What is Payroll Tax: A Comprehensive Guide to Payroll Taxation

All employers pay payroll tax—a fundamental part of business that funds social programs and government initiatives. Essentially, tax authorities collect payroll taxes on employees’ wages or salaries to go toward Social Security, Medicare, and unemployment insurance. Understanding payroll taxes is critical to ensure compliance with tax obligations. This blog breaks down payroll taxes, their purposes, and what they mean for employers and employees. Let’s begin with a basic understanding of what payroll tax is.

“Payroll tax is defined as the taxes employees and employers pay on wages, tips, and salaries. Employers withhold federal, state, and local taxes from employees’ paychecks and pay them to the government. In the US, taxes also include Social Security and Medicare (FICA).”

What is the definition of payroll tax?

Understanding payroll taxes is important for businesses and employees alike. Employers pay a share—equivalent to employees’ contributions—of FICA, federal, and state unemployment taxes. Unlike the workers’ portion, the employer’s mandated payroll tax is not withheld from employees’ paychecks.

Understanding payroll tax is crucial for businesses and employees. For businesses, knowing what payroll taxes are and how to withhold them from employees helps them stay compliant with federal and local tax regulations.

Employees who have a grasp of payroll taxes can ensure they’re receiving the benefits they’re entitled to such as unemployment insurance, Social Security, Medicare, disability, and more. Additionally payroll tax information, which is located on W2s and paychecks, can help employees prove their income. This information may come in handy if an employee is applying for a loan.

What are the different types of payroll taxes?

Payroll taxes fall into two categories: federal and state and local. Here’s an overview of each.

Federal payroll taxes: Federal payroll taxes cover Social Security, Medicare programs, and unemployment, although only the employer is responsible for unemployment tax.
As of 2024, employers and employees both pay 6.2% for Social Security and 1.45% for Medicare. Each party contributes 7.65%. Those who are self-employed must pay the entire portion (15.3%) themselves.

State and local payroll taxes: This income funds state budgets as opposed to the federal government programs. Some states use a progressive tax, others have a flat tax, and nine states don’t impose income tax at all.

Except for the states that don’t collect income tax and those with a flat tax of 2.5% to 9%, most state payroll tax percentages range from 1% to 13.3%.
Some states have a wider tax gap than others. For instance, California citizens pay between 1% to 13.3% for earnings between $10,412-and $1,000,000, whereas in Alabama, citizens are taxed between 2% to 5% with $500 being the lowest tax bracket and $3,000 being the highest.

To know how much payroll tax to pay, companies must apply their state taxes to basic formulas.

How payroll taxes are calculated

Essentially, organizations can calculate payroll taxes by multiplying an employee’s gross pay by each tax rate (i.e. Social Security, Medicare, FUTA, and SUTA). Here’s how to perform these calculations:

• Social Security tax: Employee income × 6.2%
• Medicare tax: Employee income × 1.45%
• FUTA tax: Employee income × (FUTA Tax Rate – State Credit Reduction)
• SUTA tax: Employee income × State SUTA Tax Rate

One important caveat is that each of these methods requires companies to calculate the withholding amount (the federal income tax employers take out from an individual’s paycheck and send it to the Internal Revenue Service (IRS).

The amount of tax employers withhold depends on the individual’s earnings and the information they provided on Form W–4.

Employers can also use the wage bracket and percentage methods to calculate payroll tax. The wage bracket method considers the employee’s marital status and pay period. Employers can use the percentage method for employees whose annual wages surpass certain figures.

Companies can calculate payroll themselves, but this can be an expensive and time-consuming process. The process can become even more complicated if the company employs both hourly and salaried employees. Manual payroll calculations vary across the workforce. This can lead to human error, which can result in lawsuits, fines, or other penalties.

Because calculations differ across employees, many organizations find it helpful to enlist payroll software to make instant, accurate calculations on their behalf. Payroll technology saves employees hours and hours of manual work and provides an error-free way to calculate federal, state, and local taxes. Advanced payroll solutions guarantee compliance, instantly sync payroll and financial data, and guarantee fraud prevention.

Before choosing a solution, employers may wish to review their roles within the payroll process to identify gaps or areas of improvement.

Employer responsibilities

Employers must report employees’ wages, tips, and additional compensation on IRS forms and send them to the government agency through e-file or snail mail. Necessary forms may include:

• Form 940: The employer’s annual FUTA tax return
• Form 941: The employer’s quarterly tax return that reports withholding and the employer’s FICA share
• Form 945: A form for reporting non-payroll payments such as pension
• Form W-2: The form that reports the employee’s annual wages and withheld taxes

Filing the above forms correctly means employers must adhere to specific payroll tax deadlines.

1. January 31: 4th Quarter 2024 tax payment, Employers send employees W-2s forms, Forms 940 (FUTA) and 945 are due
2. February 28 or March 31 (if filed electronically): Form 1099-MISC is due
3. July 31st: FUTA taxes from April 1st to June 30th are due
4. October 31st: FUTA taxes from July 1st to September 30th

Filing the above forms correctly means employers must adhere to specific payroll tax deadlines.

