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Withholding Taxes

Employers are responsible for withholding taxes from employees' paychecks, sending them to the proper government agencies, and other employer tax obligations. The major employer paid taxes (FICA, federal unemployment, and state unemployment taxes) will be explained later in this section.

The Federal Insurance Contributions Act (FICA) provides for a federal system of old-age, survivors, disability, and hospital insurance. The first three are financed by the social security tax, while hospital insurance is financed by the Medicare tax. To learn more about the five major benefits covered by Social Security taxes (retirement, disability, family benefits, survivors and Medicare), please refer to the Social Security Administration's Web site.

Employers must withhold social security and Medicare taxes from employees' wages and pay a matching amount. These taxes have different rates and only the social security tax has a wage base limit. There is no wage base limit for Medicare tax; all covered wages are subject to Medicare tax.

The Federal Unemployment Tax Act (FUTA), together with state unemployment systems, provides for payments of unemployment compensation to workers who have lost their jobs. Most employers pay both a federal and a state unemployment tax. Only the employer pays FUTA tax; it is not deducted from the employee's wages.

Generally, employers can take a credit against FUTA tax for amounts paid into state unemployment funds. This credit cannot be more than 5.4% of taxable wages. Those entitled to the maximum 5.4% credit have an effective FUTA tax rate of 0.8% after the credit. The IRS has tests to determine whether a particular business must pay FUTA tax.

State unemployment taxes are also paid by the employer and are not deducted from the employee's wages. Each state has a different rate and different wage limits from which the taxes are calculated. For information on state-specific unemployment taxes and contact information for the agency that administers your state's unemployment tax, use the Business Owner's Toolkit.

Generally, hiring a payroll service is a good idea for businesses in which payroll isn't the same from pay period to pay period. Businesses with hourly employees or employees earning commissions can save time and money by using a payroll service. One of the chief benefits is avoiding costly mistakes in payroll processing like failing to remit payroll taxes in a timely manner. Payroll companies calculate the amount of each paycheck and the tax obligations for each employee; print the checks; and provide payroll reports.