Sales And Payroll Tax In A Nutshell: What You Need To Know

Many states impose sales tax procedures that businesses are required to comply with. Sales taxes are generally used to fund government operations at the state, county and locality level. Retail and restaurant businesses are the most common types of businesses that are required to collect this tax from consumers and remit them to their state tax agency.

Often times, business owners mistakenly add the sales tax collected as a revenue, and consider sales tax paid to government agencies as some sort of expense. Governmental agencies want business owners to understand:

• Sales tax does not belong to business owners
• The business owner is simply a "holding agent" for the government until it is paid to them.

To be consistent with this theory, a sales tax liability account is created for every penny that is collected in regards to sales tax, and this liability account is reduced each time the money is remitted to the government.

Tip: A POS system (point-of-sale) integrated into a cloud bookkeeping platform will automatically keep track of these accounts and update them in real time.

Notice that no income or expense account is affected at any point in this transaction cycle. Although a sales tax does not directly affect business owners, it does make their products a bit more expensive to consumers and must be considered when business owners are making pricing decisions.

Payroll Taxes and Withholdings

In general, employees of a business are subject to payroll taxes and business owners are required to withhold and remit taxes to the government on behalf of their employees in addition to paying taxes on paid wages.

These taxes are comprised of the following components:

• Federal and state
• Employer and employee

At the federal and state level, businesses must withhold wages from their employees based on their allowances and filing status information on Form W-4.

They must also withhold:

• Social security tax which is 6.2% on the first $118,500 of wages
• Medicare tax which is 1.45% on the first $200,000 of wages and an additional 0.9% on any wages paid in excess of this amount.

This amount sits in the business' bank account until it is remitted to the respective tax agencies in addition to the matching social security and Medicare taxes that employers are required to pay.

Business owners are also required to pay federal unemployment taxes on the first $7,000 of wages on each employee every tax year as well as required state payroll taxes which can vary. Though not a tax, employers are required to get workers compensation insurance as long as one employee, that is not a business owner, is employed by the company.

Business owners in a sole proprietorship are never considered employees of their business and therefore do not compensate themselves through a payroll system. Instead, their annual net profit reported in Schedule C is subject to self-employment taxes which represent the employer and employee portion of payroll taxes. Half of the self-employment taxes are tax deductible when computing a business' net profit.

Partners in a partnership and owners in a limited liability company are subject to similar rules as sole proprietors. S Corporations and C corporations are the only two entities where business owners can compensate themselves through payroll. In this situation, the corporation would pay the employer portion of all payroll taxes and deduct them on its corporate tax return. S Corporation distributions are not subject to payroll taxes, making it an attractive business entity choice for certain businesses that can benefit from the extra tax savings.

There are several complex taxes associated with business ownership. By being cognizant of them and working closely with an accountant, business owners can make financially sound business decisions to further their efforts towards entrepreneurial success while ensuring regulatory compliance.