What Are Payroll Taxes and How Do They Work?

Payroll taxes are the federal and state taxes an employer withholds from an employee’s wages, and in most cases matches with its own money, to fund Social Security, Medicare, and unemployment insurance. The Social Security and Medicare portion (called FICA) runs 15.3% combined for 2026, split evenly between worker and employer, on wages up to $184,500 for Social Security and with no cap for Medicare.¹² Federal unemployment tax and state unemployment tax sit on top of that, paid by the employer. Federal (and often state) income tax withholding also comes out of the same paycheck, though it works as a prepayment toward the worker’s own annual tax bill rather than a program-specific tax.

Every business that pays wages has to calculate these amounts, withhold the employee’s share, add the employer’s share, deposit the total to the IRS on schedule, and report it on quarterly and annual forms. Missed deposits and misfiled returns carry some of the harshest penalties in the tax code.

The Three Buckets That Make Up Payroll Taxes

Social Security and Medicare (FICA)

FICA is two taxes bundled together. Social Security takes 6.2% from the employee and 6.2% from the employer, up to the $184,500 wage base for 2026. Earnings above that cap are not subject to Social Security tax for the rest of the calendar year.¹ Medicare takes 1.45% from each side with no wage ceiling, so every dollar of earned income is taxed.²

High earners owe an extra 0.9% Medicare tax on wages above $200,000 for single filers, $250,000 for joint filers, and $125,000 for married filing separately.³ This one is paid entirely by the employee. The employer does not match it, but must start withholding once an individual employee’s wages pass $200,000 in the calendar year, regardless of that employee’s filing status.⁴ Any difference between what got withheld and what is actually owed gets settled on the employee’s return.

Federal and State Unemployment (FUTA and SUTA)

Unemployment taxes are almost entirely on the employer. Workers do not normally see them on a pay stub.

FUTA is a 6.0% tax on the first $7,000 of each employee’s wages per year.⁵⁶ Employers who pay state unemployment tax on time get a credit of up to 5.4%, dropping the effective federal rate to 0.6%, or about $42 per employee per year.⁷ That credit shrinks if you operate in a “credit reduction state,” meaning a state that has borrowed from the federal government to pay unemployment benefits and failed to repay on time. The credit drops by 0.3% for each year the state stays in debt.

SUTA rates and wage bases are set by each state and depend heavily on your company’s history of former employees filing unemployment claims. States use an “experience rating” formula that compares past benefit charges to your payroll. New businesses get a default rate until they build enough history for a customized one. Paying SUTA on time each quarter is what keeps the 5.4% FUTA credit intact.

Some states also require separate payroll deductions for disability insurance or paid family and medical leave, with employee contribution rates generally between 0.1% and 1.3% of wages. Whether these apply, and who pays, depends on where the work is performed.

Income Tax Withholding

Federal income tax withholding travels through payroll but works differently from the taxes above. It is a running prepayment toward the employee’s personal income tax, not a flat rate funding a specific program. The employer withholds based on the employee’s Form W-4, which reports filing status and any adjustments for additional income or deductions.⁸ Many states and some cities layer their own income tax withholding on top. Any gap between what was withheld and what is owed shows up as a refund or a balance due at filing.

Who Pays What

Sorting out whose money each tax actually comes from is where most confusion lives:

Shared equally between employee and employer: Social Security (6.2% each) and regular Medicare (1.45% each). The employer withholds the employee’s share and pays a matching amount out of its own funds.²
Employee only: the 0.9% Additional Medicare Tax above the threshold, federal and state income tax withholding, and most state disability or paid leave contributions. The employer withholds these but does not match.
Employer only: FUTA and SUTA. These should never appear as deductions on a worker’s pay stub.

If You Are Self-Employed

Working for yourself means there is no employer to split FICA with, so you pay both halves. The self-employment tax rate is 15.3%: 12.4% for Social Security on net earnings up to $184,500 for 2026, plus 2.9% for Medicare with no cap.¹ The 0.9% Additional Medicare Tax also applies once net self-employment income passes the same filing-status thresholds that apply to employees.³

Two adjustments soften the blow. You calculate self-employment tax on 92.35% of net earnings rather than the full amount, which approximates the fact that employees do not pay FICA on the employer’s share. And you can deduct the employer-equivalent portion (half of the self-employment tax you paid) when computing adjusted gross income. That deduction reduces income tax but not the self-employment tax itself.⁹

How Employers Actually Pay and Report

Payroll taxes are not paid once a year. They move through a schedule of deposits and returns.

