Empowering Healthy Business: The Podcast for Small Business Owners

#37 Managing Payroll Tax Withholding

• Cal Wilder • Episode 37

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In this episode, Cal sits down with tax expert Greg Reed to uncover hidden risks that business owners often miss when it comes to payroll tax withholding. As your income shifts, whether from business profits, life changes, or other sources, your W2 withholding may no longer be enough. Without regular adjustments, this can lead to surprise tax bills, penalties, or even overpayments. Greg explains why reviewing your withholding yearly (ideally in January) is essential, especially after major life or income changes. He also dives into strategies like year-end bonus withholding to avoid penalties, though these come with extra payroll taxes. Plus, state tax requirements often differ from federal, adding complexity. Bottom line? Staying proactive with your payroll tax planning can help avoid surprises, keep your cash flow healthy, and protect your business from costly mistakes.

Main Takeaways:

  • Withholding errors can lead to surprise tax bills and penalties.
  • Life and business changes (new business income, marriage, etc.) require withholding updates.
  • Year-end bonus withholding can help avoid penalties, but increases payroll taxes.
  • State and federal withholding rules can differ.
  • Reviewing your withholding annually is smart and prevents surprises.
  • Working with your CPA or using IRS tools can make adjustments easier

Reach Greg Reed at greed@smartbookstax.com or book a meeting with him at smartbookstax.com


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Host Cal Wilder can be reached at:
cal@empoweringhealthybusiness.com
https://www.linkedin.com/in/calvinwilder/


Host:

Welcome to the Empowering Healthy Business Podcast. The podcast for small business owners. Your host, Cal Wilder has built and sold businesses of his own, and he has helped hundreds of other small businesses, whether it is improving sales, profitability and cash flow, building a sustainable, scalable, and saleable business, reducing your stress level. Achieving work-life balance, or improving physical and emotional fitness. Cal and his guests are here to help you run a healthier business and in turn, have a healthier life

Calvin:

Welcome back to the podcast, Greg.

Greg:

Thanks for having me. We survived tax season.

Calvin:

Yes, Greg: I made it. And this is gonna be the first episode in a long time. We don't talk about beneficial ownership reporting.

Greg:

Yeah, there's nothing to report. Yep. No change. So we're good.

Calvin:

So what are we talking about today?

Greg:

So, you know,it's the end of tax season and I kind of take this time to reflect back on, things that happened, patterns I saw, and one of the things that popped up this year was, W2 withholding not, something that maybe directly impacts all business owners, but you know, if you're an S-Corp or a C-Corp, it could definitely impact you. if you have business income or passive income that You're obviously not withholding on, then that could impact your tax situation and may warrant some extra withholding from your wages. Maybe your spouse, needs to update their withholdings. I would say it's more of a maintenance item and not, super, super fun to talk about. We're not talking about tax savings and stuff like that, but, it's certainly it's like getting the oil changed in your car.

Calvin:

Right. We do this to avoid, underpayment penalties and interest. Or potentially if with a major change in a reduction in income to avoid over withholding, right.

Greg:

Yeah, I mean, you certainly don't wanna be using the IRS as an interest to your bank account throughout the year. You want that money now? You know, some people, they love to get that check at the end of the year, and it's kind of a, springtime bonus for them. Totally fine. maybe you wanna withhold more. But, you know, I did, like I said, I had a couple clients this year that, income went up, withholdings maybe stayed the same or went down a little bit. they kind of got that surprise bill that we don't like to talk about.

Calvin:

How are the, penalties and interest actually computed?

Greg:

So taxes are actually due quarterly as you earn income throughout the year, obviously as a W2 employee, you're paying that throughout the year. But, you know, if you're earning income that you're not withholding on throughout the year, then you should be paying tax on that quarterly. That's why we pay quarterly estimates.

Calvin:

So let's use your ground numbers here. Like say I'm getting paid a salary at my S-corp of a hundred thousand dollars a year, and then my S-corp produces an extra $100,000 of taxable income of profit that year. So I basically have $200,000 of taxable income, but I'm only, withholding at the a hundred thousand dollars rate, right? So how did they calculate the extra penalties and interest I owe on the second a hundred thousand dollars?

Greg:

Yes, so maybe you're only withholding on the extra, first hundred thousand. You're not withholding on the extra, a hundred thousand there. So, you know, say 20% tax break, you owe $20,000 in tax if you earn your income, you know, pro rata throughout the year. It's, $5,000 basically in tax that you should be paying each quarter. every quarter that you don't pay that tax, they calculate interest and penalties. That number changes with inflation. It used to be, advantageous not to pay your quarterlies because a few years ago were earning, six, 7% in interest in their, regular savings accounts, they were actually almost making more money. The IRS has since caught up with inflation and that window has now closed.

