As a small business owner, you may have learned skills as you built your business. One thing you don’t want to have a hard time figuring out is payroll. You do not want to pay your employees incorrectly or be penalized by the IRS. So before you run payroll, you need to understand taxable wages.
Taxable wages are employee compensations subject to taxation. Some examples of taxable wages include salaries, hourly wages, bonuses, and commissions. You are responsible for deducting and remitting taxes from employee paychecks.
Remember how surprised you were when you saw the chunk of cash taken out of your first paycheck for Uncle Sam? Fortunately for workers, not all wages are taxable. The government regulates taxable wages.
How to calculate taxable wages
1. Taxable wage base
There are specific limits on the amount of taxes the government can demand from employees. The taxable wage base is the highest amount of wages employees must pay taxes on. Once an employee earns more than the wage base set by the government, he or she does not pay taxes.
The Social Security wage base is the highest amount of income that can be taxed for Social Security. An employee’s taxable wage base is usually equal to his or her gross wages.
The 2016 Social Security wage base is $118,500. The 2017 wage base is $127,200.
2. State-level exceptions
Wages that fall above federal wage bases may still be subject to taxes. Some states set their own wage bases. State wage bases may be higher than federal wage bases. Employees must pay taxes until their wages exceed the higher wage base.
For example, the 2016 Federal Unemployment Tax Act (FUTA) has a wage base of $7,000. But, some states have a higher wage base for unemployment insurance benefits (e.g., Ohio wage base is $9,000). Employee wages can be taxed until they reach the state wage base.
3. Reducing the taxable amount
When you figure taxable wages, you can deduct certain withholdings from an employee’s salary before computing taxes. These deductions include (but are not limited to) retirement contributions, health plan contributions, unreimbursed business expenses, and alimony payments.
Let’s say you are calculating an employee’s wages. You offer the employee health care benefits. Taxes are not taken out of employer health coverage in the employee’s paycheck. First you subtract the employee contribution to the coverage from the gross wages. Then you calculate the taxes.
4. Nontaxable income
Most wages you pay employees are taxable. But, some forms of compensation are not generally considered taxable wages.
Nontaxable wages may include: business expense reimbursements (if they follow IRS rules), certain non-cash holiday gifts for employees (e.g., turkeys during holidays), and cash advances or loans. You may want to consult a tax professional about which of your employee wages are nontaxable.
How to Avoid Calculating Taxable Wages
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