2.2 Payroll, Federal/State Tax, and Recordkeeping

Payroll, Federal/State Tax, and Recordkeeping

The NASCLA business module tests whether you can administer payroll without triggering Internal Revenue Service (IRS) penalties. You must know the difference between an employee and an independent contractor, the federal payroll taxes you withhold and match, the deposit and filing schedule, and how long records must be kept. Misclassifying workers to dodge payroll tax is a frequent exam scenario and a real audit trigger.

Employee vs. Independent Contractor

The IRS uses a common-law control test grouped into three categories: behavioral control, financial control, and the type of relationship. The key question is who controls how the work is done, not just the result. Misclassification makes the contractor liable for back payroll taxes, interest, and penalties.

Paperwork differs sharply:

• Employees complete Form W-4 (withholding) and receive Form W-2 at year-end.
• Independent contractors complete Form W-9 and receive Form 1099-NEC if paid $600 or more in a year.

Federal Payroll Taxes (FICA, FUTA, Withholding)

Federal Insurance Contributions Act (FICA) tax funds Social Security and Medicare and is split between worker and employer:

So the employer matches the 7.65% combined FICA. The Federal Unemployment Tax Act (FUTA) is employer-only; the typical net rate is 0.6% on the first $7,000 of wages after the state credit.

A Worked Payroll Example

A carpenter earns $1,000 gross in a pay period:

• Social Security withheld: $1,000 × 6.2% = $62.00
• Medicare withheld: $1,000 × 1.45% = $14.50
• Employee FICA total: $76.50

The employer remits the $76.50 withheld plus a matching $76.50, totaling $153.00 of FICA to the IRS, on top of any income-tax withholding from the W-4. Forgetting the employer match is a common exam error.

Deposits, Filings, and Recordkeeping

Withheld income tax plus both halves of FICA are deposited on a monthly or semiweekly schedule via the Electronic Federal Tax Payment System (EFTPS), with quarterly reconciliation on Form 941. FUTA is reported annually on Form 940. The dreaded Trust Fund Recovery Penalty can hold a responsible person personally liable for unremitted withholding.

Retention rules to memorize:

• Employment tax records: keep at least 4 years after the tax is due or paid (IRS).
• Form I-9: keep 3 years after hire or 1 year after termination, whichever is later.
• OSHA 300 logs: retain 5 years following the calendar year.

Federal Payroll Taxes — FICA, FUTA, and Withholding

Memorize the payroll-tax stack. FICA = Social Security 6.2% (on wages up to the annual wage base) + Medicare 1.45%, matched dollar-for-dollar by the employer, so the combined employer+employee FICA is 15.3%. FUTA (federal unemployment) is paid by the employer only. Federal income tax withholding follows the employee's Form W-4 and IRS Circular E (Pub. 15) tables. The employer deposits withheld amounts on a schedule and reports on Form 941 quarterly.

Worked Payroll Example

Example: An employee earns $1,000 gross in a pay period (under the wage base). Employee FICA = 1,000 × 7.65% = $76.50 (6.2% SS = $62.00 + 1.45% Medicare = $14.50). The employer matches $76.50. So the employer's total FICA cost on this $1,000 is $1,000 + $76.50 = $1,076.50, before FUTA/SUTA and workers' comp. This "labor burden" is why estimators mark labor up well above the base wage.

Employee vs. Independent Contractor and the 1099

Misclassification is a top audit and exam target. An employee receives a W-2; the employer withholds taxes and pays the FICA match. An independent contractor receives a 1099-NEC (for $600+), handles their own taxes, and controls how the work is done. The IRS common-law test weighs behavioral control, financial control, and relationship. Calling someone a "sub" does not make them one — control over the work is what counts.

Common Exam Traps

• Trap: FICA is 7.65% total. That is the employee share; the combined employer+employee rate is 15.3%.
• Trap: Independent contractors get a W-2. No — they get a 1099-NEC.
• Trap: A signed "independent contractor" agreement defeats reclassification. The IRS applies the control test regardless of the label.
• Trap: FUTA is split with the employee. FUTA is employer-only.

Recordkeeping, Deposits, and Certified Payroll

The IRS requires payroll tax records be kept at least four years. Withheld income tax and both FICA shares are deposited monthly or semi-weekly depending on the lookback liability, reported quarterly on Form 941 and annually on Form 940 (FUTA). Each January the employer issues W-2s to employees and 1099-NECs to contractors. On Davis-Bacon/prevailing-wage federal jobs the contractor must submit weekly certified payroll (Form WH-347) listing each worker's classification, hours, and prevailing wage paid — falsifying it is a federal offense.

State Taxes and SUTA

Layered on the federal stack are state income tax withholding (where applicable) and state unemployment tax (SUTA), an employer-paid premium whose rate varies by the firm's layoff/claims experience — frequent layoffs raise the rate. Some localities add city or county withholding. The estimator folds the FICA match, FUTA, SUTA, workers' comp, and benefits into the labor burden percentage added on top of base wages, commonly 25–40%. Misjudging burden is a top reason bids lose money even when the base wage estimate is correct.