Payroll taxes: A small business employer’s guide

Consider this scenario – your business is up and running, and you’re thinking about the next step — growth and hiring employees. While finding the right talent for your team is important, you’ll also need to figure out payroll and how to handle payroll taxes. Of course, there’s more to payroll than just cutting a check – it can be a time-consuming and involved task.

In this post we’ll answer, “what are payroll taxes?” and “how are payroll taxes calculated?” so you have a better understanding of these concepts as you grow your business (with your new helping hands).

What are payroll taxes?

Payroll taxes are based on salaries, wages, and tips. Payroll tax is withheld from an employee’s compensation by an employer, who also pays in on the employee’s behalf. Federal payroll taxes are taken out of an employee’s pay and sent to the IRS.

What do payroll taxes fund? Essentially, it’s for Social Security Administration programs like Medicare and Social Security. These taxes are also called Federal Insurance Contributions Act taxes or FICA taxes. An employee will see payroll taxes as these line items on their paystubs:

  • Social Security tax (sometimes abbreviated as OASDI) and
  • Medicare tax (sometimes abbreviated as Med or MedFICA)

Both deductions fund federal social programs — Social Security tax provides retirement and disability benefits. Medicare tax provides medical benefits to people age 65 or older, certain younger people with disabilities, and certain people with permanent kidney failure.

What else should you know?

  • Employers also pay unemployment tax for each employee.
  • States, counties, and cities could impose additional income taxes, withdrawn (and reported) on an employee’s paycheck.

How much is payroll tax

Employers are responsible for withholding payroll taxes from employees’ pay. The withholding consists of federal income tax, the employee’s share of FICA (social security and Medicare tax), and possibly state and local taxes. Payroll tax rates for federal and state income tax withholding depend on the employee’s pay, pay frequency, and W-4 information. The payroll tax rate for the employee’s share of FICA is generally 7.65%.

Payroll tax rate details

Employers are also responsible for remitting the withheld payroll taxes, along with the employer’s share of FICA (also generally at 7.65%) and federal and state unemployment taxes (generally totaling 6%), to the IRS and state taxing authorities. Together, these taxes are referred to as employment taxes.

Want to calculate payroll yourself – or get help?

While employees may not research what each line item on a paystub means, small business owners should take the time to understand them. If you have any W-2 employees, you need to make sure payroll taxes are calculated on their compensation.

If adding payroll to your list of duties feels daunting and cumbersome, consider Block Advisors small business payroll services. We can help you stay compliant and get your employees paid on time.

You can also consider managing it on your own with Wave accounting software for small businesses. Either way, you’ll get support and save time so you can get back to what you love.

How are payroll taxes calculated

Small business employers can calculate payroll tax by using two figures: an employee’s total wages and various deductions. When you subtract the two, you arrive at an employee’s net pay.

Here are the steps you’d take to calculate payroll taxes:

  1. Determine an employee’s wages subject to payroll taxes. This generally includes all pay given to an employee, in cash and other forms, and includes taxable fringe benefits. (Note: Health benefits paid on behalf of an employee are usually exempt from payroll taxes unless paid to an S corporation employee who is at least a 2% shareholder.)
  2. Calculate Social Security and Medicare taxes. These are also known as FICA taxes. Find details on the FICA tax rate and calculation.  
  3. Determine an employee’s wages subject to federal income tax (FIT) and calculate your FIT withholding amount. You’ll need to use the employee’s W-4 information. To make sure you’re withholding correctly, you should look up rates with the state and IRS as they can vary. Get additional details on FIT taxes.  
  4. Subtract taxes (the employee share of FICA and FIT) and other deductions (such as employee health plan coverage, retirement plan contributions, etc.) from employees’ gross income to arrive at net pay.

What else do employers need to do?

The calculation above helps you complete payroll as it relates to your employees’ paychecks. But there are a few more duties on your plate. At various points in the year, you’ll need to:

Calculate Federal Unemployment Tax Act (FUTA) withholding each pay period. Only you, as the employer, will pay FUTA.  The FUTA wage base is $7,000 per employee per year. The FUTA tax rate is 6.0% but employers may be able to take a credit of up to 5.4% against the FUTA tax (for a net payment of .6%) for payments made to state unemployment funds.

Deposit FUTA quarterly. Check your state for the applicable state unemployment taxes.

Remit taxes to state and federal authorities. Federal payroll taxes (FICA and FIT) can be paid online through the  Electronic Federal Tax Payment System (EFTPS) system on a monthly basis (other payment timeframes may apply depending on your situation). An employer will set up an account using the employer’s Employer Identification Number (EIN).

File a quarterly tax return (Form 941). This form reports total wages paid during the quarter, any amounts withheld during the quarter, and calculates the Social Security and Medicare tax on the wages of the employees. File quarterly and year-end payroll tax forms with the IRS and your state and local taxation agencies. (Note: Very small employers whose total FICA and federal income tax withholding is $1,000 or less can file Form 944, Employers Annual Federal Tax return and avoid Form 941 quarterly filings.)

File an annual FUTA return (Form 940). In January, you will file Form 940 to report federal unemployment insurance on your employee’s wages for the year.

Send W-2 forms annually. You’ll need to send W-2 forms for your employees each year by January 31 – this is an information return for them to file with their income tax return. You’ll also file copies with the Social Security Administration.

Get help with calculating payroll taxes

As you can see, the do-it-yourself method for calculating payroll taxes is involved. It doesn’t have to be. Take the task to Block Advisors. We offer a suite of small business services – tax, bookkeeping, and payroll—so you can get back to what you love. With 2.5 million small business clients, you can count on us to guide you in these areas.

See how our professional payroll services can help answer your payroll questions.

Schedule a free payroll consultation today.


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