Understanding payroll taxes: types and management tips

Payroll taxes can often present a major headache for businesses. They’re time- and resource-intensive, and if you have employees in different countries, understanding the various rules and relationships can be extremely complex.

However, if they’re not managed correctly, you can attract expensive penalties and fines, and negatively impact your relationships with your staff. 

In this article, we’ll explain what you need to know about payroll taxes, how to manage them effectively and compliantly, and how to minimize errors — no matter where your employees live.

So let’s dive right in. 

What are payroll taxes?

Payroll taxes are the taxes you pay on your employees’ salaries, wages, and — in some locations — tips. Some payroll taxes are covered by both you and your employee, while others are your responsibility only. 

Employees typically don’t pay payroll taxes directly. Instead, you — as the employer — withhold the necessary amount from their paychecks and then remit the money to the appropriate governmental agency. 

Employees trust their employers to withhold the correct amount. As a result, it’s not just a legal obligation to get it right each time — it’s also key to maintaining a solid employment relationship.

What’s the difference between income tax and payroll tax?

The primary difference between payroll tax and income tax is who pays it. Both employers and employees pay payroll taxes, but only employees pay income tax.

They also fund different things. Income taxes usually go toward general government spending, while payroll taxes are reserved for specific programs (as detailed below).

Types of payroll taxes

There are several types of payroll taxes, as follows:

1. Social security / insurance

Social security programs are set up by a country’s government to financially support eligible recipients. In many countries, like the US, social insurance also provides a basic income to retirees.

Paying social security is usually fairly straightforward; rates and obligations are clearly defined in most countries.

However, if you have employees around the world, this can make things a lot less clear. Social security benefits vary drastically between countries — and even local provinces or states. 

For example, in the European Union, every member state has its own social security laws. While an employee can live wherever they want, they still need to pay into the social security program of the country where they work.

Things get more complicated if the employee switches to a different country while under active coverage, or works in more than one country at a time. Therefore, if you’re hiring in multiple locations, it’s highly advisable to consult with an experienced payroll expert.

2. Health insurance

Another significant purpose of payroll tax is to fund healthcare plans. Again, how this works depends on what kind of health coverage system your employee’s country has.

For example, in countries with universal healthcare — like the UK — this tax goes toward funding the public healthcare system. Conversely, in the US, this tax goes toward government-sponsored plans, like Medicare.

3. Pension funds

Pension funds provide an income for retirees based on how long the retiree has paid into them, and their average earnings over that period. Like other types of social security, the active beneficiaries receive income from those currently paying into the funds. Many pension funds also cover people with disabilities.

Pension funds are usually governed by national legislation. In the US, for instance, the main regulations are laid out in the Federal Insurance Contributions Act (FICA), while in Canada, it’s managed by the Canada Pension Plan (CPP).

4. Unemployment insurance

Unemployment insurance provides benefits to eligible recipients when they’re either partially or fully out of work through no fault of their own. For instance, an employee who is made redundant will likely receive unemployment benefits, but someone who voluntarily quits their job won’t.

While unemployment insurance is typically a payroll tax, in some countries, like Chile, employees must also make payments.

Benefits are usually capped at a percentage of the individual’s previous earnings, with a limit on how long they can last. In Hungary, for instance, recipients can only receive unemployment benefits for up to three months, at around 60% of their previous wage.

When a person files for unemployment, the funds come out of the employer contributions, so your company doesn’t need to pay more.

How to calculate payroll taxes

When budgeting, it’s important to have an idea of what your payroll obligations are going to be. The key steps for calculating payroll taxes are as follows:

1. Determine your employee’s gross pay

2. Identify the tax obligations in their location to determine their payroll tax rates

3. Based on the rates set by law in that location, calculate how much to withhold or deduct

4. If applicable, reimburse any expenses

Of course, calculating your payroll taxes isn’t always going to be this straightforward, especially with a global team. If your employee isn’t salaried, for instance, their gross taxable income could encompass hourly wages, tips, bonuses, and/or commissions.

When identifying tax obligations in the second step, you also have to consider that tax laws change. If you have employees in multiple countries, this can be very hard to track.

In addition, the process of calculating withholdings and deductions can vary by country. In the US, for example, you need to analyze multiple factors, such as:

• Filing status (e.g., whether the employee is married, single, the head of their household, a citizen etc.)

