Running payroll means taking money from employees’ paychecks that isn’t theirs to keep — taxes that belong to the government, benefits premiums, retirement contributions. Getting this wrong is expensive. Here’s what you’re required to deduct and what the optional deductions look like.
Mandatory Payroll Deductions
Federal Income Tax Withholding
You withhold federal income tax based on each employee’s W-4 form (their filing status, dependents, and any extra withholding they elect). Use the IRS withholding tables (Publication 15) or payroll software to calculate the correct amount.
Key points:
- W-4s should be updated when an employee’s life changes (marriage, new child, second job)
- More withholding earlier = smaller refund; less withholding = potential penalty for employee
- Employees who claim “exempt” on their W-4 may still owe tax — that’s between them and the IRS
FICA Taxes (Social Security and Medicare)
Both the employee and employer pay half of FICA:
| Tax | Employee Rate | Employer Rate | Max Wages (2024) |
|---|---|---|---|
| Social Security | 6.2% | 6.2% | $168,600 |
| Medicare | 1.45% | 1.45% | No limit |
| Additional Medicare | 0.9% | — | Above $200,000 |
You withhold the employee’s share and pay your own employer share separately. Both are your responsibility to remit.
State Income Tax Withholding
If your state has income tax, you withhold based on state rules and the employee’s state W-4 equivalent. Each state has its own rates, forms, and filing schedules. Check your state’s Department of Revenue for specifics.
Nine states have no income tax (see above), so no state withholding applies.
State Unemployment Insurance (SUI)
Most states require employers to pay SUI on employee wages. Employees generally don’t contribute to this (one exception: New Jersey). The rate varies by state and by your claims history. This is paid by the employer, not withheld from employees.
Federal Unemployment Tax (FUTA)
Employer-paid only. FUTA is 6% on the first $7,000 of each employee’s wages annually, but most businesses qualify for a 5.4% credit if they pay SUI on time, making the effective rate 0.6% — or $42/year per employee at the $7,000 maximum.
Voluntary Deductions (With Employee Authorization)
Health insurance premiums: Employee’s share of health insurance, deducted pre-tax (if the plan is Section 125 eligible, which most employer plans are).
Retirement contributions (401k, SIMPLE IRA): Employee-elected contributions, deducted pre-tax for traditional contributions or after-tax for Roth.
Dental and vision premiums: Same treatment as health.
FSA and HSA contributions: Employee-elected health savings contributions, deducted pre-tax.
Life and disability insurance: Employee’s share, typically post-tax unless structured otherwise.
Wage garnishments: Legally required deductions for child support, tax levies, or court-ordered debt repayment. You have no discretion here — if you receive a garnishment order, you must comply.
Payroll Tax Deposit Schedule
The IRS requires you to deposit withheld taxes on a specific schedule based on your total tax liability:
- Monthly: If your total tax in the prior lookback period was $50,000 or less → deposit by the 15th of the following month
- Semi-weekly: If your total tax exceeded $50,000 → deposit within 3 business days of payroll
Most small businesses start as monthly depositors. Staying current with deposits is critical — the failure-to-deposit penalty can reach 15% of the tax owed.
Common Mistakes to Avoid
Not depositing on time: The penalty for late payroll tax deposits is immediate and steep. Set up automatic reminders or use payroll software that deposits automatically.
Using withheld taxes for operating expenses: The withheld taxes in your account belong to the government, not to your business. Never borrow from them. This is one of the most common and most devastating small business mistakes.
Incorrect FUTA calculation: Remember the $7,000 wage base — FUTA applies only to the first $7,000 per employee per year.
Missing state requirements: States have their own deadlines, rates, and forms. California, New York, and other large states have complex payroll tax requirements that differ significantly from federal.
Set up payroll software before hiring your first employee. The calculation complexity and deposit schedule requirements make manual payroll impractical for most small businesses — the cost of software ($40-100/month) is far less than the cost of a missed deposit penalty.
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