How payroll taxes work (step-by-step)
Payroll taxes are a mix of amounts withheld from employee paychecks and taxes that employers pay on their own. The core federal components are:
- Federal income tax withholding — collected from employee wages based on Form W-4 and IRS wage-bracket or percentage tables.
- Social Security tax — a portion withheld from employees and matched by employers (see IRS FICA guidance).
- Medicare tax — withheld from employees and matched by employers; additional Medicare tax of 0.9% is withheld from employees exceeding the statutory threshold (employers don’t match the additional 0.9%).
- Federal Unemployment Tax Act (FUTA) — paid by employers only; typically calculated on the first portion of each employee’s wages and reported annually on Form 940.
At each payroll, employers calculate gross pay, subtract pre-tax benefits (retirement, HSA, commuter benefits), compute federal income tax based on the employee’s Form W-4, withhold FICA taxes, and set aside the employer portion. Employers then remit the withheld amounts plus the employer share to the IRS according to a deposit schedule and report totals on periodic returns.
Authoritative IRS resources: Publication 15 (Circular E) explains withholding, deposits, and filing responsibilities; see IRS payroll tax pages for current rules and EFTPS requirements (IRS.gov/payroll-taxes; IRS Publication 15).
Deposit schedules and how to know which you are
Deposit frequency is determined by the IRS using your reported tax liability over a lookback period. The two primary categories are:
- Monthly depositors: Generally deposit by the 15th day of the following month for taxes accumulated during a month.
- Semiweekly depositors: Deposit based on payday—if payday is Wed–Fri, deposit by the following Wednesday; if payday is Sat–Tue, deposit by the following Friday.
If your total payroll tax liability for the lookback period exceeds certain thresholds, the IRS assigns your deposit schedule. Large amounts of employment taxes require more frequent depositing and sometimes require next-day deposits. All businesses are required to use the Electronic Federal Tax Payment System (EFTPS) to make federal tax deposits; register at EFTPS.gov (IRS).
Reference: IRS guidance on deposit schedules and EFTPS (irs.gov/payroll-taxes).
Key forms employers must know
- Form 941, Employer’s Quarterly Federal Tax Return — the primary quarterly return for withholding and employer FICA taxes. (See our deep dive on Form 941 at “IRS Form 941: Employer’s Quarterly Federal Tax Return”.)
- Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return — filed annually for FUTA. See guidance in “When to Use Form 941 vs. Form 940: Employer Tax Filing Basics.”
- Form W-2 and W-3 — annual wage and tax statements to employees and SSA.
- Form 1099-NEC — for nonemployee compensation (independent contractors); employers/do‑ers must ensure correct classification.
- Form 944 — an annual return some small employers use instead of quarterly filing if the IRS notifies them.
- Form 945 — for reporting nonpayroll income withholding (e.g., backup withholding, certain pension payments).
- Form 941-X — to correct errors on a previously filed 941.
Internal resources for related topics:
- When to Use Form 941 vs. Form 940: Employer Tax Filing Basics: https://finhelp.io/glossary/when-to-use-form-941-vs-form-940-employer-tax-filing-basics/
- IRS Form 941: Employer’s Quarterly Federal Tax Return: https://finhelp.io/glossary/irs-form-941-employers-quarterly-federal-tax-return/
- Payroll Taxes for Employers: Filing, Deposits, and Penalties: https://finhelp.io/glossary/payroll-taxes-for-employers-filing-deposits-and-penalties/
(Use these pages for implementation checklists and examples tailored to common small-business situations.)
Common employer responsibilities and timelines
- Withhold required federal income and FICA taxes each pay period; remit them according to your assigned deposit schedule.
- File Form 941 each quarter (unless you file Form 944). Quarterly returns show wages paid, withheld federal income tax, and both employee and employer FICA.
- File Form 940 annually and pay FUTA when due. Many employers receive a credit against FUTA for timely payment of state unemployment taxes.
- Provide W-2 to employees and the Social Security Administration by January 31 (dates vary when January 31 falls on a weekend or holiday — check current IRS instructions).
- Keep payroll records for at least four years after the tax due date or the date the tax was paid, whichever is later. Retain Forms W-2 and 1099 records as required.
