What Are Payroll Taxes?

Taxes are already complicated, but payroll taxes are a new level of confusion. How are payroll taxes calculated? Which payroll taxes do employers pay? Which payroll taxes do employees have to pay? And how do you actually file and report payroll taxes?

There’s plenty to learn when it comes to payroll taxes, and making a mistake can result in costly fees.

Using some of the best payroll software for small businesses might take the guesswork out of the process and do the calculations for you. However, it’s still important to have a rudimentary understanding of payroll taxes, especially if employees have questions about their paychecks.

In this guide to payroll taxes, we’ll cover what payroll taxes are, whose responsibility it is to pay them and when, how to calculate them, and more.

What Are Payroll Taxes?

Payroll taxes are the money an employer withholds from an employee’s earnings to pay taxes to the state and federal governments. These include income taxes, social security, medicare, unemployment taxes, and other state or local taxes.

How much an employer takes out and sends to the government is based on the employee’s wages and withholdings, and it is the employer’s responsibility to manage these taxes.

There’s only one exception: 1099 contractors are in charge of their own taxes. Contractors, freelancers, and small business owners pay self-employment tax, which is the equivalent of employee/employer payroll taxes. Bear in mind that when someone says “payroll tax,” they are lumping together all of the various taxes paid out of a person’s paycheck for services, but in the next section, I’m going to break down where those payroll taxes go.

Federal Payroll Taxes

There are several federal payroll taxes that employers are responsible for withholding from their employee’s checks, including federal income tax, FICA, and FUTA. The rates for FICA and FUTA, in particular, are subject to regular change (usually yearly), so it’s important to know exactly what these federal taxes entail.

Federal Income Tax Withholding

Federal income tax is based on income level, and the rates are progressive, meaning that as you make more income, your rates move, and your income tax increases as you travel up the tax brackets.

Currently, there are seven tax brackets that tax income at 10%, 12%, 22%, 24%, 32%, 35%, and 37%, as income increases.

Employees are required to select their withholding using their W-4 forms. Employers are required to collect W-4s and withhold the proper amount based on these forms.

2023 Tax Year Federal Income Tax Brackets

2024 Tax Year Federal Income Tax Brackets

*The most recent IRS announcement regarding tax brackets does not include information on income brackets for individuals who are married, filing separately, or are heads of households.

Social Security Tax

Social security is a flat-rate tax of 12.4% of taxable income. Both the employee and the employer are responsible for paying half (6.2%) of the social security tax.

Federal Unemployment Taxes

The Federal Unemployment Tax is a mandatory tax paid quarterly versus monthly. The current FUTA rate is 6.0% and applies to the first $7,000 you pay to each employee during the calendar year.

Medicare Tax

The Medicare tax is also a flat rate of 2.9%, with the employer and the employee splitting the cost at 1.45% each.

State Payroll Taxes

There are three main types of state payroll taxes: state income tax, state unemployment tax, and local taxes, which can include sales & use taxes, property taxes, etc.

State Income Tax Withholding

There are currently seven states that do not have a state income tax (also known as personal income tax): Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. For everyone else, income taxes work similarly to federal income tax withholdings.

The tax rates are very specific to each state. The withholding tables on the state government website where your business is located are the best sources of truth to discover your state’s income tax rates.

State Unemployment Taxes

Most states have some form of SUTA or state unemployment tax. State requirements differ widely, so you’ll need to check this directly with your state.

Local Taxes

Local taxes vary by city and state. Common examples of local taxes include property taxes and sales taxes. These taxes are based on local tax laws and vary significantly, so small business owners need to check/verify those taxes through the state’s tax department.

Who Pays Payroll Tax?

The burden of managing payroll and sending payroll tax payments is on the company, and the burden of paying those taxes falls on both the employee and the employer. Each state has different regulations and requirements for how state income tax is paid to the government, and the federal government collects payroll taxes quarterly.

Employer Tax Responsibilities

You are a small business owner, and it’s time for payroll. What tax responsibilities do you have?

