your quarterly Form 941. If, however, you owe more than $500 in FICA and federal payroll taxes, you qualify as a monthly depositor and must deposit the payroll taxes by the 15th day of the following month.
Monthly deposits must be made with Form 8109, and the taxes must be deposited with a Federal Reserve or authorized commercial bank. Beginning January 1, 1997, the IRS is phasing in mandatory electronic filing of federal payroll taxes. For calendar year 1997, only businesses that deposited more than $50,000 in annual federal payroll taxes in 1995 are required to file electronically. The IRS will notify you when you hit the threshold for mandatory electronic filing, which can be done via your personal computer, over the telephone, or through your bank. In the meantime, for more information on how and when to make payroll tax deposits, ask for IRS Publication 937, Employment Taxes and Information Returns.
5. Federal unemployment tax. You must pay FUTA (Federal Unemployment Tax Act) tax on behalf of your employees if you meet one of two criteria: You paid total wages for one or more employees of $1,500 or more in any quarter of the year, or you had at least one employee who worked at least one day during each of 20 different weeks of the year.
The FUTA rate is 6.2 percent, which is applied to the first $7,000 of wages of all employees. Up to 5.4 percent of any state unemployment tax you pay is subtracted from your federal rate. If you qualify for the full 5.4 percent credit, your FUTA rate could be reduced to 0.8 percent. While you only file one annual FUTA return (Form 940) at the end of the year, you must make FUTA deposits quarterly if your FUTA tax liability is $100 or more. The rules for federal unemployment tax are also explained in Circular E. Contact your state Department of Revenue to find out the requirements for state unemployment tax.