When there is an ever increasing need for more money in the paycheck, thoughts turn to ways to increase the number in the all-important 'Net Pay' box on your paycheck. If a raise is out of the question, the attention turns to all those deductions for federal withholding, social security, medicare and unemployment taxes. Sadly, there is no changing the percentages that are deducted from earnings for social security and medicare, those are fixed. There are a few ways to reduce the rest of the payroll taxes withheld, however. Which way you choose depends on whether you are an employee or owner.
Reducing Payroll Tax as an Employee
Increase the number of exemptions on your W-4 form. Employees often are not aware of how much control they have over the amount of money withheld from their paychecks. Upon being hired, each employee should have been given a W-4 form to claim a number of exemptions. Federal withholding ideally removes enough from each paycheck to ensure that your income taxes are paid at the end of the year. With each exemption claimed, less money is withheld under the assumption that at the end of the year you will be claiming each of the exemptions. Look at your last few paychecks at the amount in the federal wWithholding boxes, by claiming an increased number of exemptions, those withholdings could be in your bank account.
Print and fill out a form W-5. The form can be obtained by going online to the Internal Revenue Service (IRS) website and clicking on "Forms and Publications." The W-5 is the earned income credit advance payment certificate. Earned income credit is a refundable tax credit given to those taxpayers, with children, with a minimum income requirement and a maximum limit. Some individuals receive as much as $6,000 in taxes they never paid, simply for this earned income credit. The form W-5 gives them advance payments on this refundable tax credit in each paycheck. Instead of receiving the one lump sum payment at the end, it is given to them during the year in equal installments. The Form W-5 must be refiled every year.
Ask your employer about switching to a Section 125 Cafeteria Plan. If you have health insurance that you pay after taxes, a switch to a Section 125 plan will mean your contributions will be pre-tax which will lower the amount of social security and medicare contributions deducted from your pay, and in the same way lower the employers contribution as well. Have your employer consult with a benefits specialist to determine which kind of Section 125 plan he needs. A plan that saves you and your employer money is always a good one.
Reduce your take-home pay and increase the owner's draw. As an employer, there is really only one way of reducing your payroll taxes. That involves taking advantage of the owner's draw account. When a business owner initially invests money to start his or her business, that investment is considered an owner contribution. When the owner spends money out of the amounts invested, that withdrawal is called a draw.
For example, if you initially invested $100,000 into the business, you can take a draw of up to that amount payroll tax free. If you are paying yourself a salary of $30,000 a year, by reducing the salaried amount to $15,000 and taking a draw equal to $15,000 you will save at least $2,295 in payroll taxes per year, not counting the federal withholding. You could take that draw every year for almost seven years without paying the FICA taxes.
If you do increase the number of exemptions on a W-4, be aware that at the end of the tax year you could end up owing taxes. Calculate the amount of taxes you expect to owe and choose the best number of exemptions to help you meet that target.
- Internal Revenue Service: Publicaion 1762: AEITC
- Internal Revenue Service: Form W-5
- CBS Interactive Business Network: Reducing Payroll Taxes without swallowing the bitter Pill: National Public Accountant: March 1994: Wayne W. Erickson
- Core Documents, Inc: Section 125 Cafeteria Plan Savings for Employers
- Cash image by Greg Carpenter from Fotolia.com