Chapter 03

California Payroll Tax Administration

The true cost of employees goes far beyond wages. Every new hire comes with tax obligations and having a strong grasp on payroll taxes is something fundamental to your peace of mind as a business owner and employer.

Whether you are a household employer or taking care of a huge team, you need to understand how to compute taxable income, what to withhold, what to contribute and how to file.

Payroll taxes occur on both a federal and a state level, but we will be taking a look at the specific issues around California payroll taxes.

The Employee Development Department (EDD) administers the state payroll tax for California. It is one of the largest departments within the state government. The EDD has a number of responsibilities including:

  • Filing quarterly taxes
  • Tax audit program
  • Collection division
  • Audits and investigations
  • Assessments
  • Information exchange

California payroll taxes include withholding for personal income tax and support unemployment insurance, an employment training tax, and state disability insurance.

California state disability and personal income tax are withheld from wages while the employer is required to pay into the system for unemployment insurance and the employment training tax.

How California Payroll Taxes Are Calculated

California payroll taxes are calculated as a percentage of an employee’s income. Some taxes are deducted from the employee’s paycheck and some are paid by you, the employer, based on the employee’s wages. An employer usually becomes subject to payroll taxes after they have paid more than $100 to one or more employees in a calendar quarter.

This holds true whether you run a business, a nonprofit organization, or have just hired a housekeeper or nanny for your home.

The first thing to know is that every California employer is required by law to report information about new employees to the California New Employee Registry within 20 days of their first day of work.

You may do this in one of four ways:

  • Submitting a Report of New Employee(s) (DE 34) electronically with the California Employment Development Department (EDD)’s e-Services for Business page
  • Submitting a paper DE 34. You can download a fill-in DE 34 here
  • Submit a copy of the employee’s W-4 form, but you also need to add the employee’s start-of-work date, your California employer account number and Federal employer identification number (FEIN) to the W-4
  • You may also create your own form with the above information and mail it to the EDD

The Four Types of California State Payroll Taxes

Most wages are automatically subject to all four taxes, but there are certain fields of employment where payroll tax liability is limited or not applicable.

For a full list of types of employment and whether or not they are subject to payroll taxes/and or withholding, you can consult this list from the California Employment Development Department (EDD).

Payroll taxes are a complex subject, in part because there are four separate taxes which must be calculated. The first two, Unemployment Insurance (UI) Tax and Employment Training Tax (ETT) are paid by the employer.

The other two, State Disability Insurance (SDI) Tax and California Personal Income Tax (PIT) are paid by the employee, but you are responsible for withholding these taxes on behalf of the state. Each of these taxes is calculated at a different rate:

Unemployment Insurance (UI) Tax

Unemployment insurance is in place to provide temporary support to people who are unemployed through no fault of their own.

  • As the employer, you are responsible for paying this tax based on a percentage of the first $7000 in wages that you pay each employee over the course of a calendar year.
  • Exactly how much you pay will depend on how long you have been an employer. For the first two to three years, you will pay 3.4 percent (.034) but this rate is subject to change, and will increase over time.
  • The highest UI tax rate is currently 6.3 percent (0.62), which works out as a maximum tax of $434 per employee annually.

Employment Training Tax (ETT)

The Employment Training Tax was put into place to help the California labor market grow. The funds raised by the ETT are used to provide training to workers in certain targeted industries.

  • In your first year as an employer, you will automatically be subject to ETT.
  • After that first year, most employers will continue to pay the ETT, if they have a positive UI reserve account balance
  • The ETT rate is one-tenth of 0.1 percent (.001) on the first $7,000 of taxable wages you pay each employee. This means that the maximum tax is $7 per employee each year.

State Disability Insurance (SDI) Tax

The state disability tax program offers support payments to employees who are temporarily unable to work because of a non-work-related disability. The SDI tax also funds Paid Family Leave (PFL) benefits.

The PFL program extends benefits to employees who cannot work because they are needed at home to take care of a family member who is seriously ill, or to bond with a new child.

  • SDI is deducted from your employees’ wages.
  • You are responsible for withholding a percentage of the first $106,742 in wages that you pay each employee over the course of a calendar year.
  • In 2016, the SDI tax rate is 0.9 percent (.009) of SDI taxable wages per employee, per year, which means that the maximum tax is $960.68 per employee.
  • SDI rates may change annually: they are set by the California State Legislature each year.

California Personal Income Tax (PIT)

Personal income tax is levied on the income of California residents as well as non-residents who are earning income in California. The funds raised by income tax paid for local amenities such as schools, public roads and parks, as well as health and human services. These taxes are administered by the EDD, which is also responsible for reporting, collections, and enforcement.

  • PIT is deducted from your employees’ wages.
  • The rate is based on the Employee’s Withholding Allowance Certificate (Form W-4 or DE 4) your employee filled out at the beginning of the year.
  • There is no maximum amount of tax in this category.

