Payroll Tax: What It Is, How to Calculate It

Highlights

• There are two types of payroll taxes: the tax that you deduct from employee wages and remit to the government, and the tax that you pay on your employees out of your own revenue
• Payroll taxes that you pay out of your revenue are FICA (Social Security, Medicare) and FUTA (unemployment insurance).
• Payroll taxes that you withhold from employees are federal income tax and state and local taxes.
• Payroll tax payments must be made electronically via the Electronic Federal Tax Payment System (EFTPS).

Summary of payroll taxes

Since your business and your employee are both taxpayers, there are two types of payroll taxes: ones that come out of your own pocket and ones that you collect from employee paychecks and remit to the federal government.

Payroll taxes that come out of your pocket:

• FICA tax: contributions to Social Security and healthcare programs (Medicare). This cost is shared by employer and employee. The employer portion is 6.2% for Social Security and 1.45% for Medicare, and you’ll collect and remit the same amount from your employees.
• FUTA tax: contributions to unemployment insurance. The total amount is 6.0%. However, most states have a 5.4% credit, meaning most employers only pay 0.6%.

We’ll cover both of these in more detail later on.

Payroll taxes that you collect and remit:

• Federal income taxes
• State and local taxes

We’ll cover each of these in detail, beginning with federal income tax withholding.

State and local payroll tax

Employers are also responsible for paying state and local (city, county, etc.) payroll tax on behalf of employees.

As with federal payroll tax, part of this tax is employer-paid, and part is employee-paid. Keep in mind that “employee-paid” just means that you, the employer, withhold a certain amount from your employee’s paycheck and then remit it as part of your payroll taxes.

In addition to state payroll tax (State Unemployment Tax, or SUTA), employers are also responsible for remitting state income tax on behalf of their employees.

State and local payroll taxes are governed at the state and local levels, and payroll tax rates and rules vary by jurisdiction. To find out more about payroll tax in your state and local area, check out the Federation of Tax Administrators’ list of each state’s taxing authority.

How to make payroll tax payments

Calculating your payroll taxes is the hard part—actually making the payments is easy.

You just enroll in the Electronic Federal Tax Payment System (EFTPS), then make your payment online. It’s the only way to make a payroll tax payment (mailing checks isn’t allowed).

You can access EFTPS here.

What is the percentage of federal income tax withheld?

As an employer, you withhold income tax on behalf of your employees and then remit those taxes quarterly to federal, state, and local tax authorities.

To calculate how much of your employee’s federal income tax to withhold, you’ll need a copy of their Form W-4, as well as your employee’s gross pay.

Your next step is to determine the method you want to use to calculate withholding. Most employers have two options: the Wage Bracket Method or the Percentage Method. While not exactly simple, the wage bracket method is the more straightforward approach to calculating payroll tax.

How to calculate federal income tax withholding using the Wage Bracket Method

When using the Wage Bracket Method, there are two possible calculations: one for employees with a Form W-4 from 2019 or earlier, the other for employees with a Form W-4 from 2020 or later.

Employees with a Form W-4 from 2019 or earlier:

1. In IRS Publication 15-T, find the worksheet marked “Wage Bracket Method Tables for Manual Payroll Systems With Forms W-4 From 2019 or Earlier.”
2. Check Form W-4 to determine whether the employee files income tax as married or single and the number of allowances they claim.
3. Enter the employee’s total taxable wages for the payroll period on line 1a. This includes any earnings an employee pays taxes on, including salaries and cash tips.
4. Use the amount on line 1a to look up the Tentative Withholding Amount. Find the table that corresponds to your payroll period (daily, weekly, biweekly, monthly, or annually) and the marital status of the employee (e.g., biweekly and single if you run payroll twice a month and you’re calculating the tax for an unmarried employee)
5. Find the wage amount on the left side of the table. Once you’ve identified the row, use the number of allowances the employee has reported on Form W-4 to locate the corresponding column. The cell where these two meet will give you the tentative withholding amount for this employee.
6. Take the tentative withholding amount from this table and input it on line 1b.
7. On line 2a, enter any additional amount to be withheld as reported on Form W-4
8. 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 or later:

