4. What tax and other compensation withholding requirements do the state and federal governments place on employers with regard to employees?
Employers are obligated to comply with statutes and IRS regulations regarding the withholding of:
• Income Taxes – Employers have an obligation to withhold income taxes from employee compensation based upon an employee’s election. The employer then submits the withheld funds to the IRS and state taxing authority on behalf of the employee each month.
⁃ Note: The employee elects an amount to be withheld on IRS form W-4. This is done by indicating the number of employee claimed dependents and indicating any desire for additional withholdings.
• Payroll Taxes – Employers are required to withhold Medicare and Social Security taxes from the employee’s salary pursuant to the Federal Income Contributions Act (FICA). The employer combines these withheld funds the employer’s FICA tax obligations for the employee and submits the funds to the IRS each month.
⁃ Note: Self-employed individuals must withhold self-employment taxes, which consist of the employer’s contribution and employee’s FICA tax responsibilities.
• Federal Unemployment Tax Act (FUTA) & State Unemployment Tax Act (SUTA) – Employers are required by state and federal law to pay for unemployment insurance to cover events in which an employee loses her employment for any covered reason. FUTA is common to all employers across the United States. SUTA varies among the states. Some states allow an employer to be self-insured; while other states require employers to pay into a private or state-funded insurance plan or policy.
⁃ Note: FUTA and SUTA taxes do not apply to self-employed individuals.
• Worker’s Compensation – Worker’s Compensation is a state law regime that requires employers to maintain insurance that provides wage and benefit replacement in the event an employee is injured in the scope of her employment. Federal worker’s compensation laws, primarily the Federal Employee Compensation Act, provide the same protections to federal, non-military employees. Workers compensation covers lost wages, medical expenses, disability payments, and costs associated with rehabilitation and retraining.
⁃ Note: Application of worker’s compensation laws varies from state to state based upon the number of employees. Also, states may offer state-provided plans or allow for private worker’s compensation plans.
• Discussion: Why do you think state and federal governments have the obligation to withhold taxes from employee compensation? Do you agree with this system? Why or why not? What are the advantages and disadvantages of this type of system?
• Practice Question: Isabelle starts a business and hires her first employee. What are her obligations under state and federal law with regard to withholding from her employee’s compensation.