Everything You Need to Know About Payroll Tax: A Comprehensive Guide on Understanding and Calculating It

Once you bring on your first team member, you assume the responsibility of paying payroll tax. While it may sound like a singular tax, the payroll tax is actually an umbrella term that encompasses all taxes associated with compensating your employees.

As an employer, two main responsibilities regarding payroll taxes are:


  • Withholding a portion of your employee's wages to cover specific taxes on their behalf.
  • Remitting payroll taxes for each employee from your company's revenue.

This comprehensive guide will provide you with instructions on how to calculate both employer payroll taxes and employee payroll taxes to be remitted to the government.


How to calculate payroll taxes for Small Business Owners Without Employees

Even if your small business doesn't have any employees, you still need to remit payroll taxes for yourself in the form of self-employment tax. This type of tax, which is equivalent to Medicare and Social Security contributions, amounts to 15.3% of your net business income. To find out more about self-employment taxes, check out our comprehensive guide. However, when you do have employees, the process of handling payroll taxes becomes more complex.


Types of Payroll Taxes

When it comes to payroll taxes, there are two main categories to consider - those that are paid by the employer and those that are deducted from employees' wages and sent to the government. As a business owner, you will be responsible for both types of payroll taxes. This brief summary will give you a better understanding of the different payroll taxes and their respective sources.


Understanding Payroll Taxes: Who Pays What?

When it comes to payroll taxes, there are two main types to consider - those that are paid by the employer and those that are collected from employees' wages and remitted to the government. Here is a breakdown of the different types of payroll taxes:


Payroll Tax Paid by Employers:


  • FICA Tax: This includes contributions to Social Security and healthcare programs (Medicare), which are shared by employers and employees. The employer portion is 6.2% for Social Security and 1.45% for Medicare. Employers are responsible for collecting and remitting the same amount from their employees.
  • FUTA Tax: This is a contribution to unemployment insurance, totaling 6.0%. However, most states offer a 5.4% credit, which means that most employers only pay 0.6%.

We will delve into both of these in more detail later in the guide.


Payroll Taxes Collected and Remitted by Employers:


  • Federal Income Taxes
  • State and Local Taxes


In the following sections, we will explore each of these payroll taxes in detail, starting with federal income tax withholding.


Understanding Federal Income Tax Withholding for Employers

As an employer, it's your responsibility to withhold federal income tax on behalf of your employees and remit those taxes to the relevant federal, state, and local tax authorities on a quarterly basis. Here are the steps to calculate the federal income tax withholding for your employees:


Step 1: Obtain a copy of your employee’s Form W-4 and their gross pay.


Step 2: Choose between the Wage Bracket Method or the Percentage Method to calculate the withholding amount. While the Wage Bracket Method is the more straightforward approach, both methods require careful attention to detail.


Step 3: Once you have determined the withholding amount, deduct it from your employee’s gross pay, and remit the taxes to the appropriate tax authority.


It's worth noting that the percentage of federal income tax withheld can vary depending on your employee's specific circumstances, such as their marital status, the number of dependents they have, and the amount of income they earn. Make sure to keep accurate records and stay up-to-date with any changes to federal income tax laws to ensure compliance.


Calculating federal income tax withholding using the Wage Bracket Method:

Form W-4 from 2019 or earlier

  • Find the worksheet marked “Wage Bracket Method Tables for Manual Payroll Systems with Forms W-4 From 2019 or Earlier” in IRS Publication 15-T.
  • Check Form W-4 to determine the employee’s marital status and the number of allowances they claim.
  • Enter the employee’s total taxable wages for the payroll period on line 1a.
  • Use the amount on line 1a to look up the Tentative Withholding Amount in the appropriate table based on the payroll period and marital status.
  • Find the wage amount on the left side of the table and use the number of allowances reported on Form W-4 to locate the corresponding column. The cell where these two meet will give you the tentative withholding amount.
  • Input the tentative withholding amount from the table on line 1b.
  • Enter any additional amount to be withheld as reported on Form W-4 on line 2a.
  • Add lines 1b and 2a to find the amount to withhold from the employee’s wages and record it in line 2b.


Employees with a Form W-4 from 2020

Calculating Federal Income Tax Withholding Using Wage Bracket Method for Employees with a Form W-4 from 2020 or Later:

  • To begin, go to IRS Publication 15-T and locate the worksheet labeled “Wage Bracket Method Tables for Manual Payroll Systems with Forms W-4 From 2020 or Later.”
  • Next, check the employee's Form W-4 to determine their filing status and the number of allowances claimed.
  • Enter the employee's total taxable wages for the payroll period on line 1a, including any taxable earnings like salaries and cash tips.
  • On line 1b, use Table 5 on the same page to record the number of pay periods per year.
  • Record the other income amount found on Step 4a of the employee’s Form W-4 on line 1c. Divide this amount by the number of pay periods per year and record the result on line 1d.
  • Add lines 1a and 1d, and record the total on line 1e, which represents the employee’s total earnings from all income sources before any deductions.
  • On line 1f, enter the employee's deductions amount found on Step 4b of their Form W-4. Divide this amount by the number of pay periods and enter the result on line 1g.
  • Subtract line 1g from line 1e to get the Adjusted Wage Amount on line 1h. If this amount is 0 or less, record 0.
  • Use the appropriate table from the Wage Bracket Method Tables to find the Tentative Withholding Amount for the payroll period and marital status of the employee.
  • If the employee has tax credits on Step 3 of their Form W-4, use lines 3a to c to determine the applicable credit amount for this pay period. If not, enter the amount from 2a on line 3c.
  • Finally, record any additional withholding amount from Step 4c of Form W-4 on line 4a. Adding this amount to line 3c will give you the amount to withhold from the employee’s wages, which you’ll record on line 4b.


