As a business with employees, you have certain important responsibilities relating to payroll taxes. Payroll tax responsibilities involve not only making sure that your federal and state taxes are paid and reported to the appropriate tax agencies, but also includes reporting obligations to employees and contractors, as well as recordkeeping requirements. Accurate and timely compliance is the key to avoiding payroll tax penalties!

When you hire your first employee,  you have to apply  an employer tax identification number (EIN) with the IRS for use on all your correspondence, deposits, returns, and other documents. You may need to register with your state and local tax agencies.  The tax agencies will usually supply you with information about your specific payroll tax obligations and with the forms you’ll need to use when you deposit the taxes and file returns. Regardless of how you handle payroll, you should be know your responsibilities and deadlines. You should understand all the rule and regulation. For complete coverage of the IRS requirement for employers, you need to read IRS publication 15 and 15-A.

Payroll Tax Liability

When starting a new business and hiring employees, one very important aspect to consider is payroll tax liability. Payroll taxes must be withheld from an employee’s paycheck. This is required by law. Employers must hand these withholdings over to various tax agencies. Payroll tax deductions include:

• Federal income tax withholding
• Social Security tax withholding (6.2% up to the annual maximum)
• Medicare tax withholding (1.45%)
• State income tax withholding
• Various local tax withholdings (such as city, county, or school district taxes, state disability insurance).

In addition to the taxes withheld from an employee’s pay, the employer is also liable for federal employment taxes:

• Social Security taxes (6.2% up to the annual maximum)
• Medicare taxes (1.45% of wages)
• Federal unemployment taxes (FUTA)
• State unemployment taxes (SUTA)

Payroll Tax Deposit Requirements

Payroll tax deposits must be made according to deposit schedules. Different deposit rules apply to income and FICA taxes and to FUTA taxes.

Income and FICA taxes deposit rules.

Generally, you must deposit these taxes on a monthly basis or a semiweekly basis. Toward the end of each year, the IRS tells you which method you should use during the upcoming calendar year.

Determination of Deposit Schedule A business’ deposit schedule for a calendar year is determined annually from the total taxes reported in a four quarter lookback period beginning on July 1 of the prior year and ending on June 30 of the current year. For 2012, the lookback period is July 1, 2010, to June 30, 2011. If a business reported a tax liability of $50,000 or less in the lookback period, it must follow the monthly depositor schedule; if more than $50,000 was reported during the period, the semiweekly depositor schedule would apply. For example, if for the period July 1, 2010 to June 30, 2011, a business reported taxes of $45,000, then for the year 2012 the business would follow the monthly depositor schedule. If the taxes had been $55,000, the business would follow the semiweekly depositor schedule.

All new employers deposit their taxes on a monthly basis for their first calendar year, because their tax liability for the lookback period is considered to be zero.

Monthly Deposit Schedule Under the monthly deposit schedule, taxes on wages paid during a calendar month must be deposited by the 15th day of the following month. If the 15th day of the month falls on a day that is not a banking day, the deposit will be considered timely made if it is deposited by the close of the next banking day. Federal and state bank holidays, Saturdays and Sundays are treated as nonbanking days. An example would be if the payroll tax deposit was due on Sunday. Sunday is a nonbanking day, so the deposit would be considered timely made if posted on Monday by the bank’s cutoff. Cutoff times vary by bank; therefore, be sure to verify the cutoff time of the bank to be used.

Semiweekly Deposit Schedule Under semiweekly depositing you must deposit the taxes that you’re required to withhold or pay on wages for a given pay period within the next week. Specifically, you must deposit the taxes associated with wages you pay on Wednesday, Thursday, or Friday by the following Wednesday. You must deposit the taxes associated with wages you pay on Saturday, Sunday, Monday, or Tuesday by the following Friday. However, in no event will you have less than three banking days to make your deposit. The deposit rules are based on the day wages are actually paid, not when the employment tax liabilities are accrued.

Whenever you deposit less than you’re required, you run the risk of being hit with a penalty on the underpaid amount. However, as long as any shortfall does not exceed the greater of $100 or 2 percent of the amount you should have deposited, no underpayment penalty will be assessed.

Monthly depositors must make up any shortfall by the due date for their quarterly return. Semiweekly depositors have until the first Wednesday or Friday (whichever is earlier) falling after the 14th day of the month following the month in which the shortfall occurred or, if earlier, the due date for their quarterly return.

Exceptions to the Deposit Schedules If you as an employer accumulate tax liability of less than $2,500 , during a quarter for Form 941 (during a calendar year for Form 943, Form 944, Form 945, and Form CT-1), no monthly deposits are required if you pay in full with a timely filed quarterly (Form 941) or annually (Form 943)return. However, if you are unsure that you will accumulate less than $ 2,500, deposit under the appropriate deposit rules so that you will not be subject to the failure-to-deposit penalties.

