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Small business owners have a lot to keep track of, and payroll taxes are critical. Fortunately, Square Payroll may help ease this process by calculating and depositing your payroll taxes and filing the appropriate tax forms with federal and state agencies.
To ensure your payroll complies with federal and state payroll regulations, keep reading to learn more about how payroll taxes work and for additional resources to calculate an employee’s paycheck.
What are payroll taxes?
The federal government levies payroll taxes on earned wages and uses most of the revenue to fund Social Security and Medicare, known as FICA (Federal Insurance Contributions Act) taxes. The terms employment taxes and payroll taxes overlap but are not interchangeable in all cases. While processing and reporting on payroll involves multiple types of employment taxes, only Social Security and Medicare are officially considered payroll taxes. This terminology is used specifically on Form 941. Both employers and employees contribute to federal payroll taxes.
Federal income taxes, pay for government services, including defense and social services. State income taxes fund a variety of state programs, potentially including education, health care, transportation, state police, and parks.
Types of payroll taxes
Employee-paid taxes usually consist of:
- Federal income tax
- State income tax
- Social Security
- Medicare
Employer-paid taxes typically consist of:
- Federal unemployment tax
- State unemployment tax
- Social Security
- Medicare
The amounts of these payroll taxes and what they pay for are highlighted in the table below.
| Employer Pays | Employee Pays | Total | Cap? | What They Pay For | |
|---|---|---|---|---|---|
| Social Security | 6.2% | 6.2% | 12.4% | $168,600 | Per dollar, 85 cents goes to a trust fund that pays monthly benefits to current retirees and their families and to surviving spouses and children of workers who have died. The other 15 cents goes to a trust fund that pays benefits to people with disabilities and their families. |
| Medicare | 1.45% | 1.45% | 2.9% | No Limit^ | This tax goes to a trust fund that pays for some of the costs of hospital and related care for all Medicare beneficiaries. |
| State Unemployment | Variable | None^^ | Variable | Variable | This tax, paid to state workforce agencies, is typically used to pay unemployment benefits to state workers. State law determines individual state unemployment insurance tax rates. |
| Federal Unemployment | 6.0%^^^ | None | 6.0% | $7,000 | Unemployment tax, paid for by employers, covers the costs of administering unemployment insurance and job service programs in all states. |
^ Additional Medicare taxes apply to individual earners with an income over $200,000 or married households earning more than $250,000. The additional tax is 0.9%.
^^ Some states may require or allow employers to withhold a portion of state UI taxes from employee wages.
^^^ Employers can take a credit of up to 5.4% related to federal unemployment taxes of taxable income if they pay state unemployment taxes. This credit is lower in Credit Reduction States, where the state has not repaid money it borrowed from the federal government to pay unemployment benefits. Some types of organizations may be exempt from contributions to FUTA.
How to calculate payroll tax
The employment taxes withheld from an employee’s paycheck generally consist of federal income tax and FICA taxes (Social Security and Medicare). If you are located in a state with state income tax withholding, you will need to withhold state income tax as well. Employers should also note that some local jurisdictions may impose specific income taxes as.
Social Security is calculated at 6.2% of gross pay and is capped once the employee earns $168,600 in 2024. This means the maximum Social Security tax you will pay in one year is $10,453.20. Social Security taxes are matched by the employer, for a total of 12.4%.
Medicare has no cap and is calculated at 1.45% of an employee’s gross pay. The employer matches Medicare tax for a total of 2.9%. If an employee earns more than $200,000 in a single year, employers must withhold an additional 0.9%. This 0.9% is only paid by the employee and not the employer.
Federal and state income tax withholdings are a bit more complex and paid by the employee, not the employer. Federal income tax is determined by Form W-4, where filing status and number of exemptions are declared. Employers must calculate taxes according to IRS Publication 15-T. Note that this tax table is updated annually by the IRS.
For state income tax withholding, each state produces a similar table annually. For example, if your employees work in California, you can follow the directions on the California withholding schedule to determine how much state income tax to withhold from your employee’s paycheck.
Payroll tax penalties
Payroll taxes are due to the government on a specific schedule, depending on the size of your business. When taxes are not paid, paid late, or paid but don’t follow the correct guidelines, employers can face severe penalties and accrue interest.
By hiring a payroll service, you won’t need to worry about submission guidelines, payment accuracy , or paying your payroll taxes on time. It will be taken care of for you.
The three components that make up a correct deposit are: (1) a timely deposit , (2) the deposit is in the correct amount, and (3) the deposit is made in the correct manner. Failure to comply with any of these components will subject the deposit to the Failure to Deposit (FTD) penalty. The percentage rate charged depends on the number of calendar days a deposit is late or whether there is a direct payment.
Per IRC 6656(b)(1), there is a time-sensitive penalty system for late deposits. The penalty rate assessed depends on the number of calendar days a deposit is late, starting from the due date of the deposit. For liability amounts not properly or timely deposited, the penalty rates are as follows:
- 2% of unpaid deposit for deposits 15 days late
- 5% of unpaid deposit for deposits 6–15 days late
- 10% of unpaid deposit for deposits made more than 15 days late
- 10% of unpaid deposit for required deposits not paid by electronic funds transfer (EFT) for employers required to do so
- 15% of unpaid deposit for all amounts still unpaid more than 10 days after the date of the first notice requesting payment of the tax due, or the day on which the taxpayer received notice and demand for immediate payment, whichever is earlier.
