Additional Payroll Taxes
By Jason Watson, CPA
Posted February 28, 2020
The IRS will expect unemployment taxes (FUTA) on all W-2 wages paid, including corporate officers. According to IRS Topic Number 759, for the 2020 tax year the first $7,000 will be taxed at 6% with a credit of up to 5.4% for unemployment taxes paid to your state (SUTA). Some states such as Alaska, Kansas, Minnesota, Nebraska, Oregon, Washington state and Washington D.C. will allow you to opt out of state unemployment.
Before you opt out of your state unemployment taxes, consider two things. First, you get a credit for the state unemployment taxes paid when you file your Federal unemployment taxes on Form 940. This is a big deal. Here is how it works-
Minnesota (for example) has a wage base of $32,000 (2018). Let’s say the average SUTA rate is 2.6% and your salary is $40,000. You would pay $832 to Minnesota for unemployment. Then, because you paid into Minnesota’s unemployment system, the IRS only charges you 0.6% of the first $7,000 or $42. So… $832 + $42 = $874. If you opted out, you would only pay 6% of the first $7,000 or $420. Opting out in Minnesota at this wage base makes sense.
In Colorado, where you cannot opt-out but provides a good illustration, the wage base is $12,600 (2018). If your SUTA rate was 2.1% then you would pay $265 to Colorado and $42 to the IRS for a total of $307. If you could opt out and did opt out, the IRS would charge you 6% of the first $7,000 or $420. A tiny savings, but a savings nonetheless… you just covered a fourth of your wine pairing dinner at Ski Tip Lodge in Keystone.
Some states, such as California, was in arrears with the Federal government on unemployment debt payments and as such the credit the IRS provides was reduced. For example, the FUTA rate is 0.6% if you pay SUTA, but for California businesses the FUTA rate is 2.7% in addition to the SUTA rate. California caught up on its Federal unemployment debt in 2018 thanks to the backs of resident taxpayers, and the FUTA rate will revert to 0.6%.
Note the subtle difference- full FUTA rate is 6% and the reduced rate is 0.6%. The simple decimal move is sneaky.
Second… and this one you might laugh at… second, if you shut down your S corporation you might be eligible for unemployment benefits. Remember, unemployment benefits are administered by the state and if you opt out because of your corporate officer exemption, you could be limiting yourself unintentionally. Yeah, this is crazy but beware just the same. From direct experience with some of our clients, Colorado fights the heck out of a former business owner collecting unemployment benefits; the business owner must show that his or her business suffered a catastrophic event, one that prevented future business income.
Some states, such as California and New Jersey, also impose a state disability insurance (SDI) payroll tax when you run payroll on the shareholders. Specifically, California charges 1.0% with a maximum of $1,229 for the 2020 tax year. Yuck. You can opt-out from California if your underlying entity is a corporation or if you obtain voluntary disability insurance from an approved insurance provider.
To summarize some of these various terms that you might hear-
- FUTA and SUTA- unemployment tax. Unavoidable. You might be able to opt out, and as the Minnesota example above illustrates, there is a tax savings by doing so.
- SDI- state disability insurance. Might be able to opt out for single-owner corporate officers in California or with supplemental insurance.
- Workers Compensation Insurance- has nothing to do with unemployment or state disability insurance, and is not interchangeable with those terms. This is purely insurance coverage for on the job injuries and is provided by private insurance such as State Farm, All State, Farmers, etc. Ask your local insurance agent if you can opt out. Typically you can since you don’t plan on suing yourself for a paper cut or a rogue paperclip stabbing.
Be aware that additional payroll taxes can nibble at the S Corp savings, but frankly it is small. The worst case scenario might yield a $1,600 reduction in savings such as California if you cannot opt out of state disability insurance (SDI). Average case scenario is probably around the $500 mark.
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