Payroll taxes: What they are, who pays, and how to calculate

What is payroll tax? You probably ask yourself this question when your paycheck amount is less than you expected. Simply put, payroll taxes refer to taxes employers and employees pay to fund government programs.

Now, as a small business owner, you have to perform the crucial task of putting together pay stubs and summarizing the payroll withholdings correctly. If you find these concepts difficult, read on to learn about payroll taxes, including what they are and your obligations as a small business owner to pay them.

Jump to:

• How does payroll tax work?
• Who pays payroll taxes?
• Self-employed payroll taxes
• How much is payroll tax? 
• How to calculate payroll tax
• What is payroll tax used for?
• How to file payroll taxes as a small business owner?
• Payroll tax examples
• Find peace of mind come tax time
• Payroll taxes FAQ

How does payroll tax work?

The payroll tax process involves the process in which employers calculate the taxes, withhold them from employee wages, and pay them to the government.

The payroll tax process includes the following steps:

1. Understand the different types of payroll taxes: The payroll taxes comprise FICA taxes (Social Security taxes + Medicare taxes), Federal Unemployment Tax (FUTA), and Federal Income Tax.
2. Withhold employee taxes: The employer withholds the correct amount of payroll taxes from their employee’s salaries based on their W-4 form details.
3. Deposit taxes to IRS: You’re responsible for depositing the withheld taxes from employees’ wages along with your share of FICA taxes to the Internal Revenue Service (IRS). You can do this electronically through EFTPS (Electronic Federal Tax Payment System). The frequency of the deposits depends on the employers' tax liability.
4. Report taxes: Report any wages, tips, and additional compensations that you have paid to the employees. You can do this by filing forms 941, 943, 944, 945, and 940 either through e-file or on paper.
5. Correct previously filed payroll tax errors: If there are any errors in a previously filed tax return, you can correct them with a 94X-X form. If you overpay the payroll taxes, you can even request a refund.
6. Keep accurate records: As a small business owner, you also have to occasionally update financial records for accuracy.

Payroll taxes vs. income taxes

Taxpayers sometimes get confused by payroll tax vs. income tax, but the major difference is that employees and employers both pay payroll taxes, while only the employees pay income taxes. Understanding these differences is crucial for both employers and employees. 

Payroll taxes are specifically earmarked to fund social insurance programs that provide benefits to workers. These programs include: 

• Social Security (providing retirement, disability, and survivor benefits)
• Medicare (providing health insurance for older people and people with certain disabilities)
• Unemployment insurance (providing temporary financial assistance to those who lose their jobs)

Both employers and employees contribute to these programs through payroll taxes. The rates are fixed percentages of an employee's wages, with separate rates for Social Security and Medicare.

Income taxes, on the other hand, fund general government operations and public services. These taxes are levied on various forms of income, including wages, salaries, investments, and business profits. Unlike payroll taxes, income taxes are progressive, meaning that those with higher incomes pay a larger percentage of their income in taxes. 

Income tax rates are determined by tax brackets, which vary based on an individual's filing status (single, married, etc.) and income level. Employers withhold income taxes from employee paychecks based on the information provided on the employee's W-4 form, but the ultimate responsibility for paying income tax lies with the individual employee.

Who pays payroll taxes?

In general, employers and employees pay payroll taxes. However, the responsibility does vary depending on different factors. Read on to find which payroll taxes are paid by employers and which are the employee's responsibility

For FICA taxes, both employees and employers pay their share. Depending on the worker’s classification, you, as the business owner, may pay half or none at all. If you employ a(n):

• A traditional employee who receives a W-2 form—you each pay half of the 15.3% (7.65%) 
• Independent contractor—the employer doesn’t pay any payroll taxes. Since an independent contractor is self-employed, they pay their full 15.3% self-employment tax.

For FUTA taxes, the business owner pays the full amount without assistance from the employee. 

For SUTA taxes, the payer is dependent on the state requirements. For example, states like New Jersey require the employer and employee to pay SUTA taxes. 

What are the implications of late payroll tax deposits?

As an employer, failing to pay your taxes on time can lead to payroll tax penalties or employment tax penalties. Among the payroll tax penalties, the most common is the Trust Fund Recovery Penalty (TFRP), which happens when employers either fail to collect taxes or forget to pay them.

The employment penalty cost depends on several factors, such as the business’s size, the amount owed, and the extent of the delay. The longer the penalty is overdue, the more it will cost.

Self-employed payroll taxes

When you're self-employed, you cover both the employee and employer portions of Social Security and Medicare taxes, known as self-employment tax. 

