Understanding Payroll Taxes for Small Businesses

Payroll taxes are mandatory taxes that employers (and often employees) must pay on wages. These fund Social Security, Medicare, unemployment benefits, and sometimes state programs. Small business owners are responsible for withholding federal and state income taxes from paychecks, paying FICA taxes (Social Security and Medicare), and paying unemployment taxes (FUTA and SUTA). In short, every paycheck involves tax calculations that you must remit to the IRS and state agencies on schedule. Failing to withhold or file correctly can lead to penalties, so it’s crucial to understand the components of payroll tax and stay compliant.

Federal Payroll Taxes

FICA (Social Security and Medicare)

FICA is the Federal Insurance Contributions Act tax, covering Social Security and Medicare. In 2025, the Social Security tax rate is 6.2% each for employers and employees (12.4% total) on wages up to $176,100. The Medicare tax rate is 1.45% each (2.9% total) on all wages (no cap). High earners pay an additional 0.9% Medicare surtax on wages over $200,000 (employees only). In practice, employers withhold the employee’s 7.65% and match it with their own 7.65% for a total FICA of 15.3% per worker. These amounts must be calculated every payroll and remitted to the IRS.

FUTA (Federal Unemployment Tax Act)

FUTA funds federal unemployment benefits. Only employers pay FUTA tax; it is not withheld from employees. The standard FUTA rate is 6.0% on the first $7,000 of each employee’s annual wages. However, most employers who timely pay state unemployment taxes receive the full 5.4% credit, reducing the effective FUTA rate to 0.6% on $7,000. (If a state has a credit reduction, the net FUTA rate may be higher.) For example, the maximum FUTA tax per worker is normally $420/year (6% of $7,000) before credits. Employers report FUTA on IRS Form 940 annually.

Federal Income Tax Withholding

In addition to FICA, employers must withhold federal income tax from employee wages using the information on the employee’s Form W-4. The withholding tables (or IRS’s Tax Withholding Estimator) determine how much income tax to deduct each pay period. These withheld taxes are remitted to the IRS (via EFTPS, the Electronic Federal Tax Payment System) along with FICA and FUTA payments. Employers are legally required to deposit payroll taxes either monthly or semiweekly based on their prior-year tax liability.

Reporting and Depositing Federal Taxes

Employers deposit federal payroll taxes on a regular schedule (monthly or semiweekly) with the IRS. Payroll tax returns are then filed as follows:

  • Form 941: Employer’s Quarterly Federal Tax Return for withholding of income tax and FICA. Due the last day of the month following each quarter (April 30, July 31, Oct 31, Jan 31).
  • Form 940: Annual FUTA return, due January 31 (with a 10-day extension if all FUTA deposits were timely).
  • Form W-2/W-3: Annual wage and tax statements for each employee, filed with the Social Security Administration by January 31, and furnished to employees by January 31.
  • Form 1099-NEC: If you paid independent contractors $600+ in a year, file Form 1099-NEC by January 31 and furnish copies to payees.

Keeping up with these deadlines is critical. For example, Form 941 is filed quarterly (due end of next month), and Form 940 is filed once a year by January 31. Failing to deposit or report on time can trigger penalties and interest.

State Payroll Taxes

SUTA (State Unemployment Tax)

Almost every state imposes its own unemployment insurance tax (often called SUTA or SUI). Rates and taxable wage bases vary widely by state. For instance, California employers pay UI (SUTA) tax on the first $7,000 of each worker’s wages; rates range roughly 1.5%–6.2% (for 2025 Schedule F+). By contrast, Texas employers pay SUI on the first $9,000 of wages, with rates (for 2024–2025) from about 0.29% to 6.29% for experienced accounts. New Texas employers start at 2.70%. Texas also adds a 0.1% Employment Training tax on all wages (ETIA).

Unlike Texas, California also requires withholding of state income tax (PIT) and State Disability Insurance (SDI) from employees’ pay. California’s SDI rate is about 1.2% in 2025 (on all wages), and PIT withholding is based on the employee’s allowances (Form DE 4) with no wage cap. Texas has no state income tax, so employers do not withhold personal income taxes.

California Payroll Taxes

California levies four payroll taxes. UI (Unemployment Insurance) and ETT (Employment Training Tax) are employer-paid contributions. Employers withhold SDI (State Disability Insurance) and PIT (Personal Income Tax) from wages. The UI rate (for new employers) is 3.4%, eventually ranging up to 6.2% on the first $7,000 of wages (max $434/employee per year). ETT is 0.1% on the first $7,000. SDI is withheld at 1.2% of wages (2025 rate). PIT withholding follows California’s schedules (based on DE 4 allowances) and has no maximum, so larger salaries incur more state tax. California employers file quarterly returns (DE 9/DE 9C) reconciling wages and taxes, and deposit UI/ETT quarterly while depositing SDI/PIT on the IRS deposit schedule.