Calvin:

So, technically what do you need to do, call your CPA Probably the first thing you'd say,

Greg:

Yeah. You, could call me, or you call your CPA, and we can certainly walk you through it. The IRS actually has a pretty cool interactive tool that you can use, to calculate that withholding, and it's definitely something you want to do. Like I said, it's like an oil change. You wanna do it maybe annually in January. just something to temperature check and,make sure that you're still withholding enough. If you get married, have a kid, maybe you start a new business. The way that you earn income changes. Like I said, if you start a business and you salary, income goes down, but your business income up. So maybe you're like, oh, I earned a hundred thousand dollars last year, but I'm earning a hundred thousand dollars this year. Everything should be the same, not necessarily because the way that you're earning that income and how taxes are being withheld on that income are different. And that's what happened with one of my clients. The wife, her business started earning some income. His W2 salary stayed the same. Their withholding stayed the same, but her income was not being withheld on. So they got kind of killed at the end there. so I would say, you know, things like that so, type of income that you're earning, if you pick up a second job, have kids get married, divorced, stuff like that. You certainly wanna reassess that situation. And like I said, the IRS has that tool online. You could always call your CPA, they can walk you through it. And then in years that you do have those changes, not a bad idea to maybe to do some year n tax planning.

Calvin:

And states have their own flavors of the W4, right? I know in Massachusetts, what's it, an M2 or W2 or something like that?

Greg:

Yeah. Yup. It's a I think it's M4.

Calvin:

M four,

Greg:

Yeah. Calvin: But, you know it common that, you need to fill out a separate state form because there's a significant difference between state and federal withholding rates? Yeah. You should definitely be, looking at both the states. It's a little less of a hit because it's usually lower tax rate. But, definitely be taking a look at both. obviously the federal one is a little bit more significant.

Calvin:

Right. I don't know. We're talking mostly about, W4 withholding, but that needs to be planned in conjunction with your quarterly estimated tax payments. Right.

Greg:

Yeah. Yeah.What I'll do with my clients is say hey give me a copy of your latest pay stub. I'll extrapolate out the pay stub to basically project out what their W2's gonna look like. And then we kind of use that information in conjunction with the business income, what we're projecting that to be, to project out what the entire tax liability is gonna be. And, I do have some clients that will pay estimates. I have some clients that will use that, withholding. As a way to pay their estimates. It's kind of whatever you feel most comfortable with, wanna do stuff like that.

Calvin:

Is there any pro or con with using extra withholding versus estimated payments?

Greg:

I would say it's a pro and con It's,It depends. Obviously if you're paying it through payroll, if you're over withholding through payroll, then you're also gonna be paying, the extra payroll taxes, you know, Fica, Medicare, stuff like that. So you are paying a little bit more in tax with that. But sometimes if you haven't been paying your estimates throughout the year, you might get to year end and wanna do a bonus withholding. I don't think payroll companies. Typically love this because I always have problems with it, but it is an option. You kind of pay yourself a year end bonus of like $50,000 and 30,000 of it goes to the IRS and 15 of it goes to the, state and then the other 5 is used to pay payroll taxes. You know, You get a,check in the mail for $0 'cause everything went to the respective taxing authorities. the benefit there is that, the IRS looks at your payroll withholdings as being made throughout the year, not maybe like a yearend bonus. So you can avoid your underpayment penalties that way.

Calvin:

So if you've underpaid quarterly taxes, you can avoid penalties by doing an extra big payroll withholding at the end of the year.

Greg:

Yeah, I don't know how great your savings is because you know, you're paying those payroll taxes, but if you're an S-Corp owner also haven't taken your salary for that year, not be a bad idea.

Calvin:

Right. 'cause in that scenario, you're, bonusing yourself above and beyond your regular pay rate in order to have enough money to make a big tax payment. Right? So that's what you mean by having to pay extra payroll tax. Normally, you wouldn't be paying yourself a $50,000 bonus and have to pay Medicare or Medicaid on that depending on if you're above the social security threshold or not right.

Greg:

Yep.

Calvin:

Okay.

Greg:

So yeah. You know, the other thing to watch out for this year, especially new tax laws, probably won't know anything until 31st anyways, so it's kind of a shot in the dark. But if things change throughout the year, you know, maybe it's a good time to reassess. Do I need to withhold as much? should I start withholding a little bit more? Stuff like that.

Calvin:

Cool. Anything else the audience should know about payroll tax withholding? It's a riveting topic.

Greg:

yeah. It's,probably not gonna be the most listened to episode, but it is an important topic. People, what I find is that sometimes the withholdings will go down, but the way that the income is earned might go up Now you kind of have that differential growing and it's a big surprise to a lot of people. some people they might get hit with like a three, four, $5,000 tax bill, which could be significant to them.

Calvin:

Right.

Greg:

so,

Calvin:

And then withholding is for corporation entity types, right? C-corp. S-corp. LLC owners don't go on regular W2 payroll, so they need to do.

Greg:

Correct. If you're an LLC owner taxed as a partnership, you should not be taking payroll. the IRS does not like that because it can mess up the Fica and Medicare calculations, so you can end up paying overpaying Fica or underpaying Fica and stuff like that.

Calvin:

Awesome, Greg. Well, thanks for the update. Hopefully this is helpful to some listeners.

Greg:

Good deal. Yes, and we're here if you need us to help you calculate

Calvin:

And how do folks reach you, Greg?

Greg:

They can reach me by email greed@smartbooks.com or you can go to our website, SmartBookstax.com and book an appointment directly with me there.

Calvin:

Awesome. Thank you, Greg.

Greg:

Thanks. Host: The reference show notes and find other episodes on empoweringhealthybusiness.com. If you would like to have a one-on-one discussion with me. Or possibly engage SmartBooks to help with your business. You can reach me at Cal cal@empoweringhealthybusiness.com or message me on LinkedIn where I am easy to find. Until next time, this is Empowering Healthy Business, the podcast for small business owners signing off.

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