What Is Payroll Tax? A Breakdown for Business Owners

Two employees at a desk review paperwork together.

What is payroll tax? It’s money collected from employee wages and used to fund Social Security, Medicare, unemployment insurance, and other government programs. 

Since businesses are responsible for calculating, withholding, and remitting the tax to the government, navigating this process can be an administrative challenge.

In this article, we’ll explain the basics of the tax and how to do payroll yourself. If you’d like a professional pair of hands, indinero’s corporate payroll services are here to help.

Want to familiarize yourself with essential accounting terms and concepts for business owners? Download our accounting alphabet for entrepreneurs.

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What Are the Types of Payroll Taxes?

Since the IRS holds employers responsible for managing payroll tax, it’s important to understand the details. Here’s a breakdown of the different types of payroll taxes you may collect:

Social Security Tax

Social Security Tax, also known as FICA (Federal Insurance Contributions Act) tax, funds the Social Security Trust Fund.

One half is paid from employee wages, while employers contribute the other; self-employed entrepreneurs are responsible for both portions.

Medicare Tax

Medicare tax is another component of FICA; it supports the Medicare health insurance program. Just as with Social Security, employers and employees are each responsible for half, while the self-employed pay for both components.

Federal Unemployment Tax (FUTA)

This tax funds unemployment benefits for individuals out of work through no fault of their own. It is collected at the federal level but administered by the states.

State and Local Payroll Taxes

In addition to the above, businesses are subject to state and local payroll taxes. These vary by location and include income tax, disability, and unemployment insurance.

Federal Income Tax

This is the largest tax employers withhold from employees and is used to fund the federal government. The amount is determined by an individual’s salary, filing status, and allowances claimed on their W-4. Click here for a blank copy.

How Much Is Payroll Tax?

Since payroll tax is deducted from employee pay, it’s important not to make any mistakes. In fact, that’s one reason why companies outsource payroll and other bookkeeping tasks.

Here are the current payroll tax rates:

Social Security Tax

The Social Security tax rate is a flat 12.4% of wages up to a maximum threshold; the employee and employer are each responsible for half of this amount. Once an employee meets the limit, the government collects no more Social Security tax.

  • The 2023 maximum was $160,200
  • The 2024 maximum is $168,600

Medicare Tax

The Medicare tax rate is a flat 1.45% of all wages. Like Social Security, the employer and employee are each responsible for half.

Once an individual exceeds a certain income threshold, additional Medicare tax applies. Employees pay the entirety of this amount; there is no employer match. 

For 2024, withhold an additional 0.9% of all income above the following amounts:

  • $250,000 for married filing jointly
  • $125,000 for married filing separately
  • $200,000 for all other taxpayers

Federal Unemployment Tax (FUTA)

The 2024 FUTA tax rate is 6% of the first $7,000 of employee pay. It is paid for entirely by the employer and collected at the same time as other payroll taxes. 

Some states also levy unemployment tax (SUTA). These rates differ from state to state.

To avoid double taxation, businesses that pay SUTA are eligible for a credit that reduces their FUTA liability. The maximum deduction reduces the FUTA tax rate from 6% to 0.6%, but your rate may be smaller depending on where you’re located. Employers who pay SUTA in full and file form 940 by the January 31 due date are eligible for the maximum state-dependent deduction.

Since SUTA tax rates and FUTA credits differ from state to state, it’s worth checking your specific jurisdiction or consulting a professional for details.

Federal Income Tax

Strictly speaking, federal income tax isn’t a payroll tax; that term refers to Social Security, Medicare, unemployment, and other state and local taxes. 

However, you are responsible for withholding income tax from employee paychecks. The amount depends on the deductions indicated on their W-4. Use that information alongside the IRS tax withholding estimator to determine how much.

State and Local Payroll Taxes

State and local payroll taxes vary, with each jurisdiction imposing its own set of requirements; these are paid for by employees, employers, or both. 

In addition to state unemployment tax (SUTA), which is present in most places, you may be responsible for the following:

  • Disability Insurance
  • Public Utilities
  • City Income Tax
  • Public Transit 
  • State Income Tax
  • Occupation Specific Taxes
  • Property Tax
  • School District Tax
  • Workforce Development

Depending on eligibility criteria, you may be eligible for federal tax deductions corresponding to state and local taxes. 

Check with your local authority to learn what you’re responsible for. It’s also worthwhile to consult a business tax service specialist to confirm that you’ve accounted for everything.

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How to Do Payroll Yourself 

Doing payroll manually can be tedious and time-consuming, so we don’t recommend doing it on your own. If you can’t afford a bookkeeper or accountant, entrepreneurs should at least use software to aid in this task. 

However, understanding what the software is doing on your behalf is worthwhile. Double-checking the output can bring peace of mind in case of an audit and help catch costly errors. 

How To Calculate Payroll

Let’s say you are doing a payroll calculation for someone on your staff who earns $50,000 annually.

First, you’ll need to collect a W-4, which indicates which deductions an employee intends to take on federal income taxes. Then, you’ll collect the following when running payroll and pay the IRS according to your chosen deposit schedule (monthly or semi-weekly). 

Payroll Calculation Example

A chart from indinero shows a payroll calculation example.

*IRS Tax Estimation Tool

Assumptions Used in Our Example:

  • In this example, the Social Security maximum was not reached. Keep in mind that money earned over $168,400 is not taxed.
  • We also assumed the business was eligible for the entire federal unemployment insurance tax credit of 5.4%, which will vary from state to state.
  • The additional Medicare tax threshold wasn’t reached either. Money earned over $125,000 – $250,000 (depending on filing status) receives an additional 0.9% tax.
  • This example made reasonable assumptions for state and local tax rates, but they will vary based on a business’s jurisdiction.
  • This example uses the simplest possible assumptions for federal tax withholding. Use your employee’s W-4 for a more accurate estimate if you do this yourself.

Benefits of Outsourcing Payroll

Running payroll yourself isn’t easy, especially with so many other demands on your time. Here are some key reasons to consider indinero’s corporate payroll services.

Compliance and Risk Management

The IRS recently invested in its audit teams, leaving high-net-worth individuals and their companies under heightened scrutiny. Payroll taxes are complex; our expert team of accountants would be an asset to your company. 

Security and Confidentiality

Payroll data, including social security numbers and private financial information, is sensitive. Our firm prioritizes the strictest protocols to safeguard your information from costly security breaches.

Access to Specialized Expertise

Indinero is a full-stack accounting firm. Whether you need bookkeeping services for day-to-day financial tasks or a fractional CFO to shape your long-term vision, we’re here to help. 

Conclusion

Business owners are responsible for collecting and remitting Social Security, Medicare, unemployment insurance, and state, local, and federal income taxes. 

If you plan to do this in-house, we recommend using payroll software to save time and eliminate mistakes. Otherwise, we encourage you to reach out to our corporate payroll services team for a free consultation.