Learn more about penalties and common payroll mistakes.
Payroll taxes don’t have to be a headache.
Calculating payroll taxes by hand is a huge chore, which is why savvy businesses use a service to handle payroll and all required taxes. Square Payroll is an all-in-one solution that includes calculations, withholdings, and all related paperwork. With Square Payroll, you can save time and focus on what matters most: running your business.
There’s a lot you should be aware of when it comes to payroll taxes. The IRS provides guidance online, but here are some frequently asked questions.
1. How can I pay payroll taxes online?
After collecting federal withholding tax from employees, an employer can pay them online using the Electronic Federal Tax Payment System (EFTPS). The process of submitting payroll tax by state depends on the state agency, and all have their own electronic or manual methods for filing.
Whether you’re paying payroll taxes in Texas or New York, you must submit your federal tax filings to the IRS, state payroll tax filings to the related state agency, and Form W-2s to the Social Security Administration. The Form W-2 provides information that employees can use to accurately claim tax credits and check eligibility. They will also use their Form W-2 to complete and submit their tax return.
2. What are payroll tax rates?
There are several common types of employment taxes you’ll notice on your pay stub: federal income tax, Social Security tax, Medicare tax, and a state income tax (note that not all states have an income tax; some states may levy additional taxes, and some employees might be excluded from certain taxes). Social Security and Medicare tax portions may also be referred to as payroll taxes per Form 941. Depending on where you live and work, local taxes may also apply.
The IRS, state, and local tax agencies publish annual tables to determine the amount of tax to be withheld from each paycheck. These amounts are dependent upon the employee’s gross wages, filing status, number of withholding allowances (exemptions), and pay frequency. Social Security and Medicare taxes, which together are called FICA taxes, have their own specific rates and thresholds.
For 2024, the Social Security tax rate is 6.2% on the first $168,600 of wages paid. The Medicare tax rate is 1.45% on the first $200,000 of wages. If you earn more than $200,000 per year as an individual or $250,000 when married filing jointly, you’ll have to pay an additional 0.9% for qualifying income above that threshold. Medicare has no threshold and is paid on the total earnings.
3. Which states do not have an income tax?
There are currently nine states in the U.S. that do not levy an income tax on wages:
- Alaska
- Florida
- Nevada
- New Hampshire
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
New Hampshire and Washington don’t tax wages, but they do tax other sources of income. In New Hampshire, dividends and interest income are taxed at 5% for tax periods prior to December 31, 2023, 4% for tax periods on or after December 31, 2023, 3% for tax periods ending on or after December 31, 2024, and then is phased out completely for tax periods after December 31, 2024. Washington taxes long-term capital gains on assets sold for a profit of $262,000 or more at 7% and siphons 58 cents per $100 from employees’ paychecks into the WA Cares Fund, the state’s long-term care program.
4. Which states have flat income tax?
A flat income tax means everyone is taxed at the same rate, regardless of their income level. So, in a state with a flat tax rate of 15%, a taxpayer earning $50,000 would pay 15% of their income in taxes ($7,500). A taxpayer earning $500,000 would also pay 15% of their income ($75,000).
If your business is in a state with a flat income tax rate, you should withhold state income tax at the uniform rate set by the state. Additionally, you are responsible for handling unemployment insurance and federal payroll taxes. There are twelve states with a flat income tax:
- Arizona
- Colorado
- Georgia
- Idaho
- Illinois
- Iowa (in process of phasing in a flat tax)
- Indiana (employers also need to manage county tax rates)
- Kentucky
- Michigan
- Mississippi
- North Carolina
- Pennsylvania (local tax considerations may also apply)
- Utah
5. Which states have progressive income tax?
A progressive income tax means the tax rate increases as taxable income increases. Lower-income earners get a lower tax rate, and higher-income earners get a higher tax rate.
In states with a progressive income tax system, it’s critical for employers to update withholding tables so they align with the various tax brackets and rates. Employers are also responsible for state unemployment tax and federal payroll taxes. The following states utilize a progressive income tax system , but employers must also check for any state-specific regulations that may affect payroll:
- Alabama
- Arkansas
- California
- Connecticut
- Delaware
- Hawaii
- Iowa (in process of phasing out a progressive tax)
- Kansas
- Louisiana
- Maine
- Maryland
- Massachusetts
- Minnesota
- Missouri
- Montana
- Nebraska
- New Jersey
- New Mexico
- New York
- North Dakota
- Ohio
- Oklahoma
- Oregon
- Rhode Island
- South Carolina
- Vermont
- Virginia
- Washington, D.C.
- West Virginia
- Wisconsin
Please note that this is only intended as an overview of how payroll taxes generally work. It is not tax or legal advice that you can rely upon for your business. For guidance or advice specific to your business, you should consult with a tax or legal professional.
