How to Save on Payroll Taxes: 8 Money-Saving Strategies

Companies today are being forced to do more with less. Many businesses are examining their budgets and looking for strategies to keep costs down. As one of the largest costs for most companies, payroll is a great place to start. Luckily, there are several ways to save on payroll taxes without laying off employees or lowering salaries.

Why are employer payroll taxes so high?

Payroll taxes are high because there are a variety of taxes that employers must pay for or withhold from employees’ wages. They include:

Social Security and Medicare Tax

Federal Insurance Contribution Act (FICA) taxes fund Social Security and Medicare programs. These taxes total 15.3%, with the employer and employee each paying half. Each party pays 6.2% for Social Security tax up to a wage base limit of $160,200 and 1.45% for Medicare with no wage base limit. Employees who earn over $200,000 (single filers) or $250,000 (joint filers) pay a 0.9% surcharge for Medicare, which employers don’t have to match.

Federal income tax

Employees are solely responsible for paying federal income tax. The amount withheld from an employee’s paycheck is calculated based on their earned wages and Form W-4 information.

State and local income taxes

Employees alone pay for state income tax and local income taxes, which vary depending on location.

Federal Unemployment Tax Act (FUTA)

The Federal Unemployment Tax Act (FUTA) is a payroll tax paid by employers that helps states fund unemployment benefits. Companies must pay this tax if they have at least one employee who works at least part of the day for 20 weeks or more out of the year or if they pay employees at least $1,500 in any quarter. The tax applies to the first $7,000 of an employee’s wages. The basic FUTA rate is 6%, but employers that pay state unemployment taxes can receive a credit of up to 5.4%, bringing the net FUTA rate down to 0.6%.

State Unemployment Tax Act (SUTA)

SUTA is another payroll tax employers must pay to cover unemployment benefits for eligible employees who are involuntarily terminated from their jobs. Each state determines its SUTA wage base each year. Additionally, there is no universal SUTA rate. Every state assigns each employer an individual rate on a yearly basis, and this rate is based on factors such as business age, industry, and history of turnover or unemployment claims.

In most states, only employers are responsible for state unemployment taxes. However, employees must also contribute to this tax in Alaska, New Jersey, and Pennsylvania.

How to reduce payroll taxes and help employees save

Here’s how to save on payroll taxes:

Health savings accounts (HSAs)
Flexible spending accounts (FSAs)
Achievement awards
Fringe benefits
Create an accountable plan for employee reimbursements
Match a percentage of employee contributions
Contribute more to employee health insurance premiums
Tax deductions

1. Health savings accounts (HSAs)

A health savings account (HSA) is a tax-advantaged benefit account that works like a personal savings account for specific health-related items. Employees can spend money from an HSA on a wide range of eligible costs, including doctor’s visits, new glasses, and flu shots.

Unlike FSAs, employers do not own HSAs. Instead, employees own and control the money in their account, although some employers will still contribute to the account on their behalf and administer the HSA. The money an individual deposits into the account is triple tax-free: (1) contributions are not taxed, (2) interest and investment income are not taxed, and (3) qualified distributions for medical spending are not taxed.

Employers don’t pay FICA and FUTA payroll taxes on the employee’s HSA contributions, meaning they can save 7.65% on employee payroll deductions used to fund an HSA. If an employee puts $1,000 in their HSA, the company saves $76.50 on those contributions. HSA contribution limits for 2023 are $3,850 for individual coverage and $7,750 for family coverage. Those who are 55 or older can contribute an extra $1,000 as a catch-up contribution.

Employer contributions to HSAs are also a deductible business expense that you can write off on taxes.

2. Flexible spending accounts (FSAs)

A flexible spending account (FSA) is a tax-advantaged benefit account offered by many employers. Flexible spending accounts are tax-advantaged for employees as the money put into the account reduces taxable income, meaning it is exempt from income and payroll taxes. By reducing their taxable income, employees can hypothetically increase their take-home pay.

Like with HSAs, employers, on the other hand, aren’t expected to pay FICA and FUTA payroll taxes on the employee’s FSA contributions. FSA contributions are capped at $3,050 in 2023.

