The Employer's Guide to Payroll Taxes

Managing payroll taxes is one of the more complex aspects of running a business. But it's a responsibility that every business owner must get right.

To help you stay compliant, let's review some payroll tax basics.

Employers must generally deposit employment taxes and report them every quarter. These taxes include withholding from employees' paychecks to cover income taxes — federal, and where applicable, state and local — as well as the employees' share of Social Security and Medicare taxes (FICA).

In addition, as an employer, you must contribute your share of FICA and pay federal and state unemployment taxes. Failing to correctly withhold, deposit, or report payroll taxes can lead to significant penalties.

What Is Payroll Tax?

Payroll taxes are federal and state taxes tied to an employee's taxable compensation. They include several components:

• Income tax withholding: Based on information provided on the employee's Form W-4, this tax is withheld from their paycheck and paid exclusively by the employee.
• FICA (Social Security and Medicare): Both employers and employees share FICA tax equally. The Social Security portion, officially called Old Age, Survivors, and Disability Insurance (OASDI), funds benefits to retirees, certain family members, and individuals with disabilities. Medicare taxes allow coverage under Part A with no additional cost for those age 65 and older (or eligible individuals), with optional coverage through Parts B, C, and D available for an additional premium.
• FUTA (Federal Unemployment Tax Act): Paid only by employers, FUTA funds unemployment compensation programs.
• State unemployment tax: Typically paid by employers, although a few states also require state unemployment tax contributions from employees.

What Is the Purpose of Payroll Taxes?

Payroll taxes fund vital government programs like Social Security and Medicare, which provide financial support to retirees, individuals with disabilities, and others in need. FUTA, a federal tax, contributes to unemployment programs, helping workers who have lost their jobs.

The amount withheld from each paycheck for income taxes depends on the employee's W-4 form, which they complete when hired. This form explains how much money to withhold for federal income taxes. Note that employees can fill out a new Form W-4 when applicable.

How To Calculate Payroll Tax Withholdings

When calculating paycheck amounts for tax withholding, you must refer to the employee's W-4 form and other details like their salary and any applicable deductions. These factors determine the amount the HR manager or owner should take from the paycheck for federal income tax, FICA, and any applicable state or local taxes.

For example, if an employee earns $40,000 annually and their W-4 form places them in the 10 percent federal income tax bracket, approximately $400 would be withheld from each paycheck for payroll taxes.

Understanding Employer Payroll Tax Responsibilities

Before you can begin payroll tax calculations, you must complete new hire paperwork, including Form W-4 (for federal tax withholding), a state W-4 (if your state requires it), and Form I-9 (Employment Eligibility Verification). You may also want your staff to complete a direct deposit authorization form.

Once you have these forms in hand, employers are responsible for a series of ongoing tasks to handle payroll taxes:

• Calculate withholding: Use the W-4 and other details to calculate federal, state, and local tax withholdings
• Deposit taxes: Deposit all payroll taxes according to a set deposit schedule (with an exception for a very small employer)
• File quarterly reports: Submit quarterly tax reports for income tax and FICA (with an annual report for a small employer), and report annually to employees and the Social Security Administration about all employees' tax payments
• Submit additional reporting: Complete any additional mandatory reporting, including state-level reporting and annual FUTA reporting

Note: Employers may also need to withhold amounts from employees' paychecks for additional obligations, such as salary elective deferral amounts for employee contributions to 401(k) plans and flexible spending accounts or for garnishment to cover child support. These additional withholding amounts and pre-tax deductions are your responsibility as an employer, but they don't figure into payroll taxes.

Mandatory Employer Payroll Taxes List

Employers have responsibilities regarding payroll taxes, and not performing them properly can lead to penalties. You'll encounter several types of payroll taxes, some paid by employers, some by employees, and some shared by both. But it's up to you to calculate, withhold, and deposit all required taxes.

You may face various consequences if you don't accurately deduct payroll taxes from employee wages. These can include fines, penalties, and — in severe cases — criminal prosecution or even jail time, depending on the extent of the violation. Employers are also legally liable for unpaid taxes, interest, and associated penalties if mistakes aren't corrected within a reasonable time frame.

Federal Income Tax

Income tax withholding from your employees' paychecks helps cover what they'll owe in federal income taxes for the year. This withholding includes federal income taxes, Social Security, and Medicare obligations. Some employees may also be subject to an additional Medicare tax (explained below under "Additional Medicare Tax").

Although "income tax" and "payroll tax" are sometimes used interchangeably, each has a distinct difference. Income tax is the amount withheld from the employee's wages to cover their personal federal income tax liability. Payroll taxes refer to both the employee's and the employer's contribution to Social Security and Medicare, along with federal unemployment tax (FUTA) and any applicable state unemployment taxes.

Most states require employers to withhold state income taxes, except for Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming, which have no state income tax. Additionally, New Hampshire and Tennessee don't tax wages. Certain cities, such as New York City and Philadelphia, impose local income taxes that can result in additional wage withholdings from employees' paychecks.

