Payroll Taxes & Withholding
How taxes leave your paycheck — and why it matters for employers.
Educational only — not tax advice. Withholding estimates are simplified. Actual amounts depend on W-4 elections and IRS Publication 15-T tables.
Why This Matters
For employees, payroll taxes are the invisible deductions on every paycheck — "FICA" and "FWT." For employers like ABC Coffee Shop, payroll taxes are a compliance obligation with real penalties for getting it wrong.
Payroll taxes are the second-largest source of federal revenue (~35%) and the most frequent tax obligation for most small businesses — processed every single pay period.
The Two Types of Payroll Tax
1. FICA: Social Security and Medicare
FICA RATES (2025):
SOCIAL SECURITY: Employee 6.2% + Employer 6.2% = 12.4%
Wage base cap: $176,100 (no SS above this)
MEDICARE: Employee 1.45% + Employer 1.45% = 2.9% (no cap)
Additional Medicare: 0.9% on wages > $200K (employee only)
TOTAL FICA per side: 7.65%
FICA is a shared tax. The employer withholds 7.65% from gross pay, adds a matching 7.65%, and remits the combined 15.3% to the IRS.
2. Federal Income Tax Withholding
Unlike FICA (fixed percentage), federal income tax withholding is an estimate of annual liability, collected each paycheck. It depends on Form W-4 elections, gross wages, and pay frequency.
The W-4: The Employee's Withholding Controller
W-4 — FIVE STEPS:
Step 1: Personal info + filing status
Step 2: Multiple jobs / spouse works
Step 3: Claim dependent credits ($2,000/child under 17; $500/other)
Step 4: Other income, extra deductions, extra withholding
Step 5: Sign
Key principle: The W-4 provides inputs to a withholding calculation. IRS Publication 15-T tables do the actual math.
W-4 correct
~$200/period withheld → small refund or $0 due
Under-withheld
Too few credits → owes $2,000+ at filing
Over-withheld
Extra withholding → large refund (interest-free loan)
Paycheck Withholding Estimator
Model gross pay → FICA (SS + Medicare) + estimated federal income tax → net pay. Based on single filer, 2025 standard deduction, simplified brackets.
Employer cost (not deducted): Matching FICA $123.58 + FUTA/SUTA (varies).
Annual gross: $41,999.88 · Estimated annual federal: $2,551.50
The Complete Paycheck Calculation
ABC EMPLOYEE — BIWEEKLY (Jordan Chen, barista)
Annual salary: $42,000 · Biweekly gross: $1,615.38 · Single, no adjustments
GROSS PAY: $1,615.38
Federal income tax withholding: − $131.00
Social Security (6.2%): − $100.15
Medicare (1.45%): − $23.42
State income tax (est. 4.5%): − $72.69
Health insurance (pre-tax): − $115.38
NET PAY: $1,172.74
Employer adds: SS match $100.15 + Medicare $23.42 + FUTA/SUTA + health share. True cost to ABC: ~$2,107.10/biweekly.
Employer Withholding Obligations
1. WITHHOLD from employee paychecks
- Federal income tax
- Employee SS (6.2%)
- Employee Medicare (1.45%)
- State income tax
2. MATCH (employer's own expense)
- Social Security 6.2%
- Medicare 1.45%
3. PAY FUTA
- 6.0% on first $7,000 (net ~0.6% after state credit)
- Max ~$42/employee/year
- Employer only
4. PAY SUTA
- Varies by state and claims history
- Employer only — not withheld
Why W-4 Accuracy Matters
SCENARIO: ABC Barista earns $42,000/year
W-4 correct: ~$200/paycheck withheld → ~$0 due or small refund
Too many deps: Under-withheld → owes $2,000+ at filing
Extra withhold: Over-withheld → $2,600 refund (interest-free loan)
Goal: withhold close to what you'll owe — neither large balance due nor large refund.
Update your W-4 after marriage, divorce, new child, second job, or whenever a large refund or balance due surprises you.
Depositing Withheld Taxes: The Schedule
Withheld taxes must be deposited on a strict schedule. Holding them risks penalties.
Monthly Depositor
Lookback ≤ $50K → deposit by 15th of following month
Semi-Weekly Depositor
Lookback > $50K → deposit within 3–5 business days of payday
Next-Day Rule
$100K+ accumulated in one day → deposit next business day
LATE DEPOSIT PENALTIES:
1–5 days: 2% · 6–15 days: 5% · 16+ days: 10% · After notice: 15%
What is deposited (combined EFTPS):
- Employee federal income tax withheld
- Employee + employer Social Security (6.2% each)
- Employee + employer Medicare (1.45% each)
ABC Coffee Shop with 5 employees and biweekly payroll will likely be a monthly depositor, remitting by the 15th of each month.
Key Forms: W-4, W-2, and 941
| Form | Purpose |
|---|---|
| W-4 | Employee withholding certificate — inputs for withholding calc |
| W-2 | Annual wage and tax statement (issued by Jan 31) |
| 941 | Quarterly reconciliation of wages, withholding, and deposits |
KEY W-2 BOXES:
Box 1: Taxable wages (after pre-tax 401k, HSA)
Box 2: Federal income tax withheld
Box 3/4: Social Security wages / tax withheld
Box 5/6: Medicare wages / tax withheld
Box 7: Social security tips
Box 12: Codes (401k, health ins, etc.)
Tips: The Complication Most Employers Underestimate
For ABC Coffee Shop, tips are a major payroll complexity. All tips are taxable income to the employee.
Employee
- Report cash tips if $20+ in any month
- All tips on Form 1040 as income
- FICA applies to tips
Employer (ABC)
- Withhold income tax + FICA on reported tips
- Report in W-2 Box 7
- Claim FICA Tip Credit (Form 8846) on tips above minimum wage
The Trust Fund Tax: Why This Is Not Optional
Payroll taxes withheld from employees are "trust fund taxes." That money belongs to the government — ABC is merely holding it in trust.
- IRS can hold individuals personally liable (Trust Fund Recovery Penalty)
- 100% penalty on unpaid trust fund taxes
- Applies to owners, officers, bookkeepers — not just the entity
- Corporate bankruptcy and LLC status do not escape this
Common Payroll Tax Mistakes
Key Takeaway
Payroll taxes have two components: FICA (Social Security + Medicare, shared equally) and federal income tax withholding (based on the W-4). Employers withhold, match FICA, and deposit on a mandatory schedule — with stiff penalties for late deposits.
Withheld taxes are trust fund taxes — the most serious enforcement area in small business compliance. For ABC Coffee Shop, payroll tax compliance is as critical as accurate financial records.
Test Your Understanding
Question 1: An ABC employee earns $3,000 gross for the biweekly pay period. How much Social Security tax is withheld from this check?
Question 2: ABC Coffee Shop is a monthly payroll tax depositor. Payroll is processed on the 15th of each month. When must taxes be deposited?
Question 3: The "trust fund recovery penalty" means:
Ready to Practice?
Calculate gross-to-net pay, model FICA withholding, and trace employer payroll tax obligations in the Practice Lab.
Try the Practice Lab