When are payroll taxes due?

The IRS chooses the employer’s schedule depending on how often the employer files its federal tax returns and the amounts they report on returns during a certain period (known as the lookback period).

The lookback period for quarterly filings is July 1st two years before the current year to June 30th, one year before the current year. The lookback period for a quarterly filing business in 2024 would be July 1, 2022, to June 30, 2023. For annual organizations, the lookback period is two years earlier than the current one.

Employers following a monthly depositing schedule deposit taxes on the 15th day, the month after employees receive payment. For example, organizations that pay employees on May 30th must deposit taxes from that payroll on June 15th.

Organizations adhering to semiweekly deposit schedules deposit federal taxes according to the weekday employees were paid. If an organization pays its employees on a Wednesday, Thursday, or Friday, employers will deposit taxes by the following Wednesday. If employers pay employees on a Saturday, Sunday, Monday, or Tuesday, they deposit taxes by the following Friday.

Employers deposit unemployment taxes quarterly, unless the total collected tax for a quarter is $500 or less. In that case, they can deposit the funds the following quarter.
For all payroll tax deposits, if any of the deadlines fall on a weekend or holiday, employers can make deposits on the next business day.

Keeping accurate payroll records is a must for organizing the volume of forms— each with its own deadline. Standardized records prevent processes or deadlines from slipping through the cracks and prevent legal repercussions or employee disputes. Finally, organized and meticulous records can help organizations prepare for audits when or if they arise.

The employer is in charge of maintaining accurate records and sending them to the IRS, but employees also have their fair share of payroll tax duties.

Employee responsibilities

If employees don’t provide accurate information, employers may get penalized or audited by the IRS. That’s why the onus is on employees to understand how payroll tax works so they can provide up-to-date information and ensure deductions are correct.

Payroll deductions fall into four categories: pretax, post-tax, voluntary, and mandatory. As you’ll see below, there’s some overlap:

• Pre-tax deductions: Medical and dental benefits and 401(k) retirement
• Mandatory deductions: FICA taxes, Federal and state income tax, and wage garnishments
• Post-tax deductions: Garnishments, Roth IRA retirement plans, and charity donations
• Voluntary deductions: supplementary health insurance, job-related expenses, and retirement plans

Knowing these categories can help employees understand where their money is going and identify or correct errors regarding tax withholding or payment.

An easy way for employees to check pay stub accuracy is by following a checklist like the one below:

• Check the pay period: Review the pay period and see if the pay amount makes sense for the time worked.
• Review hours worked: This is for hourly or part-time workers. Make sure the pay reflects the hours worked.
• Check the gross pay: Gross pay is the money earned before applying deductions and withholdings.
• Scan the year to date: Year to date (or YTD) is the total amount of money earned during a calendar year.
• Go through the deductions: Deductions cover taxes, insurance, FICA tax, Medicare, and so forth. Employees’ share is 6.2% for Social Security and 1.45% for Medicare. State taxes will vary.
• Review net income: This is the total amount of money earned after taxes. Salaried workers should expect around the same figure each paycheck.

Both employers and employees are responsible for ensuring accurate payroll taxes, though the former may face harsher penalties inaccurate information or missing deadlines.

The consequences of non-compliance

Generally speaking, compliance with payroll regulations means any of the following:

Calculating wages accurately (this includes overtime)
Withholding the correct amount of payroll taxes (e.g., Social Security taxes)
Depositing 100% of the tax liability on or before the deposit due date
Filing payroll tax returns in each jurisdiction

Employers operating in multiple US states will need to apply each state’s compliance laws. Businesses charged with non-compliance will result in fines, audits, interest payments, litigation, and potentially, jail.
For instance, businesses that are more than 15 days late to deposit IRS payroll taxes could face a penalty worth 10% of the delinquent taxes. Non-compliance also increases litigation risks. For example in 2022, steelworkers in Alabama received $13.2 million for unpaid overtime.
Remaining up-to-date on compliance laws helps ensure employers can avoid costly repercussions that could damage their bottom line and reputation.

2024 changes in payroll tax laws

The Social Security Administration annually sets a maximum limit on the percentage of employee wages that goes towards Social Security tax. This changes annually. In 2024, the maximum wage amount subject to Social Security tax is $147,000.
While the payroll tax rate has stayed the same since 1990, the maximum amount of income that can be taken out changes each year. The FICA tax rate is 15.3%, but the wage base for state and federal taxes can change year to year.

A new partner in understanding payroll tax

Every employer operating in the US pays payroll taxes on behalf of their employee. Navigating the world of payroll tax, however, only grows more complicated as the business grows. For many organizations, enlisting an internal task force to stay up-to-date with payroll tax regulations isn’t feasible. Papaya Global’s payroll software provides payroll compliance experts to help companies stay on top of tax legislation while growing the business. From compliance to global payments, we’ve got you covered.
Try a demo today.