The 2025 self-employment tax rate is 15.3%, comprising 12.4% for Social Security and 2.9% for Medicare. This tax applies to your net earnings from self-employment, which is your business profit after deducting allowable business expenses. 

To calculate and pay your self-employment tax, you'll need to file Schedule SE (Form 1040) along with your annual income tax return. This form guides you through the calculation process, including a deduction for half of the self-employment tax, which helps to offset the fact that you're paying both the employer and employee portions. 

Keep in mind that you may also need to make estimated tax payments throughout the year to avoid penalties for underpayment.

How much is payroll tax? 

Payroll taxes are categorized based on employee classification and tax credits. It’s time to dig deep into the percentages for FICA, SUTA, and FUTA taxes. 

FICA taxes

The grand total for FICA payroll tax is 15.3%. If you have a traditional employee or statutory employee, you are responsible for 7.65% (half), with the employee being responsible for the other half. 

For 2025, the Social Security tax has a wage limit of $176,100, whereas there is no wage limit for Medicare tax.

While calculating payroll taxes, keep in mind that inflation or other factors can influence wage limits and their adjustments. The Social Security wage limit increases each year with inflation. This wage limit applies at the employee level. so employees with more than one employer may reach this wage limit with their combined wages, which can result in the employer overpaying Social Security taxes, increasing your financial strain.

FUTA taxes

FUTA payroll taxes are the sole responsibility of the business owner. The cost is $420 per employee annually—specifically, 6% of the first $7,000 you pay to each employee per year.

SUTA taxes

SUTA taxes aren’t as streamlined across the board as FUTA and FICA taxes. Since SUTA is a state-mandated tax, each state has its own tax range. Check with your state workforce commission for your range, if any.

With state unemployment taxes (SUTA taxes), you are eligible for a tax credit. This tax credit goes up to 5.4%, ultimately lowering your FUTA tax rate to .6%. You can achieve this by filing Form 940. Generally, everyone who qualifies for the SUTA tax also receives this tax break.

How to calculate federal income tax withholding

To calculate federal income tax withholding, first, calculate the correct percentage of taxes that you need to withhold from your employees’ salaries. For this, you will need a copy of Form W-4 and your employee’s gross pay. 

You can use either the Wage Bracket Method or the Percentage Method to determine the taxes:

Wage Bracket Method

The Wage Bracket Method is a simplified way to calculate federal income tax withholding from employee wages. It uses pre-calculated tables provided by the IRS to determine the withholding amount based on the employee's:

• Filing status: Single or married
• Pay frequency: Weekly, bi-weekly, etc.
• Gross pay: The employee's earnings before any deductions.

Other information: Reported in steps 2-4 on the employee's W-4 Form

Steps to use the wage bracket method:

1. Obtain the employee's W-4 form. This form provides their filing status and other information about their income tax situation.
2. Determine the employee's gross pay for the pay period.
3. Refer to the IRS Publication 15-T. Locate the appropriate wage bracket table based on the employee's pay frequency.
4. Find the employee's wage range within the table. The table rows represent different income ranges.
5. Identify the corresponding withholding amount. The columns in the table show the amount of tax to withhold based on filing status and withholding method used. Employees with only one job can use the standard withholding method. Employees with more than one job or a spouse with a job will use the Form W-4, Step 2, Checkbox withholding method.

Percentage Method

The Percentage Method offers a more precise way to calculate federal income tax withholding, especially for employees with higher incomes or those whose circumstances don't fit neatly within the wage bracket method tables. Employers often use this method with automated payroll systems.

Steps to use the percentage method:

1. Obtain the employee's W-4 form. This form provides their filing status and other information about their income tax situation.
2. Calculate the employee's taxable wages. Subtract any pre-tax deductions (like contributions to a 401(k) or health insurance premiums) from their gross pay.
3. Figure the tentative withholding amount. This is calculated using information in IRS Publication 15-T combined with your pay frequency, the employee's taxable wages, filing status, and whether the box in Step 2 of Form W-4 is checked.
4. Account for tax credits. Divide the amount from Step 3 of the employee's Form W-4 by the number of annual pay periods. Subtract the result from the tentative withholding amount. If this is less than zero, use zero.
5. Calculate the final amount to withhold. Add any additional withholding from Step 4(c) of the employee's Form W-4 to the result of step 4 above.
6. Apply the appropriate tax rates. Use the tax rates and income brackets provided in Publication 15-T to calculate the federal income tax withholding.

What is payroll tax used for?

Payroll taxes are put in place to help fund unemployment, Social Security benefits, and Medicare contributions. The taxes ensure that these programs get a regular flow of income to operate efficiently.

