The day you hire your first employee, you become responsible for payroll tax. Despite the name, payroll tax is not a single tax, but a blanket term used to refer to all taxes paid on the wages of employees.
If you have employees, you are going to be responsible for both:
Deducting a portion of employee wages to pay certain taxes on their behalf
Paying payroll taxes on each of your employees out of your own revenue
This payroll tax goes to pay for both your employees’ income tax, and to fund social programs like Social Security and Medicare.
Employers are responsible for federal, state, and local income tax on behalf of employees.
Further reading: Payroll—What It Is and How to Do It
You can outsource payroll tax
Payroll tax is complex. The calculations are nitpicky and 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.
We highly recommend outsourcing your payroll to a company like Gusto. They’ll take the headache out of everything from paying your employees the right amount at the right time, to handling pesky withholding calculations and payroll taxes.
If you won’t be outsourcing payroll tax just yet, or if you’re just curious about how it’s calculated, read on.
Calculating federal W-4 withholding
As an employer, you withhold income tax on behalf of your employee and then remit those taxes quarterly to federal, state, and local tax authorities.
To calculate how much of your employee’s income to withhold, you’ll need a copy of their Form W-4, as well as the payroll period (ex: monthly, semi-monthly, weekly), and 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 and the percentage method. While not exactly simple, the wage bracket method is the more straightforward way to calculate payroll tax.
How to calculate payroll tax using the Wage Bracket Method
In IRS Publication 15-A, find the tables marked “Wage Bracket Percentage Method Tables.” Use the table corresponding to your employee’s pay period.
Check form W-4 to determine whether the employee files income tax as married or single.
Find the employee’s gross wage for the pay period in columns A and B. The wage should be over the amount found in column A but under the amount found in column B.
Subtract the amount found in Column C.
Multiply the result by the percentage found in Column D.
Check form W-4 to determine if the employee requests additional tax withheld from each paycheck. If they do, add that amount to the final number.
The end result is the amount you should withhold from the employee’s paycheck for that pay period.
Source: IRS Publication 15-A
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 both methods in IRS Publication 15-A.
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.
FICA stands for “Federal Insurance Contributions Act.” It’s a mandatory payroll tax deduction used to pay for programs like Social Security and Medicare.
When it comes to funding FICA, your employee pays half from their paycheck while you, the employer, pay half out of your own revenue. As the employer, you are required to withhold and pay the amount your employee is responsible for from her 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.
Do any of your employees make over $128,400? If so, the rules are a little different. Read more at the IRS 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)
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
As an employer, you are responsible for matching what your employees pay in FICA taxes. So in this case, you would also remit $310 for Social Security tax and $72.50 for Medicare tax.
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.
State and local payroll taxes are governed at the state and local level, and every state’s payroll tax rules are different. The Federation of Tax Administrators published a list of each state’s taxing authority. You can find out more about payroll tax in your state and local area there.