5 Ways to Cut Employer Payroll Taxes

Payroll taxes, also called employment taxes, are the employer’s tax obligations with respect to compensation paid to employees. There are payroll taxes on the federal and state levels. Part of payroll taxes is the employer’s obligation to withhold income taxes and the employee’s share of Social Security and Medicare taxes (FICA); these taxes come out of the employee's pay and do not cost the employer anything (other than administrative costs).

How Much Does an Employer Pay in Payroll Taxes?

However, the employer must pay the following on the federal level:

• The employer share of Social Security and Medicare taxes (FICA). The Social Security portion is 6.2% on a wage base ($147,000 in 2022); the Medicare portion is 1.45% on all wages.
• Federal unemployment tax (FUTA). The net FUTA rate, after a credit for state unemployment tax, is 0.8% on the first $7,000 in wages per employee for employers in most states.

On the state level, the employer must pay state unemployment tax. The rate varies from state to state. States may assess this tax based on the employer’s experience with unemployment benefit claims; the fewer the claims, the lower the rate for the employer. The average rate nationwide is less than 2%.

Want to read more about small business taxes? Check these out:

• Guide to Tax Implications of Financing Options
• 5 Things to Know About Audits for Your Business
• Deducting Startup and Organizational Costs

Altogether, payroll taxes are about 10% of compensation paid to employees. If an employee earns $50,000, it costs you about $5,000 in payroll taxes. The good news is you can reduce your payroll tax costs with a few simple—and perfectly legal— strategies.

Use Accountable Plans

If you reimburse employees for travel expenses, home internet access for remote workers, tools or other job-related costs, the way in which you do this can favorably impact your payroll taxes. This means using an accountable plan which is an arrangement your company adopts (no formal written plan is required but highly suggested) for reimbursing employees that meets certain criteria listed below. 

• Not taxable to employees (and not even reported on their Forms W-2)

• Exempt from FICA and FUTA taxes

An accountable plan is one that meets three requirements:

1. Business connection. The expenses must have a business connection. Expenses incurred by an employee while doing the job usually have such a connection.
2. Proper substantiation. The employee must adequately account to the company for expenses within a reasonable time (generally within 60 days after incurring the expense). Adequate accounting means completing expense reports (written or online) and providing the company with receipts, invoices and other documentary evidence of the expense. For example, accounting for business lunches means making a record of who the employee dined with, the business purpose of the meal, where and when it took place, and how much it cost. In addition, a receipt for the meal or the charge card statement is the documentary evidence needed here.
3. Return of excess reimbursement. If the employer advances money, the employee must return to the company any excess reimbursements within a reasonable time (usually within 120 days after the expense is incurred).

Pay Benefits Exempt from Payroll Taxes

Thinking of giving a raise? Instead, consider adding fringe benefits that are exempt from FICA and FUTA taxes. These benefits are products and services that the employee might otherwise have to buy with after-tax dollars, so they may be appreciated as much, if not more than, a raise. Most fringe benefits must be provided to staff on a nondiscriminatory basis and cannot be restricted to owners and their families.

Some fringe benefits which are exempt from FICA and FUTA taxes are:

• Accident and health benefits
• Dependent care assistance up to $5,000 a year (although it was $10,500 in 2021)
• Education assistance, including student loan repayment, up to $5,250 a year
• Employer contributions to retirement plans for employees
• Employee discounts up to set limits
• Group-term life insurance
• Health savings account contributions up to set limits
• Meals and lodging on business premises for the employer’s convenience
• Retirement planning services

For a complete list of fringe benefits and their tax status, see IRS Publication 15-B, Employer’s Tax Guide to Fringe Benefits.

Pay Corporate Directors

All corporations are required to have directors and to hold meetings at least once annually. If you own a corporation, consider transforming a portion of wages into a director’s fee as long as you continue to receive reasonable compensation for work performed as a corporate employee. This can work not only for you, but also for any other employee who is also a corporate director. Set directors’ fees according to the time and work required. Fees usually include at a minimum a flat per-meeting payment ($200, $500 or more), plus reimbursement for travel and other expenses.

Directors are not employees of the corporation and payments to them are not subject to employment taxes. Directors’ fees are self-employment income, which are potentially subject to self-employment tax; if there are offsetting expenses to the fees, then there will be no such tax.

Opt Out of Unemployment Insurance for Corporate Officers

Unlike corporate directors, corporate officers are employees of the corporation. While state unemployment insurance tax is usually required for every employee, a few states (e.g., Oregon, Washington) may allow corporate officers to elect not to be covered by unemployment insurance. The option may only apply if certain conditions are met (e.g., having a certain percentage of ownership; having total payroll for the company below a set amount) and a timely election is filed for opting out. In other states, such as Minnesota, corporate officers are automatically exempt from this tax, but can opt in. Where there is flexibility, the decision to pay state unemployment tax for corporate officers should be weighed against the potential loss of benefits if an officer is terminated.

Use the Common Paymaster Rule

If a group of corporations share the services of an employee, the corporations can designate which one will be the "paymaster." The paymaster pays the employee for services performed at the different corporations. This saves the group FICA and FUTA taxes. For example, say an individual is the 100% owner of two corporations and concurrently works for both of them. Assume salary from one is $75,000 and the salary from the other is $125,000. Without a common paymaster, each corporation would pay FICA and FUTA on the respective wages. With a common paymaster, one corporation pays these taxes on the total compensation, capping the employer’s cost for Social Security taxes at the annual wage base (e.g., $147,000 in 2022) and avoiding duplicate FUTA tax. In this example, a common paymaster saves the corporations more than $3,000 in payroll taxes.

The Bottom Line

Work with a knowledgeable tax adviser who can help you find other ways to minimize employment taxes for your situation. A tax professional can help you save payroll taxes as well as help you assess the true cost of hiring new employees.

A version of this article was originally published on April 27, 2011.