Everyone who earns a salary or wage—no matter the amount—is subject to pay into these contributions. Here’s how they split income taxes:

• Social Security contributions: 12.4% total (6.2% from the employer and 6.2% from the employee). The Social Security program supports those with income losses for reasons such as retirement, death, or disability and provides financial protection to the affected population.
• Medicare contributions: 2.9% total (1.45% from the employer and 1.45% from the employee). The Medicare program is responsible for providing health care services for people aged 65 years or above, young people with disabilities, and individuals diagnosed with the last stages of renal diseases.
• Unemployment contributions: Up to 6% of the first $7,000 (this is entirely paid by the employer. The Unemployment program lends a helping hand to those suffering from unemployment.

How to file payroll taxes as a small business owner?

As a small business owner, you have to ensure proper filing of taxes, meeting the deadlines, and keeping track of all the updated tax-related forms and regulations.

Depending on the date of the tax deposit, you have to report federal (FICA and FUTA) and state (SUTA) taxes post-payroll to file payroll taxes.

Federal tax deposits

There are three main types of federal tax deposits a small business owner will file: FICA, income, and FUTA.

• FICA and income tax deposits: You are required to pay FICA and federal income tax withheld either monthly, semiweekly, or the next day, depending on your predetermined tax deposit date.
• FUTA tax deposits: You’ll only pay FUTA taxes (unemployment taxes) to the IRS on a quarterly basis. However, if your FUTA tax contributions are less than $500, you roll them over to the next quarter and pay biannually. 

If you’re in the last quarter of the year and still haven’t hit $500, use Form 940 to pay the tax by January 31.

In addition to paying the FICA and FUTA tax deposits electronically, you also need to report your taxes on Forms 941 and 940. 

• Form 941 is for your quarterly federal tax return for your FICA and federal income taxes. You will fill out and submit a Form 941 for each quarter, summing all of your FICA and federal income taxes paid within those months.
• Form 940 is mainly for your yearly federal unemployment (FUTA) tax return. You will fill out and submit Form 940 annually, summing all of your FUTA tax contributions for the previous year. If your FUTA contributions haven't reached $500 by the last quarter, use Form 940 to pay the tax by January 31.

While you can also file these forms electronically, you can still mail them to the IRS. 

State tax deposits

SUTA tax is state-specific and varies from state to state. Find out the state-specific SUTA tax rates and requirements by registering with the state’s unemployment agency. After registering, you will get an employer tax number. Most states will ask to file a yearly return and make quarterly payments.

You have to calculate SUTA taxes based on the state’s wage base (SUTA wage base/wage limit) and the tax rate assigned to you. SUTA wage refers to the amount of your employee’s earnings that are taxable under the SUTA Act, and it is the same for all employees living within a state.

For example, in Florida, the wage base is $7000, so if an employee earns $40,000 per year, the SUTA tax will only be calculated on the first $7000 of the salary and not on the entire $40,000. In this case, the employer will pay the taxes and not the employees.

Just make sure to regularly check your state government’s official website for updates on the wage limits.

Payroll tax examples

Understanding how to calculate payroll taxes can be tricky, especially with different employee classifications and varying tax rates. 

Let's say you have an employee in California who earns $50,000 per year. Here's how their payroll taxes would look for 2025:

FICA Taxes:

• Social Security: 6.2% (employee) + 6.2% (employer) = 12.4% total
• Calculation: $50,000 x 0.124 = $6,200
• Medicare: 1.45% (employee) + 1.45% (employer) = 2.9% total
• Calculation: $50,000 x 0.029 = $1,450

FUTA Taxes:

• Rate: 6%
• Wage base limit: $7,000
• Calculation: $7,000 x 0.06 = $420 (employer pays)

SUTA Taxes:

• California's SUTA tax rate: (We'll assume 3.4% for this example)
• Wage base limit: $7,000
• Calculation: $7,000 x 0.034 = $238 (employer pays)

As you can see, the total tax obligation for the employer would be $6,200 (Social Security) + $1,450 (Medicare) + $420 (FUTA) + $238 (SUTA) = $8,308

Find peace of mind come tax time

Payroll taxes play a significant role in our government's program contributions by ensuring basic benefits such as Social Security, Medicare, and unemployment for all workers. 

As an employer, you should keep track of the different types of taxes you owe and the potential tax penalties in case you miss a deadline. You can accomplish this using the QuickBooks tax penalty protection feature to safeguard your business from paying expensive penalties. 

Before you dive in, make sure you’re categorizing your employees appropriately as traditional, statutory, or independent contractors. This way, you don't underpay or overpay your payroll taxes when the time comes.

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