Contributions you make to FSAs are also considered a business expense you can deduct on your year-end taxes.

3. Achievement awards

Employers may not be aware that certain awards for length of service or excellence in safety are tax-exempt. Employers can deduct up to $1,600 if the award is part of a qualified plan, or an established written plan that does not favor highly compensated employees. If awards are not given as part of a qualified plan, employers may only deduct up to $400. Awards must be tangible and cannot be cash or cash equivalents such as gift cards. The IRS has several other regulations in place concerning achievement awards.

Length-of-service achievement awards:

The employee cannot receive the award during their first five years of employment
The employee cannot receive another length-of-service award (other than awards of very small value) during the same year or in the prior four years

Safety achievement awards:

The award cannot be given to a manager, administrator, clerical employee, or other professional employees
The award cannot be given to more than 10% of employees in a given tax year (awards of very low value don’t apply). Eligible employees must have worked full-time for one year prior to the award.

4. Fringe benefits

While some benefits such as lifestyle spending accounts are post-tax, there are several that provide tax savings. These other employee benefits can reduce employee taxable income and result in higher take-home pay along with a lower tax bill for the employer:

Dependent care assistance: Employers and employees can contribute tax-free money to a Dependent Care FSA (DCFSA) for child and dependent care use. The maximum annual benefit is $5,000 ($2,500 if married filing separately). Both employer and employee contributions count toward the $5,000 limit.
Adoption assistance: For 2023, up to $15,950 in adoption assistance is exempt from federal income taxes. It is still subject to FUTA and FICA taxes.
Commuter benefits: The monthly maximum amount for commuter benefits set by the IRS that you can deduct pre-tax is currently $300 for transit and $300 for parking in 2023.
Employer-sponsored 401(k): 401(k)s allow pre-tax income to be deposited, which reduces taxable income in the year of the contribution.
529 college/education savings accounts: College savings accounts are a popular fringe benefit that allow employees to save and grow tax-free money for higher education for themselves or a loved one. Beneficiaries must spend the money on qualified higher education expenses (QHEE) such as tuition and fees, certain electronics, books and classroom equipment, or some room and board costs for the withdrawal to be considered tax-free. Maximum plan contributions vary by state but cannot exceed the expected cost of a beneficiary’s QHEE, generally considered to be five years of tuition, room, and board at the most expensive college in the U.S. These plans may also be used for K-12 expenses, but the rules for doing so vary by state. While contributions to a 529 plan don’t reduce taxable income, some states offer tax credits or deductions for matching employee contributions.
De minimis fringe benefits: These are benefits that are considered low in value and are excluded from an employee’s taxable income. Items such as snacks, coffee, some holiday gifts, staff events, or low-value birthday gifts are deemed small and rare enough that accounting for them is unreasonable or impractical. The IRS has previously ruled that items exceeding $100 in value cannot be considered de minimis. These benefits are tax-deductible as well as tax-free. Employers can report the money spent on them as an expense and reduce their year-end tax burden.

5. Create an accountable plan for reimbursing employees

Throughout the year, employees may pay for certain expenses out of pocket which are then reimbursed by their employer. For example, employees often incur reimbursable expenses when they travel for work and pay for lodging, meals, gas, or entertaining clients.

Whether or not these expenses are taxable depends on if you have an “accountable plan.” Publication 15 (2023), (Circular E), Employer’s Tax Guide states that expense reimbursements are not counted as income and are not subject to payroll taxes if the business has an accountable plan.

The program must meet the following three conditions to be considered an accountable reimbursement plan:

The employee must have incurred the expense while performing services as your employee. The reimbursement must be a payment for the expense and cannot be an amount that would have otherwise been paid to the employee as wages.
The employee must substantiate the expenses to you within a reasonable timeframe.
The employee must return any amount paid to them in excess of the substantiated expenses within a reasonable period of time.

