What Do You Need to Know about Deductions?

As an employer, you are responsible for calculating and deducting the correct amounts from your employees' paychecks. Doing your homework in this area is a necessary evil that will pay off in terms of avoiding penalties and other troubles with tax authorities.

Payroll deductions cover

a wide range of items such as federal, state and local income taxes. Rules vary from time to time and state to state, so it is important to keep abreast of new IRS and state government mandates. Who pays the deductions also varies — some deductions are paid by the employer, some by the employee and some by both.

Both the employee and the employer contribute to Medicare and Social Security. Make sure your business adheres to the correct payment schedule (quarterly, monthly or semiweekly), which varies according to how much your business collects in employment taxes.

Employers pay for federal unemployment insurance, which funds the federal unemployment program.

State unemployment insurance is a tricky area. Some states view this solely as an employer tax, meaning you do not have to deduct this amount from payroll. Other states impose this tax on employers as well as employees. The same goes for workers' compensation insurance, which also depends on what type of business are you in.

State and local tax liabilities are just as complicated — if not more so. Start by recognizing that not all states require withholding of state taxes and not all states have local taxes. Things get even more complicated if your business operates in more than one state or if some of your employees live in one state and work in another.

Payments for disability insurance also vary widely according to the state in which you operate. Employers and employees share the responsibility differently in different states.

Since deductions vary from state to state, be sure to check with your tax advisor or state and local tax authorities to determine your specific deduction requirements.

For more useful information on business taxes, read Special Report: Top 10 Tax Tips for Small and Growing Businesses.