How to Depost Payroll Taxes

Beginning in 2011, federal tax deposits must be made electronically. There are four methods that an employer can use to electronically transmit tax payments:

• Use the Treasury Department’s free Electronic Federal Tax Payment System (EFTPS), either online or the voice response system.
• Ask your financial institution to initiate an ACH Credit payment on your behalf.
• Ask a trusted third party, such as a tax professional or payroll service, to make the payment for you.
• In extraordinary circumstances, ask your financial institution to make a same-day tax wire payment for you.

Limited exception to electronic filing requirement  Small businesses with a federal tax liability of less than $2,500 per quarter still have the option of mailing a check with their quarterly returns.

 FUTA tax deposit rules

 Generally, you must deposit your federal unemployment taxes on a quarterly basis. However, if your quarterly FUTA tax liability is $500 or less, you don’t have to deposit it. Rather, you may carry it forward and add it to your FUTA liability for the next quarter. If your liability for the last quarter of the year (plus any undeposited amounts from prior quarters) is $500 or less, you have the option of either depositing the tax or remitting it with your annual return.

Assuming your quarterly FUTA tax liability is more than $500, you must make your quarterly FUTA deposits by the last day of the month that follows the end of each quarter:

What if the date that you’re required to make a federal tax deposit falls on a nonbanking day? In that case you have until the close of the next banking day to make a timely deposit. Federal and state bank holidays and weekends are considered nonbanking days.

Because you can be assessed penalties for failing to make a tax deposit when it’s due, you don’t want to be late with your deposits. In general, the timeliness of a deposit is determined by the date it’s received.

However, for few businesses that are still eligible to make payments other than by electronic funds transfer, a mailed deposit received after the due date will be considered timely if you can establish that it was mailed at least two days before the due date, by sending the deposit by registered or certified mail and requesting a return receipt.

Federal Payroll Returns

Along with actually depositing your federal payroll taxes, you also have an obligation to file periodic returns that show how you computed your tax liabilities. As is true for deposits, the returns you must file for your income and FICA taxes are different from the returns you file for your FUTA taxes.

Income and FICA tax returns. You must file Form 941, Employer’s Quarterly Federal Tax Return, to report both the federal income taxes you withheld and the FICA taxes you withheld and paid during a calendar quarter.

The deadline for filing the return is the last day of the first month after a quarter ends. However, if you’ve been timely with each of your deposits during the quarter, you’re entitled to an automatic 10-day extension. No other extensions are permitted for filing Form 941.

If you close your business or otherwise permanently stop paying wages that subject you to payroll taxes, you can end your obligation to file quarterly returns. You do this by designating the return for the last quarter that you pay taxable wages as a “final” return, by checking a box at the top of the return.

In lieu of quarterly reporting, the IRS can require that you file on a monthly basis if you fail to make deposits or file returns when they’re due. Monthly returns, when required, are filed on Form 941-M, Employer’s Monthly Federal Tax Return. The returns are due by the 15th day of each month.

What about your FUTA tax obligations? For federal unemployment taxes, you must file an annual return on Form 940, Employer’s Annual Federal Unemployment Tax Return. The deadline for filing the return for 2011 is January 31, 2012. However, if you’ve been timely with each of your FUTA tax deposits during the year, you’re entitled to an automatic 10-day extension. The IRS may allow you a further extension upon your written request.

To help you determine if your deposits are timely, be aware that if the due date for your Form 941 or Form 940 falls on a Saturday, Sunday, or legal holiday, you have until the next business day to timely file the return. A mailed return that bears a postmark indicating that it was mailed on or before the due date will be considered to have been timely filed even if it is received after the due date. If you’re planning to rely on the “postmark” rule, send the return by registered or certified mail and request a return receipt. Using one of these mailing methods will give you written proof of the postmark date.

State Payroll Tax Filings and Payments

The general rule for income taxes is that each state requires employers to file a quarterly tax and wage report on or before the last day of the month following the calendar quarter; in most cases, if the due date falls on a Saturday, Sunday, or holiday, the due date is extended to the next business day.

Some states now require electronic filing for certain returns and payments.

Consult our state maps for information regarding the returns that must be filed to report state income taxes withheld and the deadlines for the remittance of those taxes and the state unemployment tax agency to contact for information and tax forms relating to unemployment taxes.