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Doing the California Payroll Tax Calculations

With four different taxes to track, calculating your payroll tax liability and withholding rates can seem overwhelming, especially to new employers. If you break the task down into distinct steps, you may have an easier time navigating the system:

Determine Taxable Wages

This is the first and most important step, because you will base all other calculations from this number. The EDD has a very helpful table with examples of how you would calculate the taxable wage for each employee

Calculate UI and ETT

Since these are the taxes that you will be paying as the employer, determine your liability according to your rates. Current UI rates can be found on the EDD website: you will need to log in to see your specific rate.

Calculate SDI

Withhold the current SDI rate, as determined by the California State Legislature: 0.9 percent in 2016.

Calculate PIT

California offers two methods for withholding schedules:

  1. Method A – Wage Bracket Table Method (PDF) – with Instructions
  2. Method B – Exact Calculation Method (PDF) – with Instructions

How to Get More Information About These California State Payroll Tax Calculations

If you are still worried about getting it right, do not worry. There is more support available. California offers in-person payroll tax seminars to walk you through the process, and you can find a current schedule here.

If you want more specialized assistance, or if you are dealing with an especially complex payroll tax issue, it may be worth your time to consult with a tax professional or an attorney trained in tax law. Their familiarity with all the rules and regulations means that they know the ins and outs of payroll taxes for businesses of all sizes.

A one-on-one consultation gives them the chance to offer you personal guidance and total peace of mind that you are meeting all the payroll tax requirements for the state of California.

Other Issues Concerning California State Payroll Taxes

California has some other tricky rules for state payroll taxes:

  • If you have family members working for you, they are subject to state personal income tax withholding, but they are not subject to unemployment insurance, employment training taxes or state disability insurance payments.
  • Family members include children under the age of 18 employed by a parent, or partnership consisting only of parents and include adopted children but not stepchildren or foster children.
  • Family members also include persons employed by a spouse or a registered domestic partner or a parent employed by a son or daughter, again including adoptive parents but not stepparents or foster parents.
  • Most nonprofit organizations are subject to unemployment insurance, employment training tax, state disability insurance and personal income tax withholding.
  • Special exclusions from unemployment insurance and state disability insurance payments include elected officials, members of legislative bodies or the judiciary, and members of the state National Guard or Air National Guard except those who provide services as regular state employees.

California Payroll Tax Pitfalls and Penalties

The greatest pitfall in dealing with federal and state income taxes can be attempting to handle them yourself as a business owner. The larger your business, the more complicated payroll taxes become.

If you only have a couple of employees or are experienced with the California payroll tax provisions, you may be able to take care of it yourself or pay an accountant, but at a certain point, you may require the services of a tax attorney to advise you about the details of tax law or to help you resolve penalties.

Sometimes employers are not aware of those defined as statutory employees. These are individuals who may not be employees as defined by common law but who should be classified as employees for employment tax purposes.

  • Any officer of a corporation
  • Agent-drivers or commission-drivers
  • Traveling or city salespersons
  • Unlicensed construction workers engaged to perform services for which a license is required
  • Workers who have a work-for-hire provision in their contract

As mentioned in previous chapters, the IRS has something known as the Trust Fund Recovery Penalty or TFRP (previously called the 100 Percent Rule). This extends liability for payroll taxes to corporate officers and owners of the company. However, this is limited to what was withheld from an employee’s wages, and it cannot hold an individual responsible for employer matching funds.

The California Employment Development Department has similar rules and powers but the penalties tend to be more severe in proportion. The EDD rules state that any officer, major stockholder, or other person with the responsibility for EDD payroll tax compliance who willfully fails to comply with EDD withholding laws is personally responsible for 100 percent of every red cent owed by the corporation or LLC.

If that person is you, you will be required to pay interest on the late payment as well as penalties.

The EDD and IRS equally do recognize a difference between miscalculation and tax evasion. If you simply miscalculated, it is considered to be non-willful, and you will still be responsible for penalties and interest plus you will need to file corrected tax returns.

Evasion, on the other hand, is punishable by criminal charges. Evasion can take the form of willfully misclassifying employees as independent contractors, falsifying returns, and paying workers in cash.

California Payroll Tax Penalty Resolution

Penalty resolution involves paying the full amount of payroll taxes owed plus the penalties levied by the taxing organizations. If you have been charged with evasion, of course, you will also be facing potential jail time.

You are within your rights to dispute taxes and penalties, which is where an experienced tax attorney comes in handy. However, you must understand that, while you can appeal, you will be expected to pay taxes on time until the appeal is resolved.

Both the IRS and the EDD are amenable to setting up installment payments to keep the total amount due at one time to a manageable level. You can also request an Offer in Compromise or a Hardship letter.

Payroll taxes, both federal and state, can be difficult to understand, but unwillful errors can still be costly. If you misclassify an employee or do not handle withholding properly for family members who work for you, or if you run a non-profit organization and do not handle taxes properly, you will be responsible for not only back taxes but interest and penalties, too.

An experienced tax attorney can help you avoid the pitfalls of tax law and provide valuable assistance for disputes, appeals, and other methods of resolving tax problems.

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