Withholding taxes is all part of being an employer. And you cannot just withhold one type of tax and be on your merry way. That’s right: you must withhold several different taxes, including payroll taxes. But which taxes are considered payroll taxes? What exactly are payroll taxes?
Payroll taxes include taxes that employees, employers, or both pay. Some payroll taxes, like Medicare tax, have an employee and employer portion. Other taxes, like federal unemployment tax (FUTA tax) are an employer-only tax.
There are several payroll-related taxes you need to keep on your radar, including:
- Federal income tax (FIT): Employee
- State income tax (SIT): Employee
- Local income tax: Employee and possibly employer
- FICA tax (Social security and Medicare): Employee and employer
- Federal unemployment tax (FUTA tax): Employer
- State unemployment tax (SUTA tax): Employer and sometimes employee
- State-specific taxes: Employee
While FICA tax is specifically considered a type of payroll tax, other taxes from above may be considered income taxes (e.g., federal, state, and local income tax) or employment taxes (e.g., FUTA and SUTA tax). However, all the above taxes are payroll-related and can potentially come into play when you run payroll.
Depending on your business and employee, you may need to calculate, withhold, and/or contribute to some or all the types of payroll taxes.
Breaking down payroll taxes
So, how do you know which payroll taxes you need to calculate and consider? The tax-by-tax breakdown below provides more information about each payroll-related tax.
Federal income tax
In general, you must withhold federal income tax, or FIT, from employee wages. Employers do not contribute to federal income tax based on employee pay. However, employers are responsible for collecting and remitting employee income tax. Unlike some other payroll taxes, FIT varies from employee to employee.
Factors such as gross wages, marital status (e.g., single), and number of dependents impact the amount you withhold in federal income tax from an employee. Use Form W-4 to help determine how much to withhold from employee wages. Once you have an employee’s completed W-4 form, use the income tax withholding tables in IRS Publication 15-T to determine how much to withhold for FIT.
There are two methods for calculating federal income tax withholding:
- Percentage method: Find the range that an employee’s wages fall under and add together a flat dollar amount and percentage.
- Wage bracket method: Find the range the employee’s wages fall under. Then, using the information the employee entered on Form W-4, find the amount to withhold on the withholding table.
In some cases, an employee may be exempt from federal withholding. If an employee is exempt, do not withhold any FIT from the exempt employee’s wages.
Report federal income tax either on Form 941 (quarterly) or Form 944 (annual).
State income tax
State income tax (SIT) is a type of state-mandated tax applied to an employee’s wages. As an employer, you’re responsible for withholding state income tax from employees’ wages (if applicable) and remitting it to the proper state tax agency.
SIT rates vary. They can be progressive, where wage brackets are used to tax employees at different rates, or flat, where a standard percentage is used to tax all employees, depending on the state.
Like federal income tax withholding, state tax withholding requires employees to fill out a state W-4 form.
Are you required to withhold SIT from my employees’ wages? That depends on your state. The majority of states (41 states plus Washington D.C.) have state income taxes on employment wages.
The following nine states do not have state income tax withholding:
- New Hampshire
- South Dakota
If you have an employee who lives in one state and works in another, you also need to be aware of reciprocal agreements. State tax reciprocity agreements allow employees who commute to another state to request exemption from state income tax withholding for the state in which they work. Not all states have state tax reciprocity agreements.
Local income tax
At this point you may be thinking to yourself, “Ugh, another type of income tax?” Depending on your locality, you may need to withhold local income taxes from employee wages. And in some cases, you may need to pay local income taxes as an employer.
Local income taxes typically apply to people who live or work in the locality. As an employer, it is your job to know which (if any) local taxes you must withhold and remit.
Some local income taxes are permanent, while others are temporary and fund a specific, short-term purpose. Local income tax rates can either be a flat rate (e.g., 2%) or a flat-dollar amount (e.g., $6 per paycheck).
Because local taxes are ever-changing, make sure you are always up to date with the latest local income tax laws and requirements.
FICA tax is a special type of payroll tax. It consists of both Social Security and Medicare taxes, and it is an employer and employee tax.
FICA tax is 7.65% of your employee’s pay. You must withhold 7.65% of each employee’s gross wages for FICA tax. And as an employer, you must contribute a matching 7.65%.
Look at how FICA tax breaks down for you and your employees:
- Employer: 6.2% for Social Security and 1.45% for Medicare
- Employee: 6.2% for Social Security and 1.45% for Medicare
There is a cutoff point for Social Security taxes, referred to as the Social Security wage base. When an employee earns above the wage base, stop withholding and contributing the 6.2% for Social Security taxes (both employer and employee portions). The Social Security wage base typically changes from year to year. For 2021, the Social Security wage base is $142,800.
Although the Medicare tax portion of FICA does not have a wage base, there is an additional Medicare tax of 0.9% that you may need to withhold from employee wages over $200,000. The additional Medicare tax only impacts the employee portion.
If an employee is subject to the additional Medicare tax, withhold 2.35% from their wages above the threshold instead of 1.45%, and continue contributing 1.45% for the employer portion.
Federal unemployment tax
Federal unemployment tax, also known as FUTA tax, is an employer-only payroll tax. Do not withhold FUTA tax from employee wages.
Most employers must pay federal unemployment tax. However, not all employers are required to do so. You must pay FUTA tax if you:
- Paid $1,500 or more in wages during any calendar quarter in 2019 or 2020
- Had at least one employee for at least part of a day in any 20 or more different weeks in either 2019 or 2020
The FUTA tax rate is 6%. Federal unemployment tax applies only to the first $7,000 you pay to each employee in a calendar year. Stop paying FUTA tax on an employee’s wages once you pay the employee more than $7,000 in a year.
Most employers receive a FUTA tax credit on their federal tax rates, which reduces their rates. The largest possible FUTA tax credit is 5.4%. So, the smallest possible FUTA rate you can have is 0.6%.
Deposit your FUTA taxes on a quarterly basis, and file Form 940 to report FUTA taxes to the IRS.
State unemployment tax
The State Unemployment Tax Act (SUTA) tax, also referred to as state unemployment, SUI, or reemployment tax, is a type of payroll tax that states require employers (and in some cases, employees) to pay.
In most states, state unemployment tax is an employer-only tax. However, if you have employees in Alaska, New Jersey, and Pennsylvania, you must withhold state unemployment from their wages and remit it to these states, respectively.
Each state sets its own state unemployment wage base. Pay attention to your SUTA wage base to ensure that you are withholding the correct amount of SUTA tax for each employee.
SUTA tax rates also vary by state. When you register as an employer, your state will tell you what your SUTA tax rate is (e.g., 2.7%).
Some states impose state-specific taxes that apply only to employees in that state. For example, Oregon requires that employers withhold a statewide transit tax from employees.
If your employee is not exempt from a state-specific tax, withhold it from employee wages and remit it to the appropriate state agency.
Not sure if you have state-specific taxes? No worries. Check with your state for more information about whether you need to withhold state taxes from employee wages.
Simplifying your payroll tax responsibilities: 5 tips
Phew! So many taxes to calculate, so little time. What’s an employer to do? To simplify your payroll tax responsibilities and ensure you withhold and remit the proper taxes in a timely manner, take advantage of the following tips:
- Use payroll software to calculate taxes for you.
- Keep your payroll taxes in a separate bank account to avoid accidental spending.
- Set reminders for payroll tax due dates.
- Stay up to date with federal, state, and local tax laws to remain compliant.
- Keep your records organized and secure.
To further simplify your payroll tax duties, consider investing in full-service payroll software. Full-service software not only calculates your taxes for you, but also remits them to the proper agencies on your behalf.