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Jan 02, 2023 Matt Venuto

Understanding Employment Taxes: How to Avoid Overpaying

Understanding Employment Taxes: How to Avoid Overpaying

What’s worse than paying taxes? Overpaying on taxes.

Your organization must pay employment taxes to stay in business. But with all the acronyms, annual changes in rates and contribution limits, and more, sometimes it can be challenging to identify just how much you should be paying. 

How can you ensure you are not inadvertently shorting your business by shoveling too much cash into upfront tax payments?

Understanding employment taxes is an excellent place to start.

This post will set you on the path to understanding employment taxes and payroll tax. We’ll cover the different types of employment taxes you must be aware of and how to calculate your payments like a pro.


The Importance of Understanding Employment Taxes

Employment taxes and payroll taxes are often talked about like they’re the same thing. You pay both directly to the IRS, but there’s a slight difference.

You must pay employment taxes, including federal income tax, Social Security, Medicare, and Federal Unemployment (FUTA) taxes. The slight difference is that payroll taxes (Social Security and Medicare) are defined as payroll taxes on IRS Form 941, which employers use to file quarterly returns.

Related: How to Set Up Payroll Taxes for Small Businesses

To simplify things, the IRS describes employment taxes as a list of taxes that relate to employees, including:


  • FICA (Federal Insurance Contribution Act)
  • FUTA (Federal Unemployment Tax Act)
  • Federal Income tax
  • Additional Medicare Tax


More details on those below. It’s vital to understand employment taxes because if you get it wrong and fail to withhold and deposit taxes, you’ll receive penalties.

Most payroll providers can answer questions and concerns you may have about employment taxes. ConnectPay goes one step further, connecting you to employment tax professionals who are experts in state and local requirements. 

You’ll know exactly what to do to remain compliant and avoid errors.

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Types of Employment Taxes

Federal Income Tax: As an employer, you must withhold federal income tax from your employees’ wages. Use Form W-4, Employee’s Withholding Certificate, to figure out how much to withhold.

FICA (Social Security and Medicare Taxes): As an employer, you must withhold FICA taxes from your employees’ wages and pay your share of them, too. Rates vary, and only the Social Security tax has a wage base limit. It’s currently $147,000. For both Federal Income Tax and FICA, file Form 941 each quarter

Additional Medicare Tax: If you pay an employee over $200,000 in a calendar year, you are responsible for withholding an additional 0.9 percent in Medicare taxes.

FUTA (Federal Unemployment Tax): Employees do not pay this tax, and you can’t withhold it from their pay. You must report and pay FUTA tax from your own funds. File Form 940 to report FUTA taxes.

Self-Employment Tax: For individuals who work for themselves, self-employment tax covers Social Security and Medicare taxes, similar to FICA taxes withheld from employees’ pay.


Calculating FICA Taxes

To avoid overpaying FICA taxes, ensure you get your calculations right. It’s an easy mistake to overpay an employee and, in turn, over withhold taxes, but doing so causes unnecessary stress to you and your employees. 

Both you and your employees pay a total of 7.65% (6.2% for Social Security and 1.45% for Medicare).

To calculate Social Security taxes:

Multiply Employee gross pay by the Social Security tax rate (currently 6.2%)

Example: $1000 gross pay * .062 = $62

To calculate Medicare taxes:

Multiply Employee Gross Pay by the Medicare tax rate (currently 1.45%)

Example: $1000 gross pay * .0145 = $14.50

Note: Employers are responsible for matching employee payments in FICA taxes.


Calculating FUTA Taxes

The FUTA tax provides unemployment compensation to workers who lose their jobs. SUTA is the same thing but at a state level. You’ll likely pay both.

To calculate FUTA taxes:

The current FUTA tax rate is 6% on the first $7000 paid to an employee in a year. The employer rate is 0.6% because the state covers 5.4% of FUTA payments.

Example: Employee paid $100,000, FUTA is $7000 * .06 = $420. The state pays $378; you pay $42.


Consequences of Overpaying Employment Taxes

Thankfully, you don’t receive any penalties for overpaying employment taxes. In fact, you can get a refund! However, the IRS holds on to your money for most of the year, so it might hurt your bottom line a little.

The IRS won’t notify you if you overpay or withhold too much money from a paycheck. You’ll likely find out later. As soon as you discover your error, you’ll either use From 941-X (Adjusted Employers QUARTERLY Federal Tax Return or Claim for Refund), or check the amended return box for From 940.


Beyond Understanding Employment Taxes: Managing Payroll With Ease

Nailing your employment tax calculations is essential to avoid overpaying and set your organization up for success. But if you want a truly painless payroll system, understanding employment taxes is only the beginning. 

Payroll is the lifeblood of your business. You must understand time and attendance tracking, benefits and retirement plans, Workers’ Compensation, and more to keep your employees happy and keep their paychecks coming.

Our Connected Guide to Small Business Payroll provides you with the essential information you need to run your payroll processes without tearing your hair out. Request access to our free resource, the Connected Guide, today! 

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Published by Matt Venuto January 2, 2023