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The Complete Guide to Payroll Tax

Disclosure: This content is reader-supported, which means if you click on some of our links that we may earn a commission.

Payroll taxes are a blanket term that includes all taxes paid on employees’ wages—from Federal Insurance Contribution Act (FICA) to self-employment taxes. As soon as you hire your first employee, you become responsible for deducting part of their wages to pay specific taxes on their behalf.

But payroll taxes can be confusing. 

Many business owners have no clue how payroll tax works, resulting in non-compliance and hefty penalties. Compliance is extremely important, so we’ve created this guide to help you understand payroll taxes—what they are, how they work, and how to file them.

Why Payroll Taxes Are So Important

First and foremost, payroll taxes are imposed by the federal, state, and local governments and account for 23.05% of their total revenue

This makes it the second-largest source of government revenue, and hence, a critical component of America’s taxation system. The government uses the money from the taxes to fund various activities and ensure the well-being of the citizens.

For instance, the portion of FICA taxes that are dedicated to Social Security is used to fund the Old-Age and Survivors Insurance and Disability Insurance (OASDI) program. Under this, retirees, people with disabilities, and their families receive a monthly income to sustain themselves. For context, payroll taxes are the primary funding source for these programs, accounting for 88% of all inflows into the funds in 2019.

Also, the money from payroll taxes helps keep social insurance programs like Social Security and Medicare afloat, Ensuring these programs continue providing benefits to those who need them.

Quick Tips to Improve Payroll Taxes Today

Below, we’ll discuss a few easy tips to help you successfully pay payroll taxes. Let’s take a look.

Understand What Works Best for You

You can manage employee payroll taxes and ensure compliance in many ways—by yourself, hiring a tax professional, getting a payroll service. You have to figure out which method works best for you

  • Do your taxes by yourself. You take on the responsibility of completing taxes for your employees yourself. You have to manually go through every employees’ W-4 tax form and calculate allowances. Then you’ll refer to income tables and do some basic maths to calculate the right amount of tax money after considering state and federal payroll tax withholdings. If you have three or fewer employees, this could work and not take up too much time.
  • Enlist the services of a tax professional. Tax professionals have what many business owners don’t: expertise and experience. They can guide you through each step of calculating and filing your payroll taxes. Not only can this be more convenient for you, but it also reduces the possibility of any errors. Hiring a tax professional is more expensive than doing your own taxes, though.
  • Get a payroll service. Payroll services are third-party payroll processing companies that completely take over payroll processing and tax compliance. Signing up with a payroll service will automate an otherwise manual process of calculating and filing your taxes. We’ll discuss this in more detail in our next point.

Automate Payroll Taxes

Calculating payroll tax manually can be cumbersome and is prone to errors. 

Moreover, if you calculate, pay, and file your payroll taxes wrong, you can get into a lot of trouble. The IRS or state agencies may impose hefty fines or penalties if they find you guilty of underpaying taxes. Or you might get in trouble with labor compliance if you take too much money from employee paychecks for taxes.

Luckily, you can use an online payroll solution to automatically calculate your payroll taxes on your behalf.

While there are many options on the market, we highly recommend Gusto. It can automatically calculate as well as file your payroll taxes with the necessary agencies. 

After the initial setup, you can put payroll on autopilot, which will take away the responsibility of calculating and filing taxes from your shoulders. Plus, Gusto is also very secure, user-friendly, and can run your payroll in a few minutes. 

Gusto has four pricing options:

  • Contractor Only: $0 per month + $6 per contractor per month
  • Core: $39 per month + $6 per employee per month
  • Complete: $39 per month + $12 per employee per month
  • Concierge: $149 per month + $12 per employee per month

If you have not hired full-time permanent employees, you may only need the Contractor plan. The Core plan includes the full-service payroll options, health benefits administration, employee self-service, integrations, and benefits. Complete has all of that, plus next-day direct deposit, time and project tracking, paid time off management, hiring and onboarding tools, and more. As their highest-level plan, Concierge has all the other plans’ features and includes certified HR pros to assist you, an HR resource center, compliance alerts, and top-tier support.

Gusto is a top contender in the payroll industry and tops our list of the best payroll software. Other top contenders include OnPay and ADP. Check out our buying guide and reviews of the seven best payroll options to find the one that works best for your business. If you only want online payroll options, we have you covered there, too!

Stay Up-to-Date With the Latest Payroll Tax Rates

You should know the latest payroll tax rates, regardless of whether you do your taxes by yourself, hire a tax professional, or use an online payroll solution.

The best way to know the ongoing payroll tax rate is IRS’s Publication 15 (Circular E) – The Employer’s Tax Guide. This guide is updated annually, so you’ll always have access to the latest withholding tables and tax rates to calculate your federal income tax, FUTA, and FICA.

