Payroll tax refers to the taxes that employers and employees each pay based on employee wages. In the United States, payroll taxes fund two federal programs: Social Security and Medicare. These are collected through a system called FICA (Federal Insurance Contributions Act). Payroll tax is separate from income tax: employees pay both, and employers are required to match a portion of the employee’s contribution and remit everything to the IRS on a regular schedule.
For business owners who hire employees, understanding payroll tax is not optional. Getting it wrong: depositing late, miscalculating amounts, or misclassifying workers: can result in significant penalties and interest.
How Payroll Tax Works
FICA Taxes
FICA is split into two components:
- Social Security tax: 12.4% total, split evenly between employer and employee (6.2% each). Applied to wages up to the annual wage base limit ($168,600 in 2024).
- Medicare tax: 2.9% total, split evenly (1.45% each). No wage cap. Employees earning over $200,000 pay an additional 0.9% Additional Medicare Tax, which the employer does not match.
As an employer, you are responsible for withholding the employee’s share from their paycheck and contributing your own matching share. You then deposit both the employee and employer portions to the IRS.
Federal Income Tax Withholding
Employers also withhold federal income tax from employee paychecks based on each employee’s W-4 form. This isn’t technically “payroll tax” in the FICA sense, but it is collected and remitted alongside payroll taxes in the same deposit.
FUTA (Federal Unemployment Tax)
Employers pay FUTA at 6% on the first $7,000 of each employee’s wages per year, though most states allow a credit that reduces this to 0.6%. FUTA funds unemployment insurance and is an employer-only cost: employees do not pay it.
State Payroll Taxes
Most states also have state income tax withholding and state unemployment insurance (SUTA) requirements. Rates and rules vary significantly by state.
Payroll Tax Deposit Schedule
The IRS assigns employers a deposit schedule based on their total payroll tax liability in a lookback period. Most small businesses fall into the monthly deposit schedule, meaning payroll taxes must be deposited by the 15th of the following month. Larger employers with higher payroll may be on a semi-weekly schedule. Deposits are made through the IRS’s Electronic Federal Tax Payment System (EFTPS).
Missing a deposit deadline triggers a failure-to-deposit penalty ranging from 2% to 15% depending on how late the deposit is. These penalties add up quickly and are one of the most common tax problems small business owners face when they start hiring.
A Real-World Example
A small retail store pays an employee $4,000 per month. The employer withholds $248 for the employee’s Social Security (6.2%) and $58 for Medicare (1.45%), totaling $306 withheld from the employee’s check. The employer also matches $248 + $58 = $306 from the company’s own funds. Total payroll tax deposit for this one employee: $612 per month. Multiply that across five employees with varying wages, add federal income tax withholding, and it’s easy to see why payroll administration requires careful systems.
Managing payroll tax accurately connects to broader financial health. Keeping finance in balance and avoiding common mistakes during growth both depend on having payroll under control before you scale your team.
Key Takeaways
- Payroll tax includes FICA (Social Security and Medicare), federal income tax withholding, and FUTA. Most employers also owe state payroll taxes.
- Employers match the employee’s FICA contribution, making payroll taxes a significant cost beyond just the gross wage.
- Missing IRS deposit deadlines triggers penalties of 2-15%. Set up EFTPS and use payroll software or a payroll service from the moment you hire your first employee.
The IRS provides detailed guidance on deposit schedules, rates, and employer obligations in Publication 15 (Employer’s Tax Guide) and the Employment Tax overview on IRS.gov.
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