Texas Payroll Taxes

In Texas, no state income tax is withheld from pay, so the only state payroll tax is unemployment insurance. Employers pay Texas SUI (Taxable wage base $9,000). New employers start at about 2.70%. After gaining an experience rating, employers see rates from roughly 0.25% up to 6.25% (2024 range). Employers also pay the 0.1% ETIA on all wages. Texas payroll taxes are reported quarterly: employers register with the Texas Workforce Commission (TWC) and file quarterly wage reports and tax payments by the last day of the month after each calendar quarter (e.g. April 30 for Q1).

Withholding, Reporting, and Remitting Taxes

Each pay period, you must withhold taxes from employee wages and remit them with your own contributions. For each employee paycheck, withhold federal income tax (per Form W-4), 6.2% Social Security, 1.45% Medicare, and any applicable state taxes. Additionally, pay the matching FICA (7.65%) and your share of FUTA/SUTA. Federal deposits are made through EFTPS according to the IRS schedule (monthly or semi-weekly). States have their own payment systems (e.g. California’s e-Services, Texas CEAWeb).

Tax returns tie it all together. You’ll file Form 941 each quarter to report federal withholding and FICA. Annually, file Form 940 for FUTA. Provide Forms W-2 to employees and file W-3 by January 31. Issue 1099-NEC forms to qualifying contractors by January 31. In California, use DE 9/DE 9C quarterly to report wages and taxes, and pay any SDI/PIT via DE 88. In Texas, file quarterly unemployment reports with TWC.

Key takeaways: Employers must stay on schedule. Deposit federal and state tax withholdings on time, file 941 by the end of the next month, 940 by Jan 31, W-2s by Jan 31, and state returns by their deadlines. Late filings incur interest and penalties, so most businesses use payroll software or services to automate withholding, deposits, and filings.

Payroll Tax Compliance Checklist

Use the following checklist to ensure you’re meeting all payroll tax obligations:

  • Register and set up accounts: Obtain an Employer Identification Number (EIN) from the IRS, and register for required state employer tax accounts (e.g. California EDD, Texas TWC). Keep licenses and registrations current.
  • Classify workers correctly: Verify all workers are properly classified as employees or independent contractors.
  • Collect withholding forms: Have each employee complete a federal Form W-4 (and a state withholding form if your state requires one, e.g. California’s DE 4).
  • Use current tax rates: Update payroll records with the latest federal and state tax tables. For example, the 2025 Social Security wage base is $176,100; California’s SDI rate is 1.2%; new Texas SUI rate is about 2.7%.
  • Calculate payroll taxes each period: For each paycheck, calculate employee withholding (income tax, Social Security 6.2%, Medicare 1.45%, state taxes) and employer contributions (Social Security 6.2%, Medicare 1.45%, FUTA, SUTA). Remember the 0.9% Additional Medicare tax for employees over $200,000.
  • Deposit taxes timely: Remit federal and state payroll taxes on the required schedule. Use EFTPS or state e-services. For example, deposit federal payroll taxes monthly or semi-weekly as required. California employers must deposit SDI/PIT and UI/ETT according to IRS deposit rules.
  • File payroll tax returns on time:
    • File IRS Form 941 every quarter (due April 30, July 31, Oct 31, Jan 31).
    • File IRS Form 940 by January 31 for FUTA.
    • In California, file DE 9/DE 9C quarterly and make any required DE 88 deposits.
    • In Texas, file quarterly unemployment wage reports to TWC by April 30, July 31, Oct 31, and Jan 31.
  • Issue and file year-end forms: Provide Forms W-2 to all employees (and Form W-3 to SSA) by January 31. Issue Form 1099-NEC to contractors by January 31.
  • Reconcile and record-keep: After each payroll, reconcile the total wages, taxes withheld, and taxes paid to your quarterly filings. Keep detailed records of wages, withholdings, tax deposits, and filings. Review notices from IRS/state agencies immediately and address any discrepancies.
  • Stay informed: Monitor tax rate changes and legislative updates each year. For example, update your payroll system when the Social Security wage base, state UI rates, or withholding tables change.

Following this checklist will help ensure you withhold, report, and remit all required payroll taxes for federal and state purposes. By staying organized and current with IRS and state agency rules, you can avoid costly mistakes and focus on running your business.

Outsourcing Payroll

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