How Your Business Should Handle Taxes for Payroll

Payroll taxes are funds paid by employers and withheld from employee earnings for federal, state, and local governments. For businesses with employees, managing these taxes is a legal responsibility that involves collecting employee information, calculating tax amounts, and submitting payments and reports on time. Failing to handle these obligations correctly can lead to significant penalties and legal issues.

Employer and Employee Tax Responsibilities

The responsibility for federal payroll taxes is divided between the employer and the employee. These taxes are governed by the Federal Insurance Contributions Act (FICA), which mandates contributions to Social Security and Medicare. Both programs are funded by taxes withheld from an employee’s pay and matched by the employer.

Several taxes are withheld directly from an employee’s paycheck. The primary one is Federal Income Tax Withholding (FITW), which contributes to the general fund of the U.S. Treasury. Employees also have their share of Social Security tax withheld to fund retirement and disability benefits, and Medicare tax to fund hospital insurance.

Employers are responsible for matching the employee’s Social Security and Medicare contributions. An additional employer-only tax is the Federal Unemployment Tax (FUTA), which helps fund state unemployment benefits. Some high-income employees may also be subject to an Additional Medicare Tax of 0.9% on earnings over $200,000 for single filers, which is withheld from their pay but not matched by the employer.

Information and Forms for Payroll Setup

Before processing a single paycheck, a business must obtain a federal Employer Identification Number (EIN) from the IRS. This unique nine-digit number is required for reporting all federal payroll taxes and deposits. A similar state-specific identification number is also necessary for handling state-level tax obligations.

Employers must collect a completed Form W-4, Employee’s Withholding Certificate, from each new hire before their first payday. The form is available directly from the IRS website. It provides the employer with the employee’s filing status, number of dependents, and any other adjustments they wish to make to their withholding, such as for other income or deductions. Employees can update their W-4 whenever their personal or financial situation changes.

Employers must also verify that each new hire is legally eligible to work in the United States by completing Form I-9, Employment Eligibility Verification. The employee completes their section by their first day and must present acceptable documents proving their identity and work authorization within three business days of starting. The employer then examines the documents, completes their section, and retains the form for a specific period but does not file it with any government agency.

Calculating Payroll Tax Amounts

Calculating FICA taxes involves both the employee and employer. For 2025, the Social Security tax rate is 6.2% on wages up to an annual limit of $176,100 for both parties. Once an employee’s earnings exceed this threshold, the tax is no longer applied for the rest of the year. The Medicare tax is 1.45% on all wages with no income cap, also paid by both employee and employer.

Calculating Federal Income Tax Withholding (FITW) depends on the employee’s Form W-4. The IRS provides two methods in Publication 15-T, Federal Income Tax Withholding Methods. The Wage Bracket Method uses tables for standard withholding amounts based on wage levels and filing status.

The Percentage Method offers a more exact calculation. For example, using this method for an employee who is single and paid biweekly, the employer would first adjust the wage amount based on tax credits and deductions claimed on the W-4. Then, using the percentage method tables in Publication 15-T, the employer identifies the tentative withholding amount based on the adjusted wage and filing status.

The Federal Unemployment Tax (FUTA) is an employer-only tax. The FUTA tax rate is 6.0% on the first $7,000 of each employee’s annual wages. Employers can receive a tax credit of up to 5.4% for paying state unemployment taxes on time, which reduces the effective FUTA rate to 0.6%. This credit may be reduced in certain states, resulting in a higher effective FUTA rate.

Depositing and Reporting Federal Taxes

All federal tax deposits, including withheld income tax and both shares of FICA taxes, must be made electronically using the Electronic Federal Tax Payment System (EFTPS). The frequency of deposits is determined by an employer’s deposit schedule, which is either monthly or semi-weekly.

The schedule is based on the total tax liability reported on Form 941 during a four-quarter “lookback period.” For the 2025 calendar year, this period is July 1, 2023, to June 30, 2024. If the total tax liability was $50,000 or less, the employer is a monthly depositor. If it was more than $50,000, they are a semi-weekly depositor.

Monthly depositors must deposit taxes by the 15th day of the following month. Semi-weekly depositors have deadlines based on their payday: for paydays on Wednesday, Thursday, or Friday, the deposit is due the next Wednesday. For paydays on Saturday, Sunday, Monday, or Tuesday, the deposit is due the next Friday.

In addition to deposits, employers must file several reporting forms.

• Form 941, Employer’s QUARTERLY Federal Tax Return, is filed each quarter to report income, Social Security, and Medicare taxes and reconcile them with deposits. It is due on April 30, July 31, October 31, and January 31.
• Form 940, Employer’s ANNUAL Federal Unemployment (FUTA) Tax Return, is filed once a year and is due by January 31. FUTA tax deposits may be required quarterly if the liability exceeds $500.
• Form W-2, Wage and Tax Statement, must be provided to each employee by January 31, detailing their total annual wages and the amount of each tax withheld.
• Form W-3, Transmittal of Wage and Tax Statements, is sent with copies of all W-2s to the Social Security Administration to summarize the totals from all W-2s.

State and Local Payroll Tax Compliance

Beyond federal requirements, businesses must manage state and local payroll tax obligations, which differ significantly by location. Most states with an income tax require employers to withhold it from employee wages, a process that mirrors the federal system. This requires registering for a state withholding account and using a state-specific W-4 form to determine the correct withholding amount.

A universal state-level tax is the State Unemployment Tax Act (SUTA) tax. This is an employer-only tax that funds state unemployment benefits. New employers start at a standard rate for their industry, but over time, their rate is adjusted based on an “experience rating.” A history of frequent unemployment claims from former employees can lead to a higher SUTA tax rate, while a stable workforce can result in a lower rate.

Some states and localities impose additional payroll taxes for specific programs like State Disability Insurance (SDI) or paid family leave. These are often paid by employees through payroll deductions, though some states may require employer contributions. Given the wide variation in rules and rates, employers must consult the tax agencies for the specific locations where they operate for definitive guidance on all requirements.