Payroll Tax Deduction

If you hire employees to help you grow your business, in addition to paying them wages you generally will also need to pay the federal government an employer portion of social security and medicare taxes as well as unemployment taxes on your employee's wages. You likely will also be subject to various state payroll taxes. The good news is that all of these state and federal employer payroll taxes will generally deductible on your Schedule C.


Tina is a driver for Lyft who hired an assistant at the beginning of the year to wash and maintain her vehicle. Tina paid her employee $5,500 in wages last year. Tina would be liable for $330 of federal unemployment taxes (6% base), $341 of social security taxes (6.2%), and $80 of medicare taxes (1.45%) plus any state payroll taxes she may be subject to. When Tina prepares his Schedule C she should deduct the $5,500 of base pay (which includes taxes withheld from employee) on line 26 of his Schedule C and the $751 of employer paid payroll taxes on line 23 of her Schedule C.


Rachel is a freelance photographer who hired a part time employee at the beginning of the year to help her transport equipment to her photo shoots. Rachel paid her employee $35,000 last year by simply writing paychecks out of her business account. She did not withhold any payroll taxes or pay any employer taxes during the year, since she assumed she could take care of these taxes at the end of the year with her Schedule C. Unfortunately, when Rachel prepared her return at the end of the year she found that she needed to set up business accounts with her state income and unemployment tax departments, complete required state payroll tax filings, file her Federal Form 940 (unemployment) and Federal Form 941 (social security and medicare) and also pay approximately $3,000 in employer payroll taxes. Additionally, since Rachel had not withheld taxes from her employee throughout the year her employee ended up owing the nearly $8,000 in state and federal income, social security and medicare taxes.


Nelson is an entrepreneur who owns and operates a successful food truck in Denver, Colorado. Nelson has one employee who is paid an hourly wage plus tips to help him take orders and serve customers. Nelson requires his employee to report tips they can be included as part of gross employee compensation and taxed appropriately. Nelson will be responsible for paying state and federal employer payroll taxes on all of his employee's gross compensation, including tips, even though tips are paid by his customers. At the end of the year however he will be able to deduct the employer portion of taxes paid on line 23 of his Schedule C.


Kyle is a delivery driver who delivers groceries for Instacart. During the year, Kyle withdrew $45,000 from his business bank account as compensation for his work. Since Kyle is an unincorporated sole proprietor, he would not want to pay state payroll taxes or federal social security, medicare or unemployment taxes on his compensation. He would however need to pay self-employment tax on his business income, a portion of which would be deductible on his Form 1040. To deduct his personal compensation and employer taxes, Khan would need to have his business organized as an entity where he could be an employee of the company.


Fred is a sole proprietor website designer who often hires local freelance developers to help him build his websites. Fred dictates what features his websites must have and how the finished products should look and feel, however, his developers are otherwise autonomous and self-sufficient. Since this arrangement would likely result in the development team being contractors, Fred would not need to withhold employee taxes or pay employer payroll taxes on his contractor's compensation.


  • If you have employees, in addition to withholding your employee's portion of payroll taxes, in 2018 you must pay a 6.2% Social Security tax on first $128,400 of wages and a 1.45% Medicare tax on all wages. You will likely also be required to pay a 6% federal unemployment tax (FUTA) on the first $7,000 of wages (up to 5.4% of which may be credited if you also paid state unemployment tax). In addition to these federal taxes, your state may also impose certain payroll taxes.
  • You may be responsible for paying payroll taxes on various types of employee pay including base wages, tips, bonuses, sick and vacation pay, and certain fringe benefits and awards, amongst other things. You should refer to IRS guidance and consult with your tax advisor to determine what types of compensation you should be withholding and paying payroll taxes on.
  • The employer portion of payroll taxes are generally deductible on line 23 of your Schedule C, while employee payroll taxes (withheld from employees and paid by you) are deductible as part of employee wages on line 26 of your Schedule C.
  • If you withhold payroll taxes from your employees and / or pay employer payroll taxes, in addition to filing your business tax return at the end of the year you will also need to file Form 940 (unemployment) and Form 941 (social security and medicare - quarterly) or Form 944 (social security and medicare - annual), not to mention any additional returns required by your state.
  • You will need to contact your state's department of revenue and unemployment to set up the appropriate employer payroll accounts. Remember that you can always work with a payroll company like ADP or Zenefits to help guide you through the process and submit required state and federal payroll filings on your behalf.
  • If you are self employed you typically should not withhold payroll taxes on payments or withdrawals made to yourself, since these taxes are typically paid through self employment tax. There may be exceptions to this general rule depending how your business is organized. Consult with your tax advisor regarding how you should treat your compensation.

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