If you want to grow your business, you probably need to hire employees to
help you. Becoming an employer and expanding your staff entails many responsibilities, one of which is
seeing to payroll taxes. Unfortunately, there are many myths about these taxes. Here is the reality:
1. Myth: Transforming employees into independent contractors to save on payroll
Reality: You probably know that it costs less to use an independent contractor than to have
an employee on staff. The reason: the cost of payroll taxes, along with insurance and benefits apply only
for employees. But don’t think you can simply reclassify a worker who’s been your employee as an independent
contractor. The IRS, as well as other government agencies, are on the lookout for just such action.
The classification of a worker depends on many factors, most of which boil down to a matter of control.
Essentially, if you have the right to say when, where, and how work gets done, you’re likely dealing with an
employee. The IRS uses three categories of factors to assess the degree of
control: behavioral, financial, and type of relationship. Many states, including California, use an
The worker is free from the control and direction of the hirer in connection with performing the work
- The worker performs work outside of the usual course of the hiring entity’s business
The worker is usually engaged in an independently established trade, occupation or business of the same
nature as the work performed for the hiring entity
2. Myth: All tax-free benefits are exempt from payroll taxes
Reality: Receiving tax-free fringe benefits means that employees do not have to pay income
tax on what they receive. However, it does not mean that employers are off the hook for payroll taxes. For
example, 401(k) contributions made by employees through salary reductions are still subject to FICA. And
adoption assistance is exempt from income tax withholding because the benefit is tax free to employees but
is still subject to FICA and FUTA taxes. You can find a list of various fringe benefits and their tax
treatment for employment tax purposes in Table 2-1 in IRS
3. Myth: You can pay employment taxes with your quarterly employer tax return
Reality: In general, you must deposit federal income taxes withheld and both the employer and
employee share of FICA with the U.S. Treasury using the Electronic Federal Tax Payment System (EFTPS). Also, deposits are
for FUTA tax for the quarter within which the tax due is more than $500.
4. Myth: Outsourcing to a payroll service provider relieves you of liability
Reality: Rather than handling payroll in-house, many businesses use an outside payroll
service provider to handle the chore of computing payroll taxes, withholding them from employees’ paychecks,
remitting payroll taxes to the government, and filing employment tax returns. What happens if a payroll
provider fails to remit your money to the government? Or it fails to timely file employment tax returns?
Unfortunately, you’re still on the hook for these obligations. You may have a lawsuit against the payroll
service provider for theft, breach of contract, or other bad action. You can even file a complaint with the
IRS on Form 14157
If you suspect your payroll service provider of improper or fraudulent activities regarding the deposit of
your taxes or
the filing of your returns. But it doesn’t relieve you of your obligations to the government.
5. Myth: Incorporating relieves you of liability for unpaid employment taxes
Reality: You may think that having incorporated your business or formed a limited liability
company (LLC), you have complete personal liability protection. You don’t. If you are a person responsible
for withholding, accounting for, or depositing withheld employee taxes (their income tax withholding and
their share of FICA) and you willfully fail to do so, you can be held personally liable for all of these
taxes, plus interest. This is called a trust
fund recovery penalty and it can be applied to business owners even if they have corporations or
In addition to any federal level payroll tax obligations, you may also have state-level employment taxes to
consider. Find out more about federal employment taxes from the IRS. Check with your state tax or revenue department to
learn about your obligations on the state and local levels.