Employers are generally responsible — and liable — for applying employment taxes to wage payments. To fulfill this obligation, you must determine when and where Federal Insurance Contributions Act (FICA) taxes and federal income tax withholding (FITW) are applicable.
FICA and FITW are separate employment tax regimes. Thus, when analyzing how to treat a payment, you’re best off separately determining their respective applicability, even though the end result is often the same.
What to look for
Three essential elements must be present in wage payments for services to be subject to FICA taxation and/or FITW:
1. The payment must be remuneration for services and the payment must not be specifically excepted from the definition of “wages.”
2. The type of services performed by the worker must fit within the statutory definition of employment. This determination is more specific for FICA tax purposes, because “employment” is specifically defined by statute.
3. The relationship between the service recipient and the service provider must be one of employer and employee.
If one or more of these elements is missing, the payment isn’t subject to FICA taxation or FITW. However, the payment may still constitute income and, therefore, you’ll need to report it.
FICA, the funding mechanism
Both the FICA tax regime and the FITW regime require withholding of the employee’s taxes at the source, for which the employer remains secondarily liable. When analyzing whether either FICA taxation or FITW is applicable to a particular payment, you’ll need to confirm the appropriate treatment under each regime.
In many instances, the requirement to impose FICA taxes and the requirement to withhold income taxes on a payment will coincide, even though the statutory reasons for taxation under the two regimes may not be parallel. Because FICA (the law) is the funding mechanism for the two most important social welfare programs in the United States, the correct FICA tax treatment of a payment can often be more challenging than determining whether FITW applies.
With the undercurrent of protectionism that comes with its purpose, FICA (the law) is replete with definitions, statutory requirements, convoluted cross-references, exemptions and exceptions to exemptions. What’s more, Section 3121 of the Internal Revenue Code separately defines each of the three elements necessary for the imposition of FICA taxes. This is because of the need to carefully determine whether particular types of services, and payments for the same, are intended to be covered by the Social Security Act.
In contrast, the mission of FITW — to collect taxes on payments at the source — isn’t tied to a taxpayer’s future benefits. As a result, the statutory definition of wages under Sec. 3401(a) essentially consolidates the discussion of payments for services with the types of services that constitute employment for FITW purposes.
Not so simple
Long story short, payroll taxes aren’t as simple as they may first appear. It’s in an employer’s best interest to understand precisely when FICA and FITW apply and to double-check that this is being handled properly by your staff or a third-party provider.
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