1. In IRS Publication 15-T, find the worksheet marked “Wage Bracket Method Tables for Manual Payroll Systems With Forms W-4 From 2020 or Later.”
2. Check Form W-4 to determine whether the employee files income tax as married or single and the number of allowances they claim.
3. Enter the employee’s total taxable wages for the payroll period on line 1a. This includes any earnings an employee pays taxes on, including salaries and cash tips.
4. On line 1b, record the number of pay periods you have per year using Table 5 on the same page.
5. On line 1c, enter the other income amount found on Step 4a of the employee’s Form W-4. Divide this amount by the number of pay periods recorded on line 1c and write the amount down on line 1d.
6. Add up lines 1a and 1d and record the amount on line 1e. This is the employee’s total earnings from all income sources prior to any deductions the employee is eligible for.
7. On line 1f, enter the employee’s deductions amount as found on Step 4b of their Form W-4. Divide this amount by the number of pay periods and enter that amount on line 1g.
8. Subtract line 1g from line 1e, and you’ll get the Adjusted Wage Amount on line 1h. If the amount is 0 or less, enter 0.
9. Find the Tentative Withholding Amount by using the table that corresponds to your payroll period (daily, weekly, biweekly, monthly, or annually) and the marital status of the employee (e.g., biweekly and single if you run payroll twice a month and you’re calculating the tax for an unmarried employee).
10. If the employee has applicable tax credits on Step 3 of their Form W-4, use lines 3a to c to determine how much applies to this pay period. Otherwise, record the amount from 2a on line 3c.
11. Finally, enter any additional amount to withhold from Step 4c of Form W-4 on line 4a. Adding this amount to line 3c gives you the amount to withhold from the employee’s wages, which you’ll record on line 4b.

The Percentage Method is much more complicated—not recommended if you’re doing this alone. If you want to learn more about the Percentage Method, you can read all about it and the wage bracket methods in IRS Publication 15-T.

Once you’ve figured out how much income tax to withhold from your employees’ paychecks, your next step is to figure out how much FICA to withhold (more on that below), and how much you’ll be required to pay on their behalf.

Calculating FICA

FICA stands for “Federal Insurance Contributions Act.” It’s a mandatory payroll tax deduction used to pay for programs like Social Security (disability insurance, old age, survivors) and Medicare (covering health insurance for folks over 65).

When it comes to funding FICA, your employee pays 50% from their paycheck while you, the employer, pay 50% out of your own revenue. As the employer, you are required to withhold and pay the amount your employee is responsible for from their paycheck, and remit those funds on their behalf.

Current FICA tax rates

The current tax rate for social security is 6.2% for the employer and 6.2% for the employee, or 12.4% total. The current rate for Medicare is 1.45% for the employer and 1.45% for the employee, or 2.9% total.

Combined, the FICA tax rate is 15.3% of the employee’s wages.

Do any of your employees make over $147,700? If so, the rules are a little different, and they may owe additional Medicare tax. Read more at the IRS.gov website.

How to calculate FICA payroll tax

Social Security withholding

To calculate Social Security withholding, multiply your employee’s gross pay for the current pay period by the current Social Security tax rate (6.2%).

This is the amount you will deduct from your employee’s paycheck and remit along with your payroll taxes.

Example Social Security withholding calculation:

$5,000 (employee’s gross pay for the current pay period) x .062 (current Social Security tax rate) = $310 (Social Security tax to be deducted from employee’s paycheck)

Further reading: Social Security Tax: What Employers Need to Know

Medicare withholding

To calculate Medicare withholding, multiply your employee’s gross pay by the current Medicare tax rate (1.45%).

Example Medicare withholding calculation:

$5,000 (employee’s gross pay for the current pay period) x .0145 (current Medicare tax rate) = $72.50 (Medicare tax to be deducted from employee’s paycheck

Employer matching

As an employer, you are responsible for matching what your employees pay in FICA taxes. In this case, you would also remit $310 for Social Security tax and $72.50 for Medicare tax.

Calculating FUTA

FUTA stands for Federal Unemployment Tax Act. It’s an employer-paid payroll tax that pays for 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 actually pay 0.6% since each state receives a credit to cover the remaining 5.4% of FUTA payments.

Unfortunately, some states are currently ineligible for the full credit. You can learn more in our guide to FUTA.

FICA vs. FUTA

While FICA is a payroll tax that contributes toward Social Security and Medicare, FUTA (Federal Unemployment Tax Act) is an employer-paid payroll tax that funds state workforce agencies and unemployment insurance.

They also require different tax forms.

You’ll report FUTA on Form 940 - Employer’s Annual Federal Unemployment Tax Return at the end of the financial year. The due date is January 31.

You’ll report FICA quarterly using Form 941 - Employer’s Quarterly Federal Tax Return. The due date is the last day of the month following the quarter. For example, if your quarter ends on March 31, the form is due on April 30.

How to calculate payroll tax if you are self-employed

If you run a small business without any employees, you’ll still have to remit payroll taxes—for yourself. This is called self-employment tax and is effectively Medicare plus Social Security for yourself (which amounts to 15.3% of your net business income). Learn more in our guide to self-employment taxes.

You can outsource payroll tax

Payroll tax is complex. The calculations are nitpicky, and the penalties are steep. Even paying payroll taxes just a day late comes with a 2% penalty on the amount due, with that penalty rising as high as 15% for past due payroll taxes.

That’s why it often makes sense to outsource your payroll to a company like Gusto. Gusto is a popular payroll company that can handle everything from paying your employees the right amount at the right time to handling withholding calculations and payroll taxes. When you need to check your records, you’ll have automatically generated pay stubs to review with all the essential information.

And when it’s time to record payroll costs on your books, Bench can take care of that for you. Learn more about how we save small business owners hours of admin every month.