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What Are Payroll Taxes?
Payroll taxes withhold money from an employee’s earnings. Here are some guidelines on how to handle this responsibility.
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If you’re a small business owner in the United States, you’ll need to understand payroll taxes from the moment you hire your first employee. Dating back to Franklin D. Roosevelt’s New Deal, payroll taxes are the taxes withheld from an employee’s earnings (including any wages, salaries, bonuses or cash gifts from the employer) to fund federal programs like Medicare and Social Security.
Instead of directly taxing employees, who may or may not pay their taxes on time, the government requires employers to withhold a percentage of employee paychecks. As a result, it’s up to small business owners to understand the ins and outs of taxes. Employers can handle this process on their own, enlist the help of a tax professional, or employ a payroll service to handle all of their payroll and payroll tax responsibilities.
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What are payroll taxes?
Payroll taxes are withheld from each employee’s paycheck, and they have two main components. The first part is the portion of an employee’s paycheck the employer withholds. This is called the employee contribution and is shown on their pay stub. The second part is the amount employers contribute, which is also based on employee pay.
Federal taxes
Employees and employers are each responsible for half of the approximately 15.3 percent combined federal tax rate for Social Security and Medicare. Employers may be responsible for some additional payroll taxes. Here’s how that figure breaks down:
- Social Security: Both employers and employees pay Social Security taxes and contribute the same 6.2 percent of the employee’s wages.
- Medicare: Like Social Security taxes, both the employer and employee pay Medicare taxes — 1.45 percent each of the employee’s wages, for a total of 2.9 percent.
- Federal Unemployment Tax Act (FUTA): This is an employer-only tax; FUTA is not withheld from employee wages like Social Security and Medicare taxes.
- State Unemployment Tax Act (SUTA): Like the FUTA tax, the SUTA tax is employer-only in most states. However, in Alaska, New Jersey and Pennsylvania, employees are required to contribute to SUTA taxes.
Freelancers and other self-employed people are subject to the same 15.3 percent federal tax rate. However, unlike traditional employees (or employers), they’re responsible for the entire amount — not half.
State taxes
As you may expect, state taxes can vary. As of 2024, 43 states had some form of income tax. Alaska, Florida, Nevada, South Dakota, Tennessee, Texas and Wyoming do not have a state income tax. Washington’s income tax only applies to capital gains for high-income individuals and New Hampshire’s income tax only applies to interest and dividends. However, some localities, cities, counties or districts do have income taxes. Contact your local government to determine whether your business is expected to pay certain local income taxes.
How are employee contributions calculated?
The amount that employees contribute toward payroll taxes is based on a percentage of their taxable wages. If employees receive any pre-tax benefits — for example, if they contribute to a 401(k) or receive health insurance — then their taxable income is lower than their gross pay. Their final take-home pay is their “net pay.”
How do payroll taxes work?
Payroll taxes are withheld from each employee’s paycheck to fund Social Security and Medicare. Employers are responsible for withholding their employees’ taxes and submitting them, along with their employer share of Federal Insurance Contributions Act (FICA) taxes, to the IRS.
When employees file their taxes, they do not have to manually input their payroll tax from each paycheck, as their employer will do it for them. After employees file their taxes, they may get a tax refund from the IRS. This occurs when an employer withholds more money than necessary from an employee’s paycheck. The government returns the overpayment to the employee.
What do payroll taxes include?
Payroll taxes are divided into three main streams: Social Security and Medicare, which are mandated under the FICA, and federal income.
Social Security contributions go toward senior benefits and disability insurance, while Medicare provides healthcare for the elderly. In addition to withholding taxes from an employee’s paycheck, employers must match Social Security and Medicare contributions and issue other payments like state and federal unemployment taxes or workers’ compensation.
Sonya Muenchen, CEO of The Payroll Gal and a principal/partner with Perfect Benefits, has been a payroll tax consultant for small businesses for more than 20 years. She said it’s important for business owners to understand exactly what they’re responsible for.
“As an employer, you are responsible for … keeping track of time, calculating payroll based on employees’ tax certificates and depositing a payroll check on a weekly, biweekly, semimonthly or monthly basis,” she said.
According to the Social Security Administration, the taxable wage cap for Social Security is typically raised each year based on increases in the national average wage. In 2024, the maximum earnings subject to the Social Security payroll tax is increasing by $8,400, to a total of $168,600. This figure is called the “wage base limit.” If an employee earns that amount with one employer, then their payroll taxes are capped at that wage. However, if a worker has more than one employer and earns more than the wage base limit, they’ll have to make a claim adjusting any overpaid Social Security taxes.
Payroll taxes and income tax
In addition to Social Security and Medicare contributions, which are paid into specific funds, employees must pay a federal income tax. An employee’s tax rate is determined by their federal income tax bracket, which is adjusted for inflation each year by the IRS. Unlike the FICA tax, federal income tax is not paid into any specific fund.
Depending on your location, you may have additional withholding and income taxes.
“States and some localities also have payroll taxes and often include such things as state disability insurance,” said Michael Law, a certified public accountant and owner of the firm CS and Company. “If any of your employees earn over $200,000, there is an additional Medicare surtax withholding on them.”
The Medicare tax has no wage-based limit, as all covered wages are subject to it. However, if you make over $200,000 a year, your employer will withhold an additional 0.9 percent Medicare tax.
Paying payroll taxes
Law said how often you make payroll tax payments typically depends on the size of your business, how often you run payroll and the type of employer you are.
