Everything You Need to Know About Payroll Taxes
What Are Payroll Taxes?
Introduction
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.
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…[MORE]