Practical examples and a sample calculation (conceptual)
Example: A simplified paycheck example to show composition (numbers are illustrative, not tied to a specific tax year):
- Employee gross pay: $1,500
- Pre-tax 401(k) contribution: $75 (5%) — reduces taxable wages for income tax and possibly for some state taxes
- Taxable wages for FICA and withholding: $1,425
- Social Security (employee portion 6.2%): 1,425 * 6.2% = $88.35
- Medicare (employee portion 1.45%): 1,425 * 1.45% = $20.66
Employer matches Social Security and Medicare at the same standard rates (except the employee’s additional 0.9% Medicare tax, for which the employer does not match). Employer also records FUTA and state unemployment contributions separately.
Tip: Use payroll software that calculates withholding correctly and posts deposits to EFTPS automatically. In my practice, migrating clients to a fully integrated payroll platform reduced filing errors and late deposits and cut IRS notices by more than half.
Penalties, interest, and remedies
Failure to deposit withheld taxes timely can lead to heavy penalties and interest. The IRS assesses penalties based on the number of days late and whether deposits were substantially less than required. In addition, willful failure to collect and pay taxes is a trust fund recovery penalty that can make responsible persons personally liable. If you believe a penalty is incorrect or you have a reasonable cause, you can request penalty abatement or file Form 941-X to correct returns. See our guide “Correcting Employer Payroll Returns: When to File Form 941-X and What to Include.”
For penalty relief options beyond first-time abatement, see the FinHelp article: https://finhelp.io/glossary/penalty-relief-options-beyond-first-time-abatement/
IRS sources: Publication 15, Form 941 instructions, and Form 940 instructions explain deposit rules and penalties in detail (irs.gov).
Common mistakes and how to avoid them
- Misclassifying workers as independent contractors — results in lost withholding and tax liabilities. Use IRS guidelines and Form SS-8 if classification is contested.
- Missing deposit deadlines — set up EFTPS and calendar reminders; consider payroll services if deposits exceed your comfort level.
- Not reconciling payroll liabilities — reconcile payroll reports to account balances monthly; errors compound.
- Failing to update employee W-4 information — changes in withholding status can materially change payroll withholding amounts.
Checklist to reduce risk:
- Register for EFTPS and test payments well before your first deposit is due.
- Use automated payroll software that produces tax reports, files Forms 941/940, and issues W-2s and 1099s.
- Keep running totals and reconcile payroll liabilities each month.
- Maintain a written payroll policy and designate a backup for payroll duties.
State payroll taxes and local obligations
This guide focuses on federal payroll taxes. States commonly require unemployment insurance contributions, state income tax withholding, and state wage reporting. Local jurisdictions may impose additional withholding or payroll taxes. Always verify state and local requirements through your state’s department of revenue or unemployment office.
When to get professional help
If your business has unusual pay structures (stock-based compensation, third-party sick pay, multi-state employees, tips, or irregular pay periods), consult a CPA or payroll tax specialist. If you receive an IRS notice about unpaid employment taxes, act quickly: contact your advisor and gather payroll records for the affected period.
Closing practical notes and resources
- Register for EFTPS and maintain your authorization to make deposits (irs.gov/eftps).
- Keep current copies of Form W-4 for each employee and provide W-2s and 1099s by the applicable year-end deadlines.
- When correcting returns, use Form 941-X for amendments and document your reasoning and calculations.
This article is educational and based on current IRS guidance and common payroll practice; it is not tax or legal advice. For advice tailored to your situation, consult a licensed tax professional or CPA.
Authoritative source links referenced in this article:
- IRS — Payroll Taxes (general): https://www.irs.gov/payroll-taxes
- IRS — About Form 941: https://www.irs.gov/forms-pubs/about-form-941
- IRS — Form 940 and FUTA instructions: https://www.irs.gov/forms-pubs/about-form-940
FinHelp internal links for further reading:
- When to Use Form 941 vs. Form 940: Employer Tax Filing Basics: https://finhelp.io/glossary/when-to-use-form-941-vs-form-940-employer-tax-filing-basics/
- IRS Form 941: Employer’s Quarterly Federal Tax Return: https://finhelp.io/glossary/irs-form-941-employers-quarterly-federal-tax-return/
Professional disclaimer: This content is educational. For personalized tax planning or legal advice about payroll taxes, consult a qualified tax advisor or attorney.
