Federal employment taxes, a.k.a. payroll taxes, are taxes employers are required to withhold from their employees’ paychecks and remit to the federal government. Payroll taxes also include taxes paid by businesses that are related to — but not paid by — employees.
You can learn more about your employment tax responsibilities by reading IRS Publication 15, or the Employer’s Tax Guide. We also recommend talking to your accountant to get a thorough understanding of your business’s tax obligations.
Take the stress out of payroll taxes
Calculating payroll taxes is complicated, not to mention time-consuming and anxiety-inducing. A full-service payroll software provider like ADP can save you time and offer invaluable peace of mind in terms of payroll tax compliance.
What are payroll taxes?
“Payroll taxes” is an umbrella term that refers to the federal taxes paid by employers and employees on salaries, wages and tips. Employers are required to withhold the appropriate amount in payroll taxes from their employees’ paychecks and to make their own payroll tax contributions as well.
Employers remit these taxes to the government on a monthly or semi-weekly basis. As an employer, you also submit quarterly and end-of-year tax forms to the IRS and distribute end-of-year tax forms to your employees.
Federal payroll taxes typically refer to three main types of employment taxes:
- Federal income taxes, which are deducted from employee paychecks.
- FICA (Federal Employment Contribution Act) taxes, or Medicare and Social Security taxes, which are paid by both the employer and employee.
- FUTA (Federal Unemployment Tax Act) taxes, which are paid solely by the employer.
Depending on where your business operates, you might be required to withhold and deposit state or local payroll taxes as well, such as a state income tax withholding.
Federal income taxes
Employers don’t contribute to employee income taxes, which are paid by individual employees out of their gross pay. However, employers are legally obligated to withhold the correct income tax amount from each employee paycheck, which is determined by the taxpayer information submitted by your employee on IRS Form W-4. Employers must also remit that money to the federal government with a regular cadence.
In 1935, Congress passed the Federal Insurance Contribution Act (FICA), which established rules and regulations for employee and employer contributions to the newly created Medicare and Social Security programs.
Today, employers are required to withhold Medicare and Social Security taxes — collectively called FICA taxes — from their employees’ paychecks and remit them to the federal government on the employees’ behalf. Employers also contribute to FICA taxes out of pocket.
While the total FICA tax rate is 15.3%, employees only pay half of that amount. Employers pay the other half. (In other words, employees pay 7.65% of the FICA tax and their employer pays the other 7.65%.) Self-employed individuals pay both the employee and employer halves of the FICA tax.
The Federal Unemployment Tax Act (FUTA) established an unemployment tax paid only by employers. Since the tax is based on the number of employees you have and how much they earn, FUTA taxes are categorized as payroll taxes even though they’re paid by employers, not employees.
For the 2023 tax year, the FUTA tax rate is 6% of the first $7,000 earned by every employee. It doesn’t matter how much your employee earns over the $7,000 threshold: The compensation limit means the maximum amount of money you’ll pay in FUTA taxes comes to $420 per employee per year.
Again, FUTA taxes aren’t deducted from employees’ paychecks but paid for out of pocket by employers.
Other payroll taxes
Federal income, FUTA and FICA taxes are the primary federal employment taxes most business owners need to worry about. However, depending on the state you work on, your employees’ salaries and a few other factors, you might be responsible for withholding and filing a few other payroll taxes as well.
As always, make sure to talk to your accountant to learn more about which payroll taxes you need to pay, including when and why.
Additional Medicare taxes
Employees — including self-employed individuals — who earn wages higher than a certain amount are also subject to an extra Medicare tax of 0.9%.
For the 2023 tax year, the wage thresholds for withholding and remitting the additional Medicare tax percentage are as follows:
- For single individuals: $200,000 a year.
- For married individuals filing separately: $125,000 a year.
- For married couples filing jointly: $250,000 a year.
While employers need to withhold and remit additional Medicare taxes from any employees who qualify, business owners do not need to make a matching tax contribution.