• Social Security: You will pay your half of the 12.4%, and you will withhold 6.2% from wages for your employee’s portion.
• Medicare: You will pay half of the 2.9%, and you will withhold 1.45% from wages for your employee’s portion.
• Federal Unemployment Tax: This tax is employer-paid, and the current rate is 6% on the first $7,000 earned by an employee.

Self-Employment Taxes

If you are self-employed or working under contract, you are the employer and the employee, and it’s your responsibility to pay both sides of the payroll taxes. That means that contractors need to withhold the full 12.4% for Social Security and 2.9% for Medicare and withhold their own state and federal income taxes (saving 15-20% of each check to cover these taxes is the recommended practice).

Some states also charge additional taxes for small businesses, which becomes the responsibility of a contractor. When contractors file their taxes, they will pay their portion of these taxes.

When Are Payroll Taxes Due?

Once you have collected the payroll taxes for your small business, they are due on either a monthly or semi-weekly deposit.

Semi-weekly deposits are primarily required for large businesses with large payroll tax revenue, so it is most probable that you will deposit your withholdings monthly.

Payroll taxes are due on the 15th of every month (unless that falls on a weekend, then the next available Monday).

If you are self-employed, you most likely will file estimated quarterly taxes (although some states accept yearly payments if you make under a certain amount). Check your state’s specific rules and tax brackets for the most accurate information.

Payroll Tax VS Income Tax

Running taxes for your payroll involves collecting both payroll taxes and federal/state income taxes.

When people say “payroll taxes” they are providing an umbrella term for all collected tax, but the term “payroll tax” refers to FICA taxes (social security and Medicare) and local taxes withheld from an employee’s paycheck, plus the additional percentages provided by the employer.

Income tax specifically refers to the federal, state, and local income tax rates. Even though the two are joined together in one lump, payroll taxes are specifically earmarked for certain programs. Income tax, on the other hand, is delivered to its respective federal or state governments and is used to manage the budget.

How To Calculate Payroll Taxes

Calculating your payroll taxes doesn’t have to be hard or intimidating. We’ve broken the process down into easy-to-follow steps so you can get started calculating your payroll taxes with confidence.

Step 1: Decide Between Payroll Software Or Manual Payroll Calculations

Calculating payroll taxes uses all the great basic math skills: multiplication, addition, and percentages. Be aware that if you make a mistake or are late processing a payment, the government likes to slap fees around. (I mean, no doubt, fees are a source of revenue for the government, too.)

While you can do payroll calculations by hand (and many do, including an adorable 80-year-old woman on Facebook who chastised me for suggesting someone run payroll using anything other than their head, a pencil, some paper, and the numbers), many great payroll software options can do this part for you: Gusto, Square, and ADP are all reputable companies that you can use to outsource payroll.

However, maybe you really want to tighten the budget and only have a few employees. In that case, there are also excellent cheap payroll software options.

Step 2: Know Your Pay Schedule

You’ll need to know how many times you are paying/withholding taxes from your employees before you can run payroll, so determine whether you are running payroll, weekly, biweekly, or monthly.

Step 3: Pick Your Payroll Tax Method

Then, you will need to decide if you’d like to pull taxes using the wage bracket system (recommended by most tax experts for small businesses) or the percentage method (not recommended for small businesses attempting payroll on their own).

Step 4: Use Your Employee’s W-4 To Calculate Withholdings

When you onboard employees, you will have them fill out a W-4. You will use that W-4 to note the employee’s withholdings and whether they are filing single/jointly/head of household. This is the data you need to calculate federal income taxes.

After you withhold the money for federal income taxes and any additional pre-tax deductions (retirement, worker’s compensation, healthcare) based on your employee’s W-4, then you calculate the FICA (Social Security and Medicare) taxes.

To calculate the social security tax, you will take your employee’s gross pay (the amount your employee receives before payroll taxes are removed for that pay period) and multiply it by .062 — the product is the amount of money to be withheld from the paycheck and matched by the employer.

You would do the same thing for the employee’s portion of Medicare by taking the gross pay for the pay period and multiplying it by .0145 — the product is the amount you’ll withhold and match for Medicare.

