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taxes

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

By Michael Kern
Published on February 27, 2025
Reviewed By Liz Farr

Payroll taxes definition

Payroll taxes (employment taxes) refer to the taxes business owners pay and withhold from their employees’ salaries. The government uses this money to fund social insurance programs, such as Social Security, Medicare, and unemployment benefits.


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.

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An infographic explaining different types of payroll taxes

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.
An infographic listing payroll tax steps for employers

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.


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NOTE: As an employer, you have to withhold, deposit, and report taxes before the deadlines to avoid any penalties. You can refer to the IRS tax calendar to keep up with the deadlines.