Here are the rates for the ongoing fiscal year:

  • The employer and employee each contribute 6.2% for Social Security. Therefore, the total is 12.4% to a maximum taxable earnings amount of $137,700.
  • The employer and the employee each contribute 1.45% for Medicare, making the total 2.9%. However, there are some rules: employees who earn more than $200,000 have to pay an additional 0.9%. Employers will not be responsible for contributing any extra amount for such employees. 
  • FUTA is set at 6%, with maximum taxable earnings of $7,000. But if an employee pays their SUTA tax on time, they can receive up to a 5.4% reduction. This drastically reduces the FUTA tax rate to 0.6%.
  • Local taxes are also applicable. As these taxes are unique to each locality, you’ll have to determine how much tax you must pay by contacting the local authorities.
  • State income tax and SUTA rates are state-specific. 

If this seems overwhelming, don’t worry.

The IRS and other tax authorities will give you statements showing which rates apply to your business and what payment and reporting schedules you need to follow when registering your business.

Know Your Payroll Tax Payment Deadlines

Depending on your business, you’ll have to deposit tax payments to the IRS monthly or semi-weekly. You may also have to file quarterly tax returns and other required documentation as per IRS deadlines.

Although state tax payment deadlines usually follow the IRS’s schedule, you should still double-check with your state’s authorities to be sure. You really don’t want to miss any deadlines in this case.

If you are doing your own tax calculations, make sure to put a reminder on your calendar for deadlines. If you hire tax professionals, they will take care of meeting deadlines. And if you are using payroll software, it will typically have reminders set for you or do it automatically.

Avoid Common Payroll Tax Mistakes

Filing taxes is a serious job, and there is no room for mistakes. It’s why you should be careful and double-check to avoid making common mistakes when calculating and filing your taxes. Here are two issues you may run into:

  • Misclassifying your employees. You can have full-time or part-time employees, as well as contractors and freelancers. But when it comes to taxes, employees are treated differently than contractors and freelancers. If you misclassify them, you risk becoming liable for all the back taxes.
  • Error in your EIN. EIN stands for Employee Identification Number and is a nine-digit number issued by the IRS to identify your business for tax purposes. Even a small typo in your EIN can be disastrous. EINs are temporary when issued during the application process. This can be an issue if you’re filing taxes in a state that requires a permanent EIN. Want to learn more? See our 3 Easy Steps to Get an EIN article to know how to file for an EIN.

Long-Term Strategies for Payroll Tax

The best ways to avoid making any errors when calculating and filing payroll taxes are by understanding how the process works, your responsibilities, and teaching your employees what to expect. Here is a deeper look into those longer-term strategies to help you succeed:

Understand How Payroll Taxes Work

Employees and employers pay payroll taxes on the gross pay every employee receives. So if an employee receives $1000 and the payroll tax is 10%, their net income will reduce to $900 after deducting the tax.

Each employee can see their individual payroll deductions on their paystubs, which also shows them the number of hours worked and the hourly rate. Employee paystubs should also cover other critical information regarding each deduction, including Social Security, Medicare, and federal, state, and local income taxes.

The employer then deducts non-tax items from each employee’s paycheck. This can include medical insurance, 401(k) contributions, and other employee benefits.

Finally, after making all the necessary deductions, the employee receives their paycheck that contains the net amount.

Note: The government usually bases payroll taxes on the gross amount earned by an employee. But most payroll taxes don’t make any adjustments for deductions. The employer’s payroll taxes don’t appear on the employees’ paychecks, too, depending on the size of the employee’s paycheck.

Know Your Payroll Responsibilities

As an employer, you’ll have various payroll responsibilities. These include:

  • Knowing your income tax withholding and other employment taxes.
  • Depositing all employment taxes as per a fixed deposit schedule. There is an exception for very small employers, though.
  • Preparing quarterly reports about your employment taxes that covers income tax withholding and FICA.
  • Sending annual reports regarding employee tax payments to employees and the Social Security Administration.
  • Staying on top of your annual FUTA reporting and state-level reporting.

You may also have to withhold amounts from your employees’ paychecks, such as garnishment to cover child support or salary elective deferral amounts. Remember, these deductions do not come into employment taxes. 

Educate Your Employees About Payroll Taxes

Employees are often surprised to see a paycheck lower than what they expected, especially first-time employees.

Those new to the workforce may not know their take-home pay will always be lower than their hourly wages or salary. While the employees are required to fill out a Form W-4 Employee’s Withholding Certificate, the terminology on the form can be confusing for them.

As the employer, it’s your job to educate them about how payroll taxes work to avoid bottlenecks and eliminate confusion.

Create a simple document explaining payroll taxes, including the amount of taxes you’ll be withholding from each paycheck. Be sure the supplemental information you provide employees is in plain English and easy to understand. 

The idea here is to answer all questions they might have regarding their paychecks.

Next Steps

After payroll comes ensuring compliance.

As mentioned, we highly recommend you get a modern online payroll solution to automate your payroll taxes and comply with all applicable laws and rules, and regulations. Gusto is our #1 recommendation, but you can also consider other options by referring to our best payroll software guide.

You can also check out our other payroll-related articles here:


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