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). 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 percent on a wage base ($106,800 in 2011); the Medicare portion is 1.45 percent on all wages.
- Federal unemployment tax (FUTA). The net FUTA rate, after a credit for state unemployment tax, is 0.8 percent on the first $7,000 in wages 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 rate nationwide is roughly 1 percent.
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Altogether, payroll taxes are about 10 percent 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 and entertainment expenses, tools, or other job-related costs, the way in which you do this can favorably impact your payroll taxes. If you use an accountable plan, the reimbursements are:
- Not taxable to employees
- Exempt from FICA and FUTA taxes
An accountable plan is one that meets three requirements:
- Business connection. The expenses must have a business connection. Expenses incurred by an employee while doing the job usually have such a connection.
- 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.
- Return of excess reimbursement. 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
- Education assistance up to $5,250 a year
- 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
- Moving expenses
- 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.
Unfortunately, the formerly black-and-white rule in the tax law that directors’ fees are not wages is now subject to some shades of gray. In Oregon, for example, a court said that payments to directors are subject to unemployment taxation. Washington imposes a business and occupation (B & O) tax on corporate directors with a nexus (connection) to the state if they receive more than $12,000 in directors’ fees annually.
Work with a knowledgeable tax adviser who can help you find other ways to minimize employment taxes. A tax professional can help you save payroll taxes as well as help you assess the true cost of hiring new employees.