When you own a small business, you can owe a lot in payroll taxes. If you have a small profit margin, you may be wondering how you can reduce your payroll tax liability – legally, of course.
There are a few things that contribute to your payroll tax liability, and there are also a few things that you can do to lower it. Let’s explore those options!
At CSI Accounting & Payroll, we’ve worked with small business finances for over 50 years. That means we’ve gotten a lot of questions about payroll taxes, including:
- How much do small businesses pay in payroll taxes?
- What factors contribute to how much I pay in payroll taxes?
- How can I reduce my payroll taxes?
What Businesses Pay in Payroll Taxes
As the employer, you pay a portion of the payroll taxes for your employees.
Specifically, your payroll tax liability can be broken down like this:
- Social Security. This is a flat rate. At the time of this article being written, you pay 6.2%.
- Medicare. At the time of this article being written, you pay 1.45%.
- State Unemployment (SUTA). This is going to vary based on your location and situation. For example, the Minnesota rate will range between 0.2-9%, but 1.1% is a very common initial rate for new employers who are not in the construction industry. You may also face a cap on employee wages that you need to pay this tax on. Learn how to determine your state unemployment rate here.
- Federal Unemployment (FUTA). At the time of this article being written, you pay 0.6%. There is also a cap of $7,000 in employee wages that you need to pay this tax on. That means you will pay a maximum of $42 per employee in this tax for the year.
This means that for an employee getting paid $1,000 per week in Minnesota (assuming a 1.1% new employer rate) with no pre-tax deductions, the employer pays $93.50.
As a general rule of thumb, you can expect to pay about 10% of your employee’s salary in payroll taxes.
Factors Contributing to Payroll Taxes
Aside from SUTA, your portion of payroll taxes are standard fixed percentages. What does this tell you?
It shows that the most basic way to reduce your payroll tax liability is to reduce the number of employees on payroll or reduce the total wages paid.
When considering the cost of an employee, you need to think of expenses beyond their wages – including how much you’ll need to pay in payroll taxes. Remember, payroll taxes can be 10% of their pay in many situations.
Unless you’re desperate, it’s not ideal to lay off your staff or pay them less. Luckily, there are other options. Let’s talk about them in the next section!
6 Methods to Reduce Payroll Taxes
There are several ways to legally reduce your payroll tax liability. We’ll start with our favorite and make our way to our least favorite (aside from laying off staff or cutting wages).
In that order of best to worst, these methods include:
- Offering tax-advantaged benefits.
- Claiming tax credits.
- Electing to be taxed as an S-Corp.
- Classifying workers as contractors.
- Hiring based on location.
- Challenging unemployment claims.
1.) Offering Tax-Advantaged Benefits
Some employee benefits are only partially taxable, and others are exempt from payroll taxes. Tax-advantaged benefits or fringe benefits (that lower your employees’ taxable income, reducing your payroll tax liability) that you may want to provide include:
- Health insurance premiums
- Retirement plan contributions
- Health Savings Account (HSA) contributions
- Dependent care assistance
- Group-term life insurance
- Educational assistance
Pros: It’s mutually beneficial for you and your employees because you get tax breaks and they get benefits.
Cons: Many benefits have upfront and maintenance costs to consider. You also need to make sure they stay in compliance, which is why many people partner with a payroll professional to help them monitor requirements.
2.) Claiming Tax Credits
Why tax credits? It’s simple; you can apply them anywhere in your business. There are even some tax credits, such as the Work Opportunity Tax Credit, where your payroll specialist can make decisions within their department.
Pros: You can use tax credits to offset your payroll taxes.
Cons: Many credits can be difficult to qualify and apply for. You may want to seek external help from a payroll specialist or accountant in the application process.
3.) Electing to Be Taxed as an S-Corp
If you have enough basis in your business, you can elect to be taxed as an S-Corporation and take distributions.
Pros: You may be able to lower your payroll tax liability by paying yourself a reasonable salary, which is subject to payroll taxes, and taking the rest as distributions, which are not subject to payroll taxes.
There are additional factors here, so make sure you consult with your accountant before making a change to ensure you’re eligible to use this tax strategy.
Cons: If you’re taxed as an S-Corp, even if you’re self-employed with no other employees, you will have to run payroll. This means you’ll have a little more work in this area, or you can hire a payroll provider to handle it for you.
4.) Classifying Workers as Contractors
If a worker is really more like an independent contractor, then you can classify them as such. If they’re not quite a fit for this, you can look into changing your relationship with them to make them their own boss.
Pros: Since they are not your employee, you can save a lot of money on payroll taxes across the board.
Cons: You need to be cautious with this one. Make sure you classify workers as independent contractors legally, otherwise, you risk opening yourself up to an audit. You will also be expected to pay them more wages to make up for not getting employee perks.
5.) Hiring Based on Location
Different states and local areas have different SUTA tax rates or local payroll taxes. Some states also have different requirements for employee benefits that you pay payroll taxes on. There are even some states that require state plans for workers’ compensation insurance.
If possible, research these details and be picky about where you hire employees. This is especially true if you have a choice, such as hiring fully remote workers.
Pros: You could save on SUTA tax, local payroll taxes, and taxes on certain benefits. You could also potentially save on workers’ compensation insurance by avoiding states that require state plans.
Cons: Your hiring process could take longer if you’re pickier. You may also want to work with a payroll professional to nail down all of these location-based requirements, as they can be extremely difficult to find details about online.
6.) Challenging Unemployment Claims
If a former employee files for unemployment, it can affect your unemployment tax rate. You should always raise an issue with unemployment claims if you don’t think they’re valid.
That’s also why it’s important to be cautious when hiring a new employee; they can draw unemployment benefits even if you had to fire them because they could not do the job.
Pros: You can maintain a lower unemployment tax rate.
Cons: Your hiring process could take longer if you’re pickier. It’s also very difficult at times to determine what kind of worker someone might be before you hire them. Some employers also don’t want to go through the effort of raising an issue with an unemployment claim.
Save on Your Payroll Taxes the Right Way!
Many of the methods mentioned above can be intimidating to implement on your own. If you want to make some changes to legally minimize your payroll tax liability, it’s best to reach out to external help, like a payroll specialist.
Now that you know how much you might pay in payroll taxes, what factors contribute to this, and how to reduce your liability, are you ready to check out payroll services?
If so, please consider CSI Accounting & Payroll! To see if we can be a good fit for your business, click the button below for a free consultation:
Not ready to talk? That’s okay! First, learn more about the cost of a payroll service.