In some locations, payroll tax withholdings may also include deductions for:

• Short-term disability: Provides benefits to employees unable to work due to illness or injury
• Paid family leave: Offers wage replacement for employees taking time off to care for family members
• Unemployment benefits: Funded through state programs to provide income for workers who have lost their jobs

Social Security Tax (FICA)

Employers and employees share Social Security and Medicare taxes, collectively known as FICA. These taxes fund Social Security benefits for retirees, individuals with disabilities, and survivors, as well as Medicare benefits.

You and your employee each pay a tax rate of 6.2 percent of the employee's wages for Social Security, up to an annual wage base limit ($168,600 in 2024). In addition, you both pay 1.45 percent of all wages for Medicare, with no wage limit.

Federal Unemployment Tax Act (FUTA)

The federal government doesn't pay unemployment benefits, but it does help states pay them to employees involuntarily terminated from their jobs. To fund this assistance program, employers must contribute to FUTA, a tax created by the Federal Unemployment Tax Act. The tax applies only to the first $7,000 of wages of each employee. The basic FUTA tax rate is 6 percent, but employers can receive a credit for state unemployment tax of up to 5.4 percent, bringing the net federal rate down to 0.6 percent, or a maximum FUTA payment of $42 per employee.

However, the credit is reduced if a state borrows from the federal government to cover its unemployment benefits liability and hasn't repaid the funds. Such a state then becomes a "credit reduction state," and the credit reduction (listed on Schedule A of Form 940) means the employer pays more FUTA than usual.

State Unemployment Tax

While the federal government doesn't directly pay unemployment benefits, it supports state unemployment programs through FUTA. FUTA requires employers to contribute to help fund benefits for employees who lose their jobs involuntarily (for any reason other than gross misconduct or furlough).

States fund unemployment benefits by imposing a tax on employers. The tax works like insurance, where the rate is based on the employer's claims history. Employers with more claims from former employees pay a higher tax rate. The state informs employers of their specific rate each year, which is always subject to a minimum threshold.

Additional Medicare Tax

When an employee's compensation exceeds $200,000, employers must withhold an additional 0.9 percent Medicare tax on income over that threshold. This tax rate applies to earned income above specific amounts:

• $250,000: For married persons filing jointly
• $125,000: For married persons filing separately
• $200,000: For all other filers

The employee is responsible for paying this tax, but you — the employer — must calculate and withhold it. Note that the $200,000 withholding threshold applies regardless of the employee's marital or tax filing status.

Understanding Payroll Tax Responsibilities

Employers have a range of payroll tax responsibilities. You'll be figuring income tax withholding (federal and, where applicable, state and local), depositing payroll taxes, and filing various returns to report payroll activity.

How To Calculate Employer Payroll Taxes

You'll calculate payroll taxes according to the employee's reported deductions on Form W-4. This form provides the employee's marital status and indicates whether additional withholding is necessary for personal taxes or if deductions apply to reduce their income taxes. If an employee doesn't submit a W-4, the withholding is calculated as if the employee were single with no other adjustments.

Employers relying on outside payroll service providers, like Paychex, can leave the calculations to the service provider. Some employers who do payroll in-house use software or rely on tables provided by the Internal Revenue Service (IRS) in Circular E to calculate payroll taxes accurately.

What Forms Are Required When Calculating and Submitting Payroll Taxes?

You don't need special forms to calculate or deposit payroll taxes. However, employers must submit required forms to report withholding activities to the appropriate federal, state, and local tax authorities.

Determining Payroll Deductions and Tax Credits

As an employer, you may be eligible for payroll tax credits and deductions to reduce your overall payroll tax liability. For example, the research and development (R&D) tax credit allows businesses that invest in innovation to offset some of their payroll taxes. You could also qualify for the work opportunity tax credit (WOTC) if you hire individuals from target groups, such as veterans or those facing long-term unemployment.

You can also take deductions for employee benefits, like retirement plan contributions or healthcare benefits, to lower your taxable income. By using payroll tax deductions, you can reduce your tax burden while staying compliant with mandatory payroll deductions like Social Security, Medicare, and unemployment taxes.

Consequences of Payroll Tax Non-Compliance

If you fail to follow payroll tax compliance rules, your business could face serious consequences. The IRS may charge penalties and interest and even pursue legal action in extreme cases. Missing tax payments or making mistakes can also lead to audits, which could trigger even more fines.

In some cases, employers may be personally liable for unpaid taxes, making compliance a critical priority. Staying on top of your payroll tax obligations helps you avoid these costly issues and keeps your business in good standing.

Overview of Tax Returns and Deposits

Employers must file employment-related tax returns and deposit employment taxes according to set deadlines. If they don't do it on time, they may be subject to failure to file and failure to pay penalties. Additionally, any "responsible persons" in the company who fail to deposit trust fund taxes — amounts withheld from employees' paychecks — can be held 100 percent personally liable. This trust fund recovery penalty applies when someone with the authority to make payment decisions willfully neglects to deposit these taxes. Given the severity of these penalties, employers must get things right.