Federal tax deposits must be made electronically, through the Electronic Federal Tax Payment System (EFTPS), the business tax account on IRS.gov, or Direct Pay for businesses. The IRS assigns each employer either a monthly or semi-weekly deposit schedule based on total tax liability during a lookback period, and sets that schedule before the start of each calendar year.¹⁰

Two main returns follow those deposits:

Form 941, filed quarterly, reports Social Security, Medicare, and federal income tax withheld. It is due April 30, July 31, October 31, and January 31.¹¹
Form 940, filed annually, reports FUTA. It is due January 31 of the following year, with a 10-day extension available if all FUTA deposits were made on time.¹²

Employers must also give each employee a Form W-2 by January 31 summarizing prior-year wages and taxes withheld.¹³ All employment tax records (payroll registers, W-4s, deposit records, filed returns) must be kept for at least four years after the tax is due or paid, whichever is later.¹⁴

What Happens When Payments Are Late or Missing

Late deposits trigger escalating penalties based on how overdue the payment is:¹⁵

1 to 5 days late: 2% of the unpaid deposit
6 to 15 days late: 5%
More than 15 days late: 10%
After an IRS notice demanding payment: 15%

These do not stack. A deposit 10 days late incurs the 5% penalty, not 2% plus 5%. Filing Form 941 late carries a separate penalty of 5% of the unpaid tax per month, capped at 25%.

The heaviest consequence is the Trust Fund Recovery Penalty. When an employer withholds Social Security, Medicare, and income taxes from paychecks but does not turn that money over to the IRS, the penalty equals 100% of the unpaid trust fund taxes. It can be assessed personally against any individual who was responsible for collecting or paying over the taxes and willfully failed to do so, including officers, directors, and bookkeepers with check-signing authority.¹⁶

Two Boundaries Worth Knowing

Employee or Independent Contractor

Everything above applies to employees. Independent contractors handle their own Social Security and Medicare through self-employment tax, and no employer withholds anything from their payments. The IRS decides the classification using three categories: behavioral control (does the business direct how the work is done?), financial control (does the worker invest in tools, carry unreimbursed expenses, and have the chance for profit or loss?), and the type of relationship between the parties.¹⁷ Misclassifying a worker as a contractor when they should have been an employee exposes the business to back employment taxes, penalties, and interest. If the answer is unclear, Form SS-8 asks the IRS for a formal determination.

Common FICA Exemptions

Not every paycheck is subject to Social Security and Medicare. Two common exceptions:

Students employed by the school, college, or university where they are enrolled and regularly attending classes are generally exempt from FICA on those wages. The work must be incident to pursuing a course of study, and the student must attend at least half time. The exemption does not apply to a “professional employee,” meaning someone eligible for benefits like retirement plan participation or paid leave.¹⁸

Children working for a parent’s sole proprietorship are exempt from FICA until age 18. For domestic work in a parent’s private home, the exemption runs until age 21. The exemption disappears if the business is a corporation or a partnership where the partners are not both parents of the child.¹⁹

1
Social Security Administration. Contribution and Benefit Base
2
Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates
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Internal Revenue Service. Topic No. 560, Additional Medicare Tax
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Internal Revenue Service. Questions and Answers for the Additional Medicare Tax
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Office of the Law Revision Counsel. 26 U.S. Code 3301 – Rate of Tax
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Office of the Law Revision Counsel. 26 U.S. Code 3306 – Definitions
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Internal Revenue Service. FUTA Credit Reduction
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Office of the Law Revision Counsel. 26 U.S. Code 3402 – Income Tax Collected at Source
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Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes)
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Internal Revenue Service. Depositing and Reporting Employment Taxes
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Internal Revenue Service. Employment Tax Due Dates
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Internal Revenue Service. About Form 941, Employer’s Quarterly Federal Tax Return
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Internal Revenue Service. Instructions for Form 941
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Internal Revenue Service. How Long Should I Keep Records
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Internal Revenue Service. Failure to Deposit Penalty
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Office of the Law Revision Counsel. 26 U.S. Code 6672 – Failure to Collect and Pay Over Tax, or Attempt to Evade or Defeat Tax
17
Internal Revenue Service. Employee (Common-Law Employee)
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Internal Revenue Service. Student FICA Exception
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Internal Revenue Service. Family Employees