How Payroll Withholding Helps a Company’s Employees

Our clients who come to us for payroll help sometimes ask why they have to do tax withholdings on their employees. It’s a lot of work and it seems odd that it would be the employer’s responsibility.

But have you ever wondered how payroll withholding helps a company’s employees? And beyond that, where it started, and how it ended up being your responsibility as a small business owner to withhold payroll taxes?

A Little History: How Payroll Taxes Began

In 1862, President Lincoln signed the Revenue Act to help fund the Civil War. It was the first time in U.S. history that a federal income tax had been collected from its citizens. Initially, it called for a 3% salary tax. A couple of years later, it increased to 5%. (Still, a bargain compared to today’s rates!) The law exempted the President from having to pay, but Lincoln chose to anyway. Over the next 3 years, he paid a whopping $3,552 in taxes on his personal income.

Our current system of income taxes began in 1943 in response to World War II. The Current Tax Payment Act required employers to withhold federal income taxes from employees’ paychecks and then pay it directly to the government for the employees.

The idea was that if the government made it easier to pay taxes, more taxes would be paid. And they were right. In the years leading up to the Current Tax Payment Act, the government collected about 1% of people’s personal income. Afterward, that rate quickly rose to 11%.

According to the U.S. Treasury’s own History of the U.S. Tax System, “This greatly eased the collection of the tax for both the taxpayer and the Bureau of Internal Revenue. However, it also greatly reduced the taxpayer’s awareness of the amount of collected tax, i.e. it reduced the transparency of the tax, which made it easier to raise taxes in the future.”

If you’ve ever looked at your tax returns, you are well aware of how successful that plan has been.

how does payroll withholding help your employees

How Payroll Withholdings Are Done Now

When someone comes to work for your company, you are required to have them fill out Form W-4 from the IRS. This enables payroll taxes to be withheld from their paychecks. These taxes are specifically used today to fund Medicare and Social Security. Income taxes are used to support the government’s general fund.

In 2020, the IRS introduced a new W-4. It is not at all like the one most of us have seen all our lives. Kiplinger does a good job of explaining the differences in their article, “10 Things Every Worker Needs to Know About the New W-4 Form for 2020.” Here are some of the main highlights:

  1. Withholding “allowances” are gone.
  2. Having multiple jobs may affect the amount withheld.
  3. You can easily account for anticipated credits and deductions.
  4. There’s a handy Withholding Estimator tool now.
  5. However, you can keep using the old form if you prefer…as long as you don’t make any changes.

How Payroll Withholding Helps a Company’s Employees

So with all that history of payroll taxes and the “nuts and bolts” of how it’s done, let’s answer the question we started with: “How does withholding payroll help your employees?”

Whenever you’re selling something to someone, the more you can do to reduce “friction” in the sales process the more likely they are to actually buy from you. If the process gets too complicated, you’ll lose them. For instance, it may be something as simple as designing your website so that a purchase only takes one click instead of two. (See also Amazon’s dark orange “Buy Now” buttons.)

The same principle applies to your employees and their taxes. By withholding and paying their portion of payroll taxes for them, you are helping simplify their lives so that they can focus on using the income they receive from you to fund the things they need and want.

If they had to calculate their own payroll taxes each pay period and set aside the right amount of money, the odds are good that eventually something would go wrong. Life happens. We all get busy and forget to do things. Or some people just wouldn’t do it.

The government likes counting on business owners to do it because, as we quoted earlier, it helps them get tax money more dependably. Your employees like it because it’s one less thing they have to think about.

As a business owner, you may not like the stress and hassle of it. But at least now you know why you’re doing it.

How to Make Sure You Provide The Right Payroll Help

As the employer, you have very specific legal obligations to pay federal and state payroll taxes to the appropriate agencies. The IRS issues severe civil and criminal penalties for willfully avoiding tax payment.

To make sure that you accurately fulfill your payroll withholding responsibilities, you need to do 2 things:

  1. Set up a separate “Payroll Tax Bank Account.” Use this account throughout the year as the holding tank for all of the payroll taxes that you withhold from your employees’ paychecks. By not mixing these funds with your regular business bank accounts, you avoid the risk of not being able to pay when the time comes.
  2. Hire someone else to do your payroll. While it might be tempting to “save some money” by doing it yourself, you’d be ahead in the long run to trust this part of your business to a dedicated professional. (In fact, this myth of “we save time and money doing it ourselves” is one of 7 misconceptions about outsourcing payroll that we covered in another post.)

We recommend outsourcing your payroll to a trusted third-party firm. You avoid having the overhead of another full-time staff member, and you get the experience and expertise of dedicated accounting experts.

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CRS CPA Can Help Make Payroll Easy

No business owner wakes up and thinks, “what can I do to complicate my life today.” How payroll withholding helps a company’s employees also ultimately helps you—if you do it correctly.

By taking on the burden of accurately and reliably withholding, paying, and reporting your workers’ payroll taxes…pay period after pay period without error…intentionally complicating your life is exactly what you’re doing.

CRS CPA has been in the business of providing exceptional accounting services and business advice to small business owners in all kinds of industries for over 40 years. We understand how important it is to get payroll right.

We specifically provide professional HR & Payroll Services to help you stay on top of taking care of your employees so they can provide for the people who depend on them.

Schedule a call today to discover what can happen when you “expect more from your CPA.”

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