Recently I published a series of short blog posts on the topic of payroll processing for small businesses. In summary, I’ve suggested that today’s automated payroll services are a fantastic value but that coördination and oversight by a small business compensation professional helps avoid problems and penalties that stem from miscommunication. I’ve suggested that the minimum price of this service with professional oversight could be $75 per month for the smallest businesses. Of course, firms with more employees or more complex requirements may incur higher costs. For discussion purposes only in this blog post, I will assume a typical payroll service expense of $2,000 per year.
This post explores ways to have the payroll service assist with the implementation of tax reduction strategies1 that can offset the cost of the payroll service itself. While the specifics of wage taxes can vary, this post generalizes for the sake of clear communication.
Employers must pay 7.65% of the total wages as a federal wage tax. States assess more taxes on employer’s wage base. Some required or voluntary employee benefits add to the cost2. Then on top of these wage taxes employers must pay workers compensation insurance premiums based on the wages. For the sake of simplicity in this discussion, this blog post assumes that employer expense on wages adds 20% to the cost of the wages paid. So an employer who pays $10,000 in wages pay an additional $2,000 in taxes and workers compensation. It follows then that an employer who can reduce taxable wages by $10,000 saves enough to offset the entire $900 cost of the payroll service.
But how can this be accomplished? One simple way is to change the way employee medical expenses are paid.
Employees of small businesses typically spend about 10% of their take home pay on medical expenses. Some pay additional amounts on dependent care and education expenses. Federal tax law allows employers to set up employee benefit plans that exclude these expenses from taxable wages. The names of popular benefit plans are Health Reimbursement Arrangements, Health Savings Accounts, Flexible Spending Accounts, Simplified Employee Pensions, and more. Taken together, these benefit plans make up the safest and surest tax shelters allowed under the law.
Regardless of the specific type of benefit plans chosen, there are four steps required to achieve the employer tax savings;
- Plan the benefit to meet legal requirements and the employer’s goals
- Document the plan in writing
- Communicate and enroll employees
- Set up the payroll processing transactions to avoid wage taxes.
A small business compensation planning expert can handle these steps efficiently; often at little cost above the regular payroll processing fees.
How does the savings work for employers and employees?
Consider an example of a small business employer that has annual wages of $200,000. Assume that the business sets up an employee benefit plan that lets employees convert 5 % or a total of $10,000 of their existing after-tax expenses into pre-tax reimbursements. The employees collectively save about $2,000 on wage taxes (about 20% income an FICA tax on the amount that is no longer considered wages) and the employer also saves about $2,000 (also about 20% of the amount that is no longer taxes as wages). The savings to the employer alone is often enough to offset the entire annual cost of the payroll service, essentially making the payroll service of a small firm pay for itself. Of course, the actual amounts will vary for each company.
The key to making this savings strategy work is to have someone who can handle the setup and administration flawlessly. I am pleased all four of the steps above for small business clients to ensure a smooth transition and lock in the expected tax savings. To learn more, please schedule a complimentary telephone discussion.
1Wage tax saving strategies are covered in other earlier blog posts here.
2This blog post was updated and republished after New Jersey passed a required sick leave benefit that affects all small businesses in the state with employees that adds 3.33% to payroll costs.