According to the IRS, it is generally considered reasonable to reimburse employees within 30 days of when they incur the expense. It is reasonable for employees to account for expenses within 60 days of when they incur them and to return any excess reimbursements within 120 days of when they incur them.

6. Match a percentage of employee contributions

Offering employees an employer-sponsored 401(k) is a great way to help employees set aside pre-tax income for their retirement. These accounts offer many tax benefits for employers, too. Because employee contributions to a 401(k) reduce their taxable income, employers reduce their payroll tax obligations. Companies won’t usually have to withhold income tax for these contributions but must pay Social Security and Medicare taxes on them. Employers also still have to pay payroll taxes on employee contributions.

Employers can save more by offering matching contributions to their employees’ 401(k) accounts. Many companies provide a 401(k) match on employee contributions, matching as much as 50 cents on the dollar on up to 6% of an employee’s salary. Companies can also deduct matching contributions from their corporate tax returns, although these deductions can’t be more than 25% of the compensation paid to eligible employees participating in the plan.

Some small business owners may also be eligible for a startup cost tax credit, or the Credit for Small Employer Pension Plan Startup Costs. The credit covers 50% of eligible costs, up to $5,000 a year for three years. A small business can claim the credit for the costs of setting up and administering the plan and educating employees about the plan.

According to the IRS, your small business may be eligible for the credit if:

It had 100 or fewer employees who received at least $5,000 in compensation in the previous year.
It had at least one plan participant who was a non-highly compensated employee.
No employees received contributions or benefits in another plan sponsored by your company in the previous three years.

The IRS defines a highly compensated employee as an individual who:

Owned more than 5% of the business during the year or preceding year, regardless of the amount of compensation they earned
Earned more than $150,000 in compensation in the 2022 tax year and was in the company’s top 20% in pay. This amount is increased from $135,000 for the 2022 tax year.

Keep in mind that there are annual limits for 401(k) contributions. In 2023, the limit is $22,500 for employee contributions and $66,000 for combined employee and employer contributions. Employees who are 50 or older are eligible for an additional $7,500 in catch-up contributions.

7. Contribute more to employee health insurance premiums

There are many benefits to providing health insurance to your employees, the most important being the improved health and wellness of your workforce. There are also tax advantages for employers.

Employer-provided health insurance premiums for group health plans are tax-free, reducing your tax obligations. On top of this, employees pay for health insurance with pre-tax dollars. This lowers their taxable income, meaning your company pays fewer payroll taxes.

Paying for employees’ health insurance premiums provides another huge tax benefit. These payments are considered a business expense that you can write off as a deduction when filing taxes.

8. Tax deductions

Healthcare is not the only benefit that you can deduct as a business expense. You can also deduct an employee’s income and wages, along with FUTA/FICA taxes and workers’ compensation insurance premiums. According to the IRS, compensation is tax-deductible if it is:

ordinary and necessary
reasonable in amount
paid for services that were actually performed
paid or incurred during the tax year for which you claim the deduction

Employee compensation qualifies because you are paying for services that are considered necessary for your business. Compensation is deemed “reasonable” if a similar business would pay the same amount for comparable services.

Using these guidelines, you may also be able to deduct some benefits such as bonuses, awards, sick leave, vacation pay, employee discounts, or education assistance. If you want to deduct these benefits as a business expense, they must be reported as taxable income on an employee’s W-2.

Questions to ask your CPA to save on payroll taxes

Guidelines surrounding tax-advantaged plans can be quite complex, and we recommend working with an accountant or financial advisor to help you strategize your approach. Here are several questions to ask during your planning period that may help you reduce your payroll tax obligations:

How could my organization benefit from tax-advantaged programs?
Which programs do you recommend based on my business and employee base?
What direct business expenses can I deduct from my taxes?
Is this still the right business structure for my organization?
Does my state have unique tax laws or policies I should be aware of?
Are there any industry-specific tax regulations I should know about?
How should I protect my company in case of an audit?

Tax-advantaged programs are a win-win for employees and employers. Have more questions about how to build a benefits program that reduces your company's payroll tax burden? Feel free to book a demo or reach out to us at sales@getbenepass.com.