Tax Returns

Employers are responsible for filing several tax returns related to employment taxes. At the federal level, these include:

• Form 940: An employer's annual FUTA tax return.
• Form 941: An employer's quarterly tax return reporting withholding and the employer's share of FICA.
• Form 943: The employer's annual return for agricultural employees.
• Form 944: Used for small employers eligible to pay employment taxes annually rather than depositing them according to a schedule.
• Form 945: A federal income tax return used to report non-payroll payments, including pension distributions.

Employers must also report withholding to employees and the Social Security Administration annually. To do this, they must file:

• Form W-2: Provided to employees to report wages and tax withholdings.
• Form W-3: Filed with the Social Security Administration, this transmittal form summarizes all W-2s (copies of all W-2s are included with the W-3).

Employer Tax Deposits

Employers must deposit all payroll taxes with the government by specific deadlines set by the IRS. The payroll tax deposit schedule you follow depends on the size of your tax liability:

• Semi-weekly schedule: Required for the largest employers
• Monthly schedules: Used by most employers

You can submit some payments with either Form 941 or Form 944, depending on certain criteria. For more details, refer to the section on Depositing Taxes in Circular E (pages 30 to 36 in the 2024 guide).

Filing Employer Tax Returns

Employers must file returns by set deadlines. In most cases, employer tax returns are filed electronically through an authorized e-file Provider or payroll software purchased specifically for this purpose.

How Often Do I Have To File Taxes?

Most employers' tax returns are filed annually. However, the employer's federal return (Form 941) must be filed quarterly.

States have their own filing schedules for their returns. Be sure to check with your state's tax, revenue, or finance department for specific deadlines.

How Much Should I Withhold?

It's up to the employer to calculate the correct amount of withholding based on an employee's submitted Form W-4. A revised Form W-4 went into effect in 2020, but existing employees don't need to submit new forms — employers can figure withholding based on any previous versions on file. However, if an employee's tax status changes and they want to adjust the amount of their claimed deductions (and associated tax withholdings), they must submit an updated Form W-4.

Withholding Forms

You must have employees complete Form W-4, Employee's Withholding Certificate, and state and local withholding forms where applicable, when you hire them. This way, you'll have all the information to correctly compute withholding.

For new employees, employers must require them to complete Form I-9 to verify they are legally eligible to work in the U.S. It's also a good idea for employers to have employees complete Form 8850, which is a form employers must submit to the state workforce agency to determine whether the new employee falls within a targeted group that entitles the employer to a work opportunity tax credit (WOTC).

Once I've Calculated My Business Employment Taxes, How Do I Submit Them?

You must deposit payroll taxes electronically through the Electronic Federal Tax Payment System, or EFTPS. Small employers who are permitted to pay employment taxes annually can opt to use EFTPS.

For state employment taxes, check your state's tax department to determine how to deposit employment taxes.

How Do I Handle Independent Contractors or Self-Employed Individuals?

You don't pay employment taxes for independent contractors or self-employed individuals — they are not employees. However, businesses should review the status of the worker to ensure they're properly classified as an independent contractor.

These workers pay self-employment (SE) tax on their net earnings from self-employment (their profits from their business activities), which essentially covers the employee and employer share of FICA. If a self-employed person also has wages from a job, the wages are coordinated with the SE tax to apply the wage-base ceiling properly.

If total payments to an independent contractor in the year are $600 or more, the business must file an annual information return — Form 1099-NEC — to report the payments to the worker and to the IRS.

Common Mistakes Employers Make With Payroll Taxes

Employers can make common payroll tax mistakes, such as calculating incorrect withholdings, missing deposit deadlines, or misclassifying workers as independent contractors. These errors can lead to penalties, interest charges, and compliance issues.

To avoid payroll tax mistakes, use up-to-date tax tables, review employee classifications regularly, and stick to a consistent payroll schedule to meet deposit deadlines. You can also reduce errors by automating payroll processes or working with a trusted payroll provider to help manage payroll taxes accurately.

Payroll Tax Recordkeeping and Documentation

To stay compliant with payroll tax regulations, businesses must have accurate recordkeeping. Employers must keep detailed records of employee wages, tax withholdings, deposits, and filed tax returns. The IRS requires you to retain these records for 4 years after filing the fourth quarter of the year.

Most employers store these documents digitally in a payroll management system, although small businesses may opt to keep paper records of payroll taxes. Hard copies require safe storage, such as a fireproof lockbox. To store these records digitally, you can save them using cloud storage or external hard drives — or both, to be sure you have a backup.

Staying Updated on Payroll Taxes Is Critical

Employer payroll responsibilities often seem overwhelming, especially with ever-changing regulations. Recent updates include the 2020 revision of Form W-4, an increased wage base limit for Social Security taxes, mandatory payments of certain benefits offset by employment taxes, and a deposit deferral option.

The consequences of improperly processing payroll taxes can lead to severe penalties. To make sure you do things correctly and avoid costly mistakes, consider outsourcing payroll to a payroll service provider.