Payroll Taxes and Employer Responsibilities
How to Calculate and Report Deductions
Employers calculate payroll taxes using an employee's gross or total wage earnings and various deductions to arrive at net or take-home pay. This seems simple enough on the surface, but calculating the deductions requires that attention to detail and extreme accuracy.
The Basic Formula for Net Pay
In simplest terms, the basic formula for net pay works like this:
Employee's gross pay (pay rate x hours worked)
minus statutory payroll tax deductions
minus voluntary payroll deductions
equals net pay
Statutory Payroll Tax Deductions
The law requires that payroll taxes must be withheld from an employee's paycheck each pay period. Employers must then transmit these withholdings to various tax agencies. Payroll tax deductions include the following:
- Federal income tax withholding based on the withholding tables in Publication 15
- Social Security tax withholding of 6.2% up to annual maximum taxable earnings or wage base of $137,700 as of 2020
- Medicare tax withholding of 1.45%
- Additional Medicare tax withholding of 0.9% for employees earning over $200,000, a tax withholding requirement that began in 2013
- State income tax withholding
- Various local tax withholdings, such as city, county or school district taxes, state disability, or unemployment insurance
Voluntary Payroll Deductions
Voluntary payroll deductions are withheld from an employee's paycheck only if the employee has agreed to the deduction. Voluntary deductions pay for or contribute toward various benefits which the employee has elected to participate in. Voluntary deductions can include the following:
- Health insurance premiums, such as medical, dental, and eye care
- Life insurance premiums.
- Retirement plan contributions such as a 401(k) plan
- Employee stock purchase plans such as ESPP and ESOP plans
- Meals, uniforms, union dues, and other job-related expenses
Voluntary deductions can be paid with pre-tax or after-tax dollars, depending on the type of benefit that's being paid for. Some pre-tax deductions reduce only wages subject to federal income tax, while other deductions reduce wages subject to Social Security and Medicare taxes as well.
Employer Payroll Tax Responsibilities
The responsibility for payroll taxes continues even after paychecks have been issued to employees. The company is also responsible for:
- Paying the employer's share of payroll taxes
- Depositing tax dollars withheld from the employees' paychecks
- Preparing various reconciliation reports
- Accounting for the payroll expense through their financial reporting
- Filing payroll tax returns
Employer Payroll Taxes
Companies are responsible for paying their portion of payroll taxes as well. These taxes are an added expense over and above the expense of an employee's gross pay. The employer portion of payroll taxes includes the following:
- Social Security taxes of 6.2% up to the annual maximum
- Medicare taxes of 1.45% of wages
- Federal unemployment taxes (FUTA)
- State unemployment taxes (SUTA)
FICA stands for the Federal Insurance Contributions Act. The FICA tax consists of both Social Security and Medicare taxes. FICA taxes are paid both by the employee and the employer. Each party pays half these taxes. Both halves of the FICA taxes add up to a total of 15.3%, broken down as follows:
- Social Security (employee pays 6.2%)
- Social Security (employer pays 6.2%)
- Medicare (employee pays 1.45%)
- Medicare (employer pays 1.45%)
The 6.2% employee portion of the Social Security tax increased from 4.2% in 2011 and 2012. That "tax holiday" was legislated as part of the Tax Relief Act of 2010, which was then extended by HR 3765 and extended again by HR 3630. But the employee portion of Social Security reverted back to the full 6.2% in 2013.
The Additional Medicare Tax
An Additional Medicare tax has been applied to employees who file taxes as head of household, single, or as a qualifying widow(er) with a dependent child and whose Medicare wages exceed $200,000 since 2013. The threshold is much lower for married individuals who file separate tax returns: $125,000. The Additional Medicare tax applies to income over $250,000 for married taxpayers who file joint returns.
This is an employee-only tax. There's no corresponding tax imposed on the employer.
Reporting Payroll Taxes
Employers are required to report their payroll tax obligations and to deposit payroll taxes in a timely manner. Reporting requirements include:
- Making federal tax deposits
- Annual federal unemployment tax return (Form 940 or 940EZ)
- Employer's quarterly payroll tax return (Form 941)
- Annual Return of Withheld Federal Income Tax (Form 945)
- Wage and Tax Statements (Form W-2)
Employers also have requirements to file reports with various state and local agencies. Employers can find links to state tax agencies through the American Payroll Association website.
Originally written by Diana Van Blaricom, a certified Professional in Human Resources (PHR). Edited and revised by Beverly Bird.
Social Security Administration. "Contribution And Benefit Base." Accessed April 8, 2020.
IRS. "Topic No. 751 Social Security and Medicare Withholding Rates." Accessed April 8, 2020.
Brandeis University. "Paychecks: Voluntary and Involuntary Deductions/Garnishments." Accessed April 8, 2020.
IRS. "10 Minutes on Reconciling Forms 941/W-3/W-2 to Gross Payroll." Accessed April 8, 2020.
IRS. "Publication 15-B Employer's Tax Guide to Fringe Benefits." Accessed April 8, 2020.
National Academy of Social Insurance. "Who Pays for Social Security?" Accessed April 8, 2020.