Percentage Method: Considerably more intricate than the Wage Bracket Method, it is advised not to attempt the Percentage Method without professional guidance. For further understanding of both the Percentage and Wage Bracket Methods, consult the IRS Publication 15-T.


After determining the amount of income tax to withhold from your employee’s wages, the next step is to calculate the amount of FICA to withhold (more information below), as well as the employer’s portion that must be paid.


Understanding FICA Tax Calculation

FICA, which stands for Federal Insurance Contributions Act, is a mandatory payroll tax that is deducted from an employee’s paycheck to fund programs such as Social Security and Medicare. As the employer, you are responsible for withholding and paying your employee's share of FICA taxes.


FICA tax is split between the employer and the employee. The current tax rate for social security is 6.2% for both the employer and employee, while the current rate for Medicare is 1.45% for both the employer and employee, resulting in a combined FICA tax rate of 15.3% of the employee’s wages.


It is essential to note that if any of your employees make over $147,700, additional Medicare tax may apply. For more information, visit the IRS.gov website.


Calculating FICA Payroll Tax

Social Security Withholding Calculation

To calculate the Social Security withholding, you need to multiply the gross pay of your employee for the current pay period by the current Social Security tax rate, which is 6.2%. This amount is what you will deduct from your employee’s paycheck and remit, along with your payroll taxes.


Here's an example of the Social Security withholding calculation:


Employee’s gross pay for the current pay period: $5,000

Current Social Security tax rate: 6.2%

Social Security tax to be deducted from the employee’s paycheck: $310


Medicare Withholding Calculation

To calculate the Medicare withholding, you need to multiply your employee’s gross pay by the current Medicare tax rate, which is 1.45%.


Here's an example of the Medicare withholding calculation:


Employee’s gross pay for the current pay period: $5,000

Current Medicare tax rate: 1.45%

Medicare tax to be deducted from the employee’s paycheck: $72.50


Employer Matching

As the employer, you need to match what your employees pay in FICA taxes. In this case, you will remit $310 for Social Security tax and $72.50 for Medicare tax.


Calculating FUTA Payroll Tax

The Federal Unemployment Tax Act (FUTA) is a payroll tax paid by employers to fund state unemployment agencies. The FUTA tax rate is 6% on the first $7,000 of wages paid to employees in a calendar year. However, employers pay only 0.6% because each state receives a credit to cover the remaining 5.4% of FUTA payments.

Although most states are eligible for the full credit, some states are currently ineligible for it.


Comparison of FICA and FUTA Payroll Taxes

FICA and FUTA are two different types of payroll taxes with distinct purposes. FICA, or Federal Insurance Contributions Act, is a mandatory payroll tax that finances Social Security and Medicare, while FUTA, or Federal Unemployment Tax Act, is an employer-paid payroll tax that funds state workforce agencies and unemployment insurance.


In addition, the two taxes have different reporting requirements. To report FUTA, employers must file Form 940, the Employer's Annual Federal Unemployment Tax Return, by January 31 of the following year. On the other hand, employers must file Form 941, the Employer's Quarterly Federal Tax Return, to report FICA taxes every quarter. The deadline for filing Form 941 is the last day of the month following the end of the quarter. For instance, if the quarter ends on March 31, the form is due by April 30.


Making Payroll Tax Payments with EFTPS

Enrolling in the Electronic Federal Tax Payment System (EFTPS) is the first step to making your payroll tax payments. Once enrolled, you can make payments online easily and securely. You can only make payroll tax payments through EFTPS, as the IRS does not allow the mailing of checks.


To enroll, visit the EFTPS website and complete the online enrollment form. You’ll receive a PIN and password in the mail within a week or two. Once you have this information, you can log in to the system and make payments.


When making a payment, you’ll need to know your tax liability, the tax period for which you’re making the payment, and your bank account and routing numbers. You’ll also need to schedule your payment in advance, as payments can take up to 24 hours to process.


EFTPS is available 24/7, so you can make payments at any time. You can also schedule payments in advance, which can help ensure that you never miss a deadline.

If you have any questions about using EFTPS, you can contact the EFTPS customer service line for assistance.


State and Local Payroll Taxes

Employers have the responsibility to pay state and local payroll taxes on behalf of their employees, in addition to federal payroll tax. Employers commonly refer to State payroll tax as State Unemployment Tax (SUTA), and they have the responsibility of remitting state income tax for their employees.


State and local authorities govern payroll tax rates and rules, which vary depending on the jurisdiction. Employers withhold a certain amount from their employee's paychecks and remit it as part of their payroll taxes.


To know more about payroll taxes in a specific state and locality, employers can check the Federation of Tax Administrators’ list of each state’s taxing authority.


Outsourcing Payroll Tax and Bookkeeping Services

If you find payroll tax calculations to be a hassle, you’re not alone. The calculations can be tricky, and the penalties for errors or late payments can be steep. To avoid stress, consider outsourcing your payroll tax and bookkeeping services to a professional service like Bookkeeping Pro Services.


By outsourcing, you can have a team of experts take care of paying your employees the correct amount at the right time. Handling all withholding calculations and payroll taxes. Plus, you’ll have easy access to your records with automatically generated pay stubs containing all the necessary information.


And when it’s time to record your payroll costs, Bookkeeping Pro Services can take care of that too. By outsourcing your bookkeeping, you can save yourself hours of administrative work each month. Giving you more time to focus on growing your business.


To outsource your payroll tax and bookkeeping needs to Bookkeeping Pro Services, visit Bookkeepingproservices.com to learn more.