State income taxes
Washington, D.C. as well as 43 states have their own state income taxes that employers must withhold from employee paychecks. State payroll tax deadlines typically follow the same schedule as federal payroll tax deadlines, which you can learn more about by reading our piece on payroll tax due dates.
State unemployment taxes (SUTA)
Along with a federal unemployment tax, employers in most regions also pay a state unemployment insurance tax (SUTA tax). The state unemployment insurance (or SUI) tax rate varies from state to state. It can differ depending on how old your business is and what industry you work in, among other factors.
You’ll find out what the state unemployment insurance tax rate is when you register your business with your state’s tax agency. Your accountant can also give you more information.
Some local cities and municipalities impose their own unique business taxes. Tools like tax code locators can help you figure out which local taxes you need to withhold or pay, if any.
Your accountant, state tax agency and payroll software provider can also offer more information on whether a local tax applies to you or not.
How payroll taxes work
Even though payroll taxes come from your employees’ wages, tips or salaries, it’s up to you as an employer to deduct payroll taxes from individual paychecks. You must also hold any employment tax withholding amounts in trust before submitting them to the appropriate federal and state tax agencies on a regular schedule.
Payroll tax deadlines, tax requirements and tax withholding amounts vary between businesses. However, most companies will follow these general steps to calculate, withhold and remit payroll taxes.
If you don’t want to handle payroll taxes on your own, you can hand them off to an outsourced bookkeeping team or professional employer organization (PEO). An in-house bookkeeper or accountant on retainer can also help you understand your tax obligations, or you can choose full-service payroll software that automates and streamlines the steps listed below.
1. Request an Employer Identification Number (EIN)
Before you can hire employees and start depositing payroll taxes, you need an Employer Identification Number, which is (in effect) the business equivalent of a Social Security Number. Each business has a completely unique number for easy tax identification.
You can apply for an EIN directly through the IRS’s website. Applying for and receiving an EIN is completely free, and the online process shouldn’t take more than a few minutes.
2. Acquire a state EIN
If you pay any state-specific taxes, you’ll need to request a unique state EIN that differs from your federal EIN. Visit your state’s website to find out if you need a state EIN and, if so, how to apply for one.
3. Collect employee tax documents
To determine how much to withhold from your employees’ paychecks, you must collect IRS Form W-4 from every in-house employee. Form W-4, or the Employee’s Withholding Certificate, includes crucial information that ensures you deduct the proper amount for each individual employee:
- The employee’s tax filing status (single, married filing jointly, married filing singly, etc.).
- Whether the employee has dependents or not.
- Whether the employee wants you to withhold any additional taxes per paycheck.
Form W-4 also includes information like the employee’s Social Security Number and home address, which are essential details your payroll team needs to correctly process and file taxes on behalf of each employee.
Independent contractors do not submit Form W-4 when they first start working with your company. Instead, they fill out IRS Form 1099, which lists the contractor’s income.
You do not need to withhold, deduct or remit any payroll taxes on behalf of your contractors. However, you do need to distribute Form 1099 to your contractors at the end of the year so they can file taxes accordingly.
SEE: The Best Contractor Payroll Services (TechRepublic)
4. Calculate payroll tax amounts for each paycheck
Once you’ve tallied each employee’s gross pay for the pay period, you’ll calculate any deductions for federal, state and local payroll taxes based on the information in Form W-4.
You can calculate payroll tax withholding by hand using one of two methods: The Percentage Method and the Wage Bracket Method. You can learn about each method and view the tables you’ll use to calculate the right tax withholding amounts in IRS Publication 15-T.
If you’re committed to running payroll and calculating tax amounts by hand, we recommend using free payroll software, templates or paycheck calculators to simplify calculations. However, bear in mind that calculating payroll taxes by hand is time consuming, complicated and stressful — especially since deducting the wrong amount can have major financial consequences for both your employees and your business.
Instead of running payroll by hand, you can work with an accountant or use a full-service payroll system with comprehensive tax administration to accurately calculate paycheck amounts, income tax withholding, FICA and FUTA taxes, state taxes and the employer portion of any payroll taxes.