“Household employers with small payrolls have the most lenient deposit requirements, with annual deposits,” he said. “Those with larger payrolls need to make deposits either monthly or semiweekly.”
Law said businesses that are unlucky enough to be located in a federally declared disaster area may have their required payments relaxed for a short time.
While it’s possible to complete payroll taxes on your own, it can be complicated, especially when it comes to keeping track of payments and withholding the right amount of money.
“The most solid yet basic advice I give business owners is to get a payroll company and get in the habit of depositing everything they tell you to deposit,” said Anthony Parent, managing partner of tax law and business tax services firm Parent & Parent LLP.
Managing payroll taxes
There are several ways you can manage employee payroll taxes and ensure that your business is compliant with the IRS:
- Do them yourself. Complete the payroll taxes for each employee in your company. This involves analyzing each employee’s W-4 tax form, calculating allowances, referring to income tables and doing basic arithmetic to withhold the right amount of money. Keep in mind that you’ll have to calculate for state and federal payroll tax withholdings.
- Use a payroll service. Payroll services are third-party payroll processing companies that manage employee payroll. These services come fully baked with tax compliance, payroll processing and various other features. They make money off a monthly fee or on the interest of the money they collect for payroll taxes. Payroll service pricing typically includes both a flat monthly fee and a per-employee fee. The base monthly costs generally range from $20 to $100 per month, with the per-employee fees ranging from $1 to $15.
- Work with a tax professional. Besides working with a payroll service, you can work with a tax professional. You can also talk with an accountant about completing payroll taxes, although they may refer you to a payroll service.
If you invest in a service or work with a tax professional, rather than taking care of payroll taxes yourself, you can spend more time handling important projects and issues within your business.
The best payroll software
The right payroll software should help you avoid costly tax mistakes as well as offer a wide range of tools to keep your business operating smoothly. If you handle your payroll taxes on your own, you might overlook a crucial detail or miss a deadline that could put your business at risk. That’s especially true for newer business owners, who may not have the experience or expertise to handle complex tax situations. Payroll software removes much of the guesswork to help your business stay tax-compliant. Typically, software automatically adjusts to changing regulations, making it easier to follow the rules. If you’re looking for the best payroll tool for your business, consider the following options:
- Paychex works well for a variety of business sizes and structures. Sometimes, having different types of employees can make payroll more challenging — but not with Paychex. Its flexible payroll services could help you manage not only full-time employees but also part-timers, freelancers and 1099 contractors. That flexibility extends to payroll itself — employees could choose to receive their pay in the form of a physical check, direct deposit or even a prepaid debit card. Paychex may be uniquely helpful for payroll taxes because they employ a team of hundreds of compliance experts who update the software with regulatory changes as they occur, keeping your taxes up to date. Plans start at $39 per month plus $5 per employee. For a more thorough breakdown of Paychex’s advantages and disadvantages, you can consult our complete Paychex review.
- Remote is designed for businesses with remote teams. If you have team members in multiple states or even countries, you’ve likely had to navigate complicated tax scenarios. Remote simplifies that process, offering tools for contractors, remote workers and global employees. In fact, they’re tax-compliant in over 60 countries and they can provide benefits packages tailored to each location. Opting to use them as your employer of record makes it even easier to handle payroll, taxes and benefits internationally. Their plan starts at $299, or $599 for the employer of record option. However, the cost may vary for global payroll.
- Rippling offers an accessible, streamlined user experience, demystifying payroll — and payroll taxes. The tool is so user-friendly that you could run the entire payroll process in 90 seconds. Payroll taxes are largely automated through Rippling; it automatically files international taxes and deducts tax withholdings based on each employee’s filing status. Because Rippling requires everyone to use its workforce system, all relevant information for payroll tax prep is held within the tool. Consider our extensive Rippling review to better understand Rippling’s strengths and weaknesses.
What happens if you don’t pay your payroll taxes?
Making sure payroll taxes are paid to the right agencies and on time isn’t a task you should take lightly. If you don’t make your payments on time, you could face huge fines, see your business shut down and possibly spend time behind bars.
Law said any money that you withhold from your employees’ paychecks for payroll taxes technically belongs to the government.
“You have a fiduciary duty to turn over those funds to the applicable government agency,” he said. “You are not compensated for the fiduciary relationship, but you are penalized if you fail to pay [100 percent of what’s owed].”
If you don’t pay the correct payroll taxes or you send in payments later than they are scheduled, the IRS may pay you a visit.
“Should you get behind in paying the payroll taxes, you will get IRS notices and eventually a personal visit from the IRS,” Law said. “Continual failure to pay the payroll taxes will result in the IRS shutting down your business and possible jail time.”
Parent said the IRS can get aggressive over missed payroll taxes. The structure of payroll taxes means that when a company doesn’t withhold the right amount of money, the government can miss out on a lot of funding. That means IRS officials will be up to date on whether you’re paying your share of taxes.
“A revenue officer will likely get assigned and make an up-close-and-personal inspection of your affairs,” Parent said. “Many people, including myself, think that skipping payroll deposits to make ends meet is truly a deal with the devil.”
Make payroll taxes a priority
While payroll taxes certainly aren’t the most glamorous aspect of running a business, understanding and managing them well is vital for your success. It might be easy to focus on your day-to-day operations and let high-level organizational aspects like payroll taxes fall to the wayside. However, managing income taxes with care keeps your business running smoothly and protects you and your team. Consider either partnering with a payroll service or working with a tax professional to protect your business from tax hiccups that may become major problems.
Cailin Potami and Siri Hedreen contributed to this article. Source interviews were conducted for a previous version of this article.