Reports to Employees and Contractors

In addition to your obligation to file payroll tax returns with your taxing authorities, you have a reporting obligation to your employees and your independent contractors. In essence, you must tell the employees how much you paid them in taxable compensation and how much you withheld from their wages for federal and state income taxes and FICA taxes.

For federal tax purposes, you make the report by providing each employee a Form W-2, Wage and Tax Statement.

You must provide a Form W-2 to each employee who works for you during the calendar year. The W-2s must be distributed by January 31 of the year following the calendar year covered by the form.

Special rules apply for employees who were terminated during the course of the year. These employees may request that you provide their W-2s at an earlier date. When a terminated employee requests the W-2s earlier, you must furnish the forms within 30 days of the request or, if later, within 30 days of your last payment of wages to the employees.

If for any reason you’re unable to distribute a W-2 to an employee, be sure to retain the undeliverable form as part of your records.

Filing W-2s. You must file copies of your employees’ W-2s with the Social Security Administration (SSA) by the end of February. If you file electronically, the due date for the W-2s for 2011 compensation is April 2, 2012. In transmitting the forms, you should file Form W-3, Transmittal of Wage and Tax Statements.

Correcting W-2s. If you have the need to correct or replace a W-2 that you’ve distributed to an employee or filed with the SSA, use Form W-2c, Statement of Corrected Income and Tax Amounts.

Independent contractors. You don’t provide W-2s to your independent contractors, because you generally don’t withhold or pay any payroll taxes with respect to them. However, you are required to file a federal information return (Form 1099-MISC) for any independent contractor to whom you’ve paid at least $600 as compensation for services. Copies of the return must be provided to the contractors by January 31, and to the IRS by February 28.

State reporting. Your state may also require you to prepare information returns for employees and/or independent contractors. Consult our state map for information on the requirements in your state.

Payroll Tax Records

For federal tax purposes, you must retain records for at least four years after the due date of the return or the date the taxes were paid, whichever is later. A similar record-keeping requirement exists in each state, with varying time periods.

Types of records. There is no particular form prescribed for properly retaining records. However, the records must be kept in a manner that will enable the IRS and your state tax authorities to ascertain whether any tax liability has been incurred and, if so, the extent of that liability.

The types of information you should retain include:

• the name, address, and Social Security number of each employee
• the total amount and date of each payment of compensation
• the period of service covered by each payment of compensation
• the portion of each payment of compensation that constituted taxable wages
• copies of each employee’s withholding exemption certificate (Form W-4)
• dates and amounts of tax deposits you made
• copies of returns you filed
• copies of any undeliverable Form W-2

IRS inspection. You’re obligated to keep all your required records at convenient and safe locations that are accessible to IRS representatives. And, your records must be available at all times for IRS inspections.

Payroll Tax Penalties

The IRS pursues collection of payroll tax penalties more aggressively than penalties on most other taxes.  The IRS can come after business owner or shareholder all income and FICA taxes. there are major penalties you can be hit with failure to deposit and pay, failure to file.

Failure to deposit and pay-The amount of the penalty for failure to deposit payroll taxes on time or in full depends on the past due amount and how late the payment is. For deposits made 1-5 days late, the penalty is 2% of the past due amount. For deposits made 6-15 days late, the payroll tax penalty is 5% of the past due amount. For deposits made 16 or more days late, the penalty amount is 10% of the past due amount. Payroll tax penalties increase to 15% of the past due amount if the IRS has sent a notice requesting the tax due and it remains unpaid for more than 10 days after that notice was received by the business. The amount of the late deposit penalty is calculated using calendar days starting with the due date of the payroll tax deposit.

Trust Fund Recovery Penalty-If income, social security or Medicare taxes that must be withheld are not withheld or are not paid, (as a responsible party) may be personally liable for the trust fund recovery of 100% unpaid tax in additional to penalties and interest.

Failure to file penalty-For Form 941, 5% of the unpaid tax due with the return, for each whole or part month a return is not filed when required. The maximum penalty can be up to 25% of the tax due.

Form W-2. If you fail to prepare a Form W-2 for your employees, or if you willfully furnish incorrect ones, you will be subject to a $50 penalty for each statement that should have been sent or that was incorrectly prepared. The maximum can be up to $500,000 for small businesses.

You could face penalties if your failure to withhold was due to your misclassification of an employee as an independent contractor. A business owner may be required to pay payroll taxes on disbursements to the contract worker or employee.

Civil penalty may be imposed on anyone required to collect, account for or pay over the taxes and who willfully fails to do so. In the context of tax penalties, willfulness requires that the individual’s conduct be intentional, knowing, and voluntary. In some cases, a reckless disregard of obvious facts will suffice to show willfulness.