Payroll Tax Withholding Explained for Small Business Employers

So what is payroll tax withholding, exactly? It’s the process that employers use to deduct taxes directly from their employees' paychecks. Yes, it’s your responsibility as an employer to hold back a portion of employee wages and send that money straight to the IRS and other tax authorities.

Why does this matter? For employees, proper withholding ensures they’re paying taxes gradually throughout the year—this way, employees can avoid big, unexpected bills at tax time. 

For the IRS, payroll withholding provides a consistent cash flow for federal expenses like Social Security, Medicare, infrastructure, and public services. Improper tax withholding can lead to penalties for your business and stressful tax surprises for your employees.

We’ll walk you through how payroll tax withholding works—including how to calculate withholding tax for payroll, which payroll taxes employers must pay themselves, and why getting it right matters for your small business’s bottom line.

TL;DR: Payroll Tax Withholding Explained For Employers

Need to get payroll tax withholding right? Here’s what you need to know:

‍Payroll tax withholding is when employers withhold federal, state, and local taxes from employee paychecks and send them to the appropriate government agencies. It's essential for staying IRS-compliant and avoiding costly penalties.

‍Why accurate withholding matters: Under-withholding can trigger IRS audits and late fees. Over-withholding frustrates employees and can lead to messy tax returns.

What gets withheld from employee paychecks:

• Federal income tax (based on W-4 and IRS tables)
• Social Security tax (6.2%)
• Medicare tax (1.45%)
• State and local income taxes, if applicable

Taxes paid by employers (not deducted from employees):

• Employer portion of Social Security and Medicare (6.2% + 1.45%)
• Federal Unemployment Tax (FUTA)
• State Unemployment Tax (SUTA)

How to calculate payroll tax withholding:

1. Use the employee’s W-4 info
2. Refer to IRS Publication 15-T or an IRS tax table
3. Calculate federal income tax withholding
4. Add FICA taxes and any additional deductions
5. Use software or a payroll tax withholding calculator to avoid errors

Top tools to simplify payroll tax withholding:

• IRS Tax Withholding Estimator
• Homebase Payroll

Why is it So Important To Withhold The Correct Amount of Payroll Tax?

Withholding the right amount of payroll tax is necessary for good bookkeeping. It’s also simply good business practice. “How so?” You may ask. 

If you don’t withhold enough, you could face steep penalties, fines, or even IRS audits. Not only are IRS audits stressful, they’re also a big time-eater—they waste precious time that you could spend running your business instead.

For your employees, accurate withholding means they’re paying their taxes throughout the year—no nasty surprises or large lump-sum payments come tax season. When amount of taxes withheld = what’s actually owed, filing tax returns is straightforward and stress-free. 

On the flip side, incorrect withholding = frustrated employees, as they may owe unexpected amounts or miss out on tax refunds.

In short: Correct tax withholding protects your business from costly mistakes and keeps your team financially secure and confident when tax time rolls around.

“Before Homebase I was manually tallying up my team's work hours and entering them into payroll, crossing my fingers I hadn't made any mistakes. Now our entire team logs in and out quickly and easily with the Homebase app, and all I have to do is send their hours to my payroll program with the click of a button.” — Kathleen Smith, Founder of Smiling Tree Toys (Retail)

How Payroll Tax Withholding Works: What Gets Withheld

Every time you run payroll, you’ll withhold certain taxes from your employees’ paychecks. Knowing exactly what withholding tax means and maintaining correct withholding rates keeps your business compliant and your team confident.

Here’s exactly what gets withheld and why it matters:

• Federal income tax: This is the largest chunk of payroll tax withholding. Employees fill out a Form W-4, which helps you calculate payroll tax withholding based on their income, filing status, and dependents. The federal income taxes that are withheld from employees’ paycheck go directly to the federal government to pay for public services, infrastructure, defense, and more.
• Social Security tax: Both you and your employees contribute to Social Security. Employees currently pay 6.2% of their income (up to an annual wage limit, adjusted annually). Employers match this amount, making it one of the primary payroll taxes paid by employers.
• Medicare tax: Like Social Security, Medicare taxes are split between employee and employer. Employees pay 1.45% of their wages, with no annual cap. Employers pay an equal amount on their behalf, another example of taxes paid by employers on behalf of employees. This means that the total rate for Medicare tax is 2.9%.
• State and local income taxes: You may also need to withhold state and local taxes. The actual rate depends on your specific location. Rates vary widely, so check your state’s revenue agency to understand your obligations and accurately calculate payroll tax withholding for your specific area.

