Understanding Payroll Tax Penalties and How to Avoid Them 

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Payroll tax penalties are an avoidable business expense, however, each year many organizations shell out thousands for them. These penalties are caused by incorrect calculations, missed deadlines and improper reporting. Employers can minimize these expensive mistakes with a robust payroll process. As your business grows in size, payroll requirements can become more complex, often making it a necessity to work with an external payroll provider to stay in compliance.  

Payroll Taxes

Employers are required to withhold and pay all employment taxes applicable to their business. Below are some common taxes, but not a complete list. 

  • Federal Insurance Contribution Act (FICA) Taxes – Employers must withhold FICA taxes, also known as Social Security and Medicare taxes, from employee wages. They are also required to pay their employer portion, up to the Social Security wage base. Payment schedules vary based on payroll sizes, but they are typically paid monthly or semi-weekly and reported quarterly via IRS Form 941.  
  • Federal and State Income Taxes – The IRS, most states and some municipalities require employers to withhold income taxes from their employees’ wages. Similar to FICA taxes, federal income taxes are due monthly or semi-weekly and are reported quarterly on Form 941. Due dates for state and local income taxes vary by location. 
  • Federal Unemployment Taxes – Businesses that pay $1,500 or more to employees in any one quarter or have one or more employees for 20 or more weeks per year generally have to pay the federal unemployment tax. These tax payments may be made quarterly or annually, depending on how much is owed. At the end of the year, employers need to file IRS Form 940.  
  • State Unemployment Taxes – Typically, employers pay state unemployment tax in every state where they have employees working. Payments are usually due quarterly, but the rates and wage base vary by state. A business’s industry and previous experience with unemployment claims may affect its unemployment tax liability.  
  • Employee Wage and Tax Reporting Forms – Failing to accurately complete wage and tax reporting forms or missing distribution deadlines can result in penalties. For example, businesses are required to send Form W-2 to employees and Form 1099-NEC to independent contractors by Jan. 31 of the following tax year.  

How Payroll Taxes are Calculated

A flat rate is charged by the IRS for payroll or FICA taxes. Employers deduct 6.2% of the employee’s gross wages for Social Security (until the wage base is met) and 1.45% for Medicare. Those two rates come to a combined rate of 7.65%, which the employer must match for their employer portion. An additional Medicare tax of 0.9% applies to employee income above a certain threshold.  

Income tax and unemployment tax may have to be calculated each pay period. Income tax is based on employee withholding certificates and federal and state income tax brackets. Unemployment taxes vary, employers pay 6% federal unemployment tax on the first $7,000 that each employee earns, but may qualify for a credit up to 5.4% if they also pay state unemployment taxes.  

Payroll Tax Penalties and How to Avoid Them

Businesses that violate employment tax laws could incur monetary penalties, interest on back taxes, liens against property, civil and criminal sanctions and/or jail sentences. Therefore, there is a large incentive to avoid payroll tax penalties.  

Employers can avoid employment tax penalties by improving their payroll processes, ensuring all compensation paid to employees and all taxes withheld from wages are remitted and reported to government agencies on time. If this is a daunting task for your business, outsourcing your payroll can help keep you in compliance. Working with a payroll provider can ensure your payroll taxes are calculated and deposited on time. In addition, they can manage your monthly, quarterly and year-end employment tax filings and the remittance process. In turn, this allows you to focus on running your business.   

Want confidence that your payroll taxes are accurately calculated, deposited and tax filings are submitted on time? Our payroll pros are here to show you the way.

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