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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 what you should know about payroll taxes before establishing a business as a foreigner in the United States. 

 

Payroll Tax 

A payroll tax is a percentage deducted from an employee's paycheck. Payroll withholding is done on the employee's behalf by the employer. Employees' wages, salaries, and tips are subject to tax. The Internal Revenue Service requires the deduction of federal payroll taxes from an employee's compensation. Then, employers must pay the payroll taxes 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 (EIN) to comply with federal tax regulations. State 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-partner's wage 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. 

The current tax rate for social security is 6.2% for the employer and 6.2% for the employee for a total of 12.4%. 

  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. The current rate for Medicare is 1.45% for the employer and 1.45% for the employee, or 2.9% total.  

 

  1. Unemployment Insurance 

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 state and the federal government deposit payroll taxes into a federal trust fund to fund benefits and program expenses. 

FUTA, 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. 

 

Withholding Tax 

Withholding payroll tax is the amount of federal income tax withheld from the employee’s paycheck to cover the above taxes. Payroll withholding tax is mandatory when you have employees. The amount of the withholding is based on the employee’s filing status, the number of allowances claimed, and any additional amount requested by the employee. 

The Purpose of Withholding  

The purpose of payroll withholding is to ensure that employees pay their taxes by deducting small amounts from each paycheck rather than making the employee pay the whole amount of tax once a year. It is called the pay-as-you-go tax collection system, and the system works very well for the US as well as many other countries. 

When employees submit their taxes, the payroll tax withholding 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 and submit the payroll taxes to the Internal Revenue Service. When employees pay their annual taxes in April, any personal tax not yet sent is paid or if the employee overpaid their taxes, they would get a refund. 
  • If applicable, employers will withhold income to pay state or local income taxes. Texas and Florida, for instance, have no income tax, although the District of Columbia does. Employers in Texas and Florida would not withhold state income for tax purposes, whereas employers in Washington, D.C. would. 

Corporate Income Tax 

In addition to payroll taxes, you should be aware of your corporate income tax requirements. The United States imposes a tax on the profits of US resident corporations at a rate of 21 percent. Further, some states and 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. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income.

 

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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