5. Determine your payroll tax deadline schedule
When your payroll taxes are due to the IRS or state government depends largely on your business’s overall tax liability. Learn all about tax payment schedules by visiting the IRS’s website, consulting your accountant and reading our guide to payroll tax due dates.
6. Enroll in the Electronic Federal Tax Payment System (EFTPS) and make payments
The federal government accepts payroll tax deposits online via the Electronic Federal Tax Payment System. If you can’t access the website for any reason on your tax deposit deadline, you’ll need to call the IRS at 1-800-555-3453 to make a payment over the phone instead.
7. File the right annual and quarterly tax forms
Along with depositing funds, you need to file the correct corresponding tax forms. The most common tax forms you’ll submit include (but aren’t limited to):
- IRS Form 940 (Employer’s Annual Federal Unemployment Tax Return).
- IRS Form 941 (Employer’s Quarterly Federal Tax Return).
- IRS Form 944 (Employer’s Annual Federal Tax Return).
- IRS Form 945 (Annual Return of Withheld Federal Income Tax).
You should also send end-of-year tax forms to your employees (Form W-2) and contractors (Form 1099-MISC).
Your accountant can prepare and file all your required quarterly and federal tax forms. Full-service payroll software should also include pre-filled tax forms that are automatically submitted on a regular schedule. (Some self-service payroll software for small businesses include pre-filled tax forms that employers can submit on their own.)
Frequently asked questions
What’s the difference between income taxes and payroll taxes?
Income taxes are typically viewed as a type of payroll tax, a broad term that usually refers to taxes deducted by employers during regular payroll runs. Even though the income tax is paid by employees, not their employers, employers are responsible for withholding and remitting those taxes. As a result, along with FICA and FUTA taxes, income taxes may be considered a type of payroll tax.
What are wage limits for payroll tax?
The Medicare portion of the FICA tax does not have a wage limit. Instead, individuals who earn over a certain threshold are subject to an additional Medicare tax that their employer does not contribute to.
In contrast, the Social Security portion of the FICA tax does have a wage limit. For the 2023 tax year, wages are only subject to the Social Security tax up to an annual income of $160,200. Wages earned beyond that limit are not taxed for Social Security.
What is the FICA tax?
FICA taxes, which stands for the Federal Insurance Contributions Act taxes, are mandatory tax contributions to national Social Security and Medicare funds. The total FICA tax rate for the 2023 tax year is 15.3%. Workers contribute toward 7.65% of the total and their employers contribute the other 7.65%.
Does everyone pay a payroll tax?
Yes. Every worker — including both self-employed contractors and traditional in-house employees — contributes the same flat rate to Social Security and Medicare funds. Other taxes, such as income taxes, are assessed on a sliding scale based on the earner’s income level. However, while those with an income below a certain threshold may not pay income taxes, every wage-earning worker is subject to the same FICA tax rate, and every employer is subject to the same FICA tax match.
Which taxes make up payroll taxes?
Federal payroll taxes include three main types of taxes:
- Federal income taxes, which are deducted from individual employee paychecks.
- FICA taxes, which are Social Security and Medicare taxes paid by both employees and employers.
- FUTA taxes, which are federal unemployment insurance taxes paid solely by employers.
Depending on your business and its location, you might pay additional payroll taxes:
- An additional Medicare tax, which is deducted from employee paychecks based on their annual earnings.
- SUTA taxes, or state unemployment insurance taxes, which are paid by employers only.
- State income taxes, which are deducted from employee wages in 43 states and Washington, D.C.
How can I lower my payroll taxes?
You cannot lower your payroll taxes. FICA and FUTA tax rates are set by the federal government, and you must make required employer tax contributions or face severe fines. More severe consequences for failing to make payroll tax payments on the correct schedule can include liens being placed on your personal property, legal action and even jail time.
However, you may be able to write off certain business expenses for your end-of-year tax return, including the employer portion of FICA taxes. You may also be able to include employee wages as a tax deduction. These write-offs may lower your overall taxable income. Your accountant can help you understand which expenses to write off and whether doing so is the right move for your business’s finances.
Read next: The Best Payroll Apps of 2023 (TechRepublic)
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