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Payroll: Deductions and Taxes

There are different requirements for payroll and taxation in the United States, depending on the state and/or business activity. Federal and state individual income tax for employees, Social Security and Medicare tax, payroll tax, sales tax, withholding tax, corporate tax, and permanent establishment problems are the key considerations for a foreign company that needs to comply with tax rules in the United States. Employers may also be responsible for state and federal unemployment insurance, as well as workers' compensation costs. 

Business owners and employees often overlook the sleeping giants of payroll taxes. Here is an overview of the three categories of taxes you need to know before investing in business as a foreigner in the United States. 

 

1. Withholding Rax 

The revenue that a company deducts from an employee's paycheck and remits to the federal, state, and/or municipal governments refers to withholding. The amount of income generated, the taxpayer's filing status, the number of allowances claimed, and any additional amount requested by the employee are all factors that go into calculating it. 

The Purpose of Withholding  

Withholding occurs in most jurisdictions in the context of wage income. Rather than requiring a taxpayer or business to pay their whole tax due to the federal, state, or local government all at once, businesses withhold or "keep back" a small amount of their income during the year. When corporations and individuals submit their taxes, this almost always reduces their tax liability. When submitting an income tax return, income tax withholding should ideally match income tax liability. 

What percentage of employees' pay do their employers withhold and why? 

  • Employers withhold a small amount of employees' pay for personal income taxes to the Internal Revenue Service. When employees pay their annual taxes in April, any personal tax not yet sent is paid.  
  • Employees deduct money from their paychecks to cover the employee portion of payroll taxes. 
  • If applicable, employers will withhold income to pay state or local income taxes. Texas, for instance, has no income tax, although the District of Columbia does. Employers in Texas would not withhold income for tax purposes, whereas employers in Washington, D.C. would.

2. Corporate Income Tax  

Corporate income tax imposes on all entities treated as corporations at the federal level. Further, some municipalities impose a corporate income tax. All domestic corporations, as well as international corporations with income or activity in the jurisdiction, are subject to corporate income tax. A domestic corporation is an entity that is treated as a corporation and is organized under the laws of any state. For the state, entities organized within the state are considered domestic, while those organized outside the state are considered foreign. 

S corporations, mutual funds, and other types of corporations are not taxed at the corporate level. However, their owners are taxed on the corporation's income when it is recognized.

3. Payroll Tax  

A payroll tax pertains to a percentage deducted from an employee's pay to the government. This is on the employee's behalf by the employer. Employees' wages, salaries, and tips are subject to tax. The Internal Revenue Service deducts federal payroll taxes from an employee's compensation. Then, pays them to the International Revenue Authority (IRS). 

A corporation in the United States must register for payroll tax in the state where founded. The organization will need to obtain an Employer Identification Number to comply with federal tax regulations (EIN). Payroll tax, like most other things, remains state-based. Therefore, the specific procedure varies by state, and most states also have income tax withholding rules. Using a local expert payroll provider will ease this procedure for many businesses while also ensuring full compliance with local rules. 

Types of Payroll Taxes Include 

  1. Social Security 

Social Security is a federal program in the United States that pays retirement and disability benefits to eligible individuals, as well as their spouses, children, and survivors. Workers must be at least 62 years old and have paid into the Social Security system for at least ten years to be eligible for retirement payments. Workers who wait until they are 70 years old to claim Social Security will receive higher monthly benefits. Spouses and ex-spouses may be eligible for benefits based on their partner's or ex-wage partner's record. If unable to work due to a handicap, you may be eligible for benefits if you meet specific criteria. 

Employees pay into this insurance plan through their payroll withholdings in their workplaces. Self-employed workers remit their pay when they file their federal tax returns. 

  1. Medicare Taxes

The Hospital Insurance (HI), also known as Medicare taxes, pays for inpatient hospital stays and other healthcare services for the elderly and individuals with certain illnesses. Other elements of Medicare, such as Part B, which pays for doctors' and other providers' fees, receive funding primarily via general revenues and beneficiary premiums rather than payroll taxes. 

The employee payroll taxes primarily pays for the HI program. Employers and employees both contribute 1.45% of a worker's earnings to the HI trust fund, for a total contribution of 2.9 percent.

  1. Federal Unemployment

Unemployment insurance (UI) pays payments to insured workers who remain involuntarily unemployed and meets certain criteria. States run UI initiatives in collaboration with the federal government. Both the states and the federal government deposit payroll taxes into a federal trust fund to fund benefits and program expenses. 

The federal unemployment insurance rate is 6% (applied to the first 7,000 dollars of each employee's earnings). All 50 states and the District of Columbia require state unemployment insurance, which varies by state. Employers can deduct monies paid to state unemployment insurance funds from their federal taxes, up to 5.4 percent. 

 

Learn More About Payroll Taxes and Deductions  

Payroll taxes are extremely difficult to understand and provide no space for error.  Several entrepreneurs face harsh repercussions because they neglected to plan and deal with their payroll taxes during the year. While procrastinating may be appealing, you risk serious problems unless you cooperate with professionals to relieve you of this administrative burden and ensure it is handled properly.

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