All state and local taxes are calculated on a state-by-state basis.

Step 5: Check For Payroll Deductions

But hey…those Statutory Payroll Tax Deductions (all the things we just talked about above, federal and state income tax, social security, Medicare, unemployment taxes) are not the only payroll tax deductions you’ll need to make as you process payroll. In addition to the mandatory deductions, you also have Voluntary Payroll Tax Deductions. These are things like health care, retirement benefits, worker’s compensation, or any other pre-tax deductions. As a small business owner, you might offer some of these programs and benefits, but some of the cost can (and does) trickle down to employees.

Read our full guide on payroll tax deductions to learn more.

How To Report & Pay Payroll Taxes

When you are figuring out how to run payroll, calculating the taxes and discovering your employee’s net pay (aka their take-home pay or the amount they make after payroll taxes are removed) is only the first part of the process.

After you’ve run your payroll numbers, you face the important task of getting those taxes into the right hands and accounting for your payroll to the government.

As a small business owner, it is your responsibility to:

• Withhold all payroll taxes and submit them on time (the 15th of every month or the next available business day) to state and federal agencies.
• Report income, withholdings, and matching of payroll taxes to the government quarterly.
• Keep records of yearly payroll for state and federal reporting agencies.
• Send W-2s and 1099s to employees and contractors listed with the correct amounts of their gross/net pay and tax withholdings.

When you have the monthly deposit to submit, you must submit the funds electronically (barring special circumstances allotted to small businesses only) using one of the following methods: via a third-party payroll service, your bank’s Automated Clearing House (ACH) network, or the Treasury Department’s free Electronic Federal Tax Payment System online/over the phone.

Some small businesses, especially those with low liability, can opt-in to a yearly payroll payment. This requires filling out Form 944. Check the IRS’s website to check for current eligibility requirements.

Your Federal Unemployment Taxes are due to the government quarterly. Form 941 is your guide to reporting income, withholdings, and payroll taxes to the government, and the tax forms are due on the last day of the month after the end of the quarter. For example, quarter one ends March 31, and the report is due by April 30. At the end of the tax year, you have until January 31 to deliver the necessary tax forms to your employees, former employees, and contractors, so they can file their taxes correctly.

If you are self-employed, you’ll need to gather your 1099-MISCs and file a Schedule C when you file your taxes (due April 15).

For both small business owners and the self-employed, it is imperative to maintain impeccable records of your state and federal payroll taxes, whether by hand in a notebook, in an old spreadsheet document, or by using online software.

Watch Out For Payroll Tax Penalties

If you fail to withhold the proper amount from your employees, you, the employer, are 100% liable and will need to furnish the missing money from your own pocket in addition to any legal penalties and fees you face.

Employer error is costly because tax laws say that the onus for accuracy is on you, the business owner. And if you can’t pay those fees? That trickles down into every aspect of your business in a cycle: higher consumer costs, decreased employee wages, and a hiring freeze. Not to mention that it erodes the trust between an employer and an employee.

If you don’t pay your payroll taxes on time every month, you incur a 2% penalty for 1-5 days late, a 5% penalty for 6-15 days late, 10% for 16+ days late or within ten days of the first hearing from the IRS. The maximum is 15%.

Also, the government doesn’t care if you outsource your payroll taxes — if a third party isn’t paying on time (your payroll service or your bookkeeper), you will receive the penalty all the same because you hired them.

There are other ways you can be penalized, too, like if you miscategorize employees or you make an error in your reporting. There are too many potential errors to explain them all, so it’s important small business owners meet with tax attorneys or other tax experts for a full understanding of the myriad ways things can go off the rails.

The most important thing to remember is that rates and guidelines can change yearly depending on inflation and tax laws, so keep up with current literature on the tax brackets from the IRS Forms. Know your state’s laws, file accurately and promptly, pay on time, and report on time.

You can also make the process even easier by using payroll software, which handles calculating payroll and payroll taxes for you.

Take a look at the best payroll software options to save your business money and time on payroll taxes.