• The year they earned the income you’re calculating taxes for

• How often they get paid (payment frequencies are set by state law and can differ widely)

• Whether you’re choosing to use percentages or brackets to calculate tax withholding

How to manage payroll taxes

For a smoother payroll management experience, we recommend the following best practices:

1. Understand the legal requirements

To ensure you’re following the rules, it’s crucial to have some payroll expertise in your corner, whether it’s in-house or outsourced.

However, if you’re running a global team, things are not so simple. As we’ve mentioned several times, payroll taxes vary from one jurisdiction to the next — and that’s before you account for how they change over time.

It’s highly recommended to work with a reliable payroll partner wherever your people are based, but especially if they’re overseas. Remote proactively monitors any upcoming law changes in your employees’ locations, and ensures that you’re withholding the correct amounts based on their location.

2. Automate where possible

Not only does automation save time and make everyone’s life easier, but it helps reduce the chances of human error, too. With the right payroll management software, you can automate numerous processes, from time and attendance tracking to actually paying your employees.

If your company already has existing workflows that you don’t want to change, use an API — like the one offered by Remote — to build your own automations.

3. Audit frequently

Conduct regular checks to ensure that your payroll system functions as intended. Proactive, regular audits will reduce errors, deduce if you’re paying the right taxes, and ensure you’re complying with any relevant laws.

All the records you need for a successful audit should be available in your company’s general ledger. You should also be able to review your company’s cash flow, assets, and other financial data in this ledger.

4. Secure your system

In the majority of countries, employers are legally obliged to safeguard their tax and payroll data. Any potential breach usually carries legal consequences, financial penalties, and — depending on the size of the breach — significant reputational damage. Therefore, you should ensure your payroll security (or your chosen vendor’s payroll security) is robust.

Remote’s payroll management platform exceeds international security standards. It’s ISO27001 Certified and SOC 2 Compliant, as verified by independent security auditors. It implements measures such as two-factor authentication (2FA) and single-sign-on (SSO) to prevent unauthorized access, with a dedicated security team always on hand. 

5. Keep records

Keeping and managing your payroll tax records helps you prepare accurate financial statements for reporting as required by the relevant authorities.

Remote can help you save time and streamline this process by securely pooling your workforce’s financial data at scale for storage, analysis, and reporting.

6. Maintain an open policy

As mentioned, payroll taxes are not just a legal requirement; they are a trust exercise between you and your employees. As a result, you should adopt a collaborative approach when it comes to ensuring your data is correct.

Remote’s self-service features allow employees to review payslips, annotate tracked time, and submit expenses for reimbursement.

7. Develop a schedule

If you’re operating a global team, you can expect to sink a lot of time into your payroll tax management. Having a schedule can help you mitigate this. 

Section off dedicated time blocks and prepare the relevant documents in advance. This helps reduce procrastination while boosting productivity.

Between automation and employee self-service, Remote can shave even more hours off of this task, especially when you’re managing payroll taxes for a distributed workforce.

What happens if you don’t pay payroll taxes?

Payroll taxes are a vital revenue source for governments across the world — and most countries have penalties for non-payment.

If the situation is serious enough, the local government may launch civil and criminal proceedings against you. This could result in costly fines, or even prison time.

Managing payroll taxes with Remote

If you’re hiring across borders, payroll taxes are a sizable obstacle to overcome and manage.

However, our global payroll platform removes this blocker. Instead of looking for multiple third-party providers, poring over tax legislation, and worrying about compliance every time you make a hire, let Remote do all the heavy lifting for you.

We take care of:

• Payroll calculation. Our platform automatically tracks your employees’ gross income and filing status to determine the right withholding amount.

• Local tax returns. Our local, in-country experts help you file employee and employer tax returns in any jurisdiction you’re required to.

• Social security reporting. We report changes that might affect an employee’s social security status to the relevant authority.

• Tax and benefit deductions. We help you calculate deductions related to benefits and non-payroll taxes from employees (and independent contractors).

• Reporting and compliance. Our platform safely stores the records needed for reporting and complying with local laws around the world.

• Payslip generation. Your employees can access their payslips at any time through our self-service portal.

• Secure document storage. Our independently audited security features keep financial data safe from leaks and breaches.

To learn more about how we can help, take the tour or speak to one of our friendly payroll experts today.

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