What Employers Pay: Taxes Paid on Behalf of Employees

While payroll tax withholding involves taking taxes from employee paychecks, employers also directly pay certain taxes out of their own pockets. Here are the employer taxes on payroll that businesses must cover:

Social Security and Medicare (FICA)

Employers match the amount withheld from employee wages:

• Social Security: 6.2% on employee earnings (up to the annual wage limit).
• Medicare: 1.45% of all employee earnings, with no annual cap.

Federal Unemployment Tax (FUTA)

Employers also pay FUTA, which is typically 6% on the first $7,000 each employee earns annually. If you’re from a credit reduction state, you may receive tax credits on FUTA, which can reduce the rate significantly. With credits, the effective rate could be as low as 0.6% if they file their Form 940, which is the Employer’s Annual Federal Unemployment (FUTA) Tax Return.

State Unemployment Tax (SUTA)

Rates vary by state and employer history, which is usually based on your company’s employee turnover rate. Like FUTA, this is fully funded by employers—and has no employee paid portion.

How to Calculate Payroll Tax Withholding

Calculating payroll tax withholding got you scratching your head? Follow this step-by-step guide to get it right, every paycheck.

1. Grab the employee’s W-4
Start with the employee’s W-4 form. This form shows their filing status, number of dependents, and any exemptions or additional withholding they’ve requested. Use this form as your baseline for accurate withholding.

2. Use IRS tax withholding tables
Next, check the IRS withholding tables, which are updated annually in IRS Publication 15-T. These tables show you exactly how much federal income tax to withhold based on wages, filing status, and pay frequency.

3. Calculate federal income tax withholding
Using the W-4 and withholding tables, calculate payroll tax withholding amounts for federal income taxes. This ensures the proper amount gets withheld—avoiding any nasty tax-time surprises for your employees.

4. Add FICA taxes (Social Security and Medicare)
Next, include Social Security and Medicare taxes (FICA). Withhold 6.2% for Social Security (up to the annual limit) and 1.45% for Medicare. Remember, you’ll match these amounts as part of the payroll taxes paid by the employer.

5. Don’t forget state, local, and other deductions
If your state or local area requires additional income tax withholding, factor these in as well. Add any voluntary deductions employees have authorized—like retirement or health plan contributions.

Pro tip: Skip the manual math by using a trusted payroll tax withholding calculator or payroll software like Homebase. By helping you manage employee hiring, scheduling, and payroll all in one platform, it automatically keeps you compliant, accurate, and stress-free.

Tools and Resources to Simplify Payroll Tax Withholding

You’ve got a business to run—don’t let payroll tax withholding slow you down. Use these tools and resources to streamline the payroll process, stay compliant, and ditch manual calculations for good.

1. IRS Tax Withholding Estimator

This free, easy-to-use payroll tax withholding calculator helps you quickly verify withholding accuracy. Perfect for double-checking your math or handling tricky W-4 situations.

2. Payroll Software Solutions like Homebase

Payroll software tools like Homebase can simply payroll for your business. Homebase can automate payroll calculations, handle employee deductions, file taxes automatically, and make compliance effortless—saving hours every payday.

“Homebase has reduced our cost of doing business overall. As a small business it's vital that we have multi-purpose tools that assist with our daily operations. We use Homebase for scheduling time away, payroll and team communication.” — Joi and Val Jackson, Owners of Hairizon (Beauty & Wellness)

4. IRS Publication 15 (Employer’s Tax Guide)

Bookmark IRS Publication 15 as your go-to employer reference. It covers federal withholding tables, rules, and compliance guidelines clearly and concisely.

Frequently Asked Questions about Payroll Tax Withholding

Can I do payroll withholding manually?

Yes, but it’s not for the faint of heart. You’ll need to calculate federal income tax using IRS withholding tables, add up FICA taxes (Social Security and Medicare), and consider state or local taxes if applicable. It’s doable—but time-consuming and error-prone. That’s why most businesses opt for payroll tax withholding calculators or software to get it right.

‍What happens if I withhold too little or too much?

If you withhold too little, your employee may owe a big chunk come tax season—and you could face penalties for non-compliance. If you withhold too much, your employee gets a tax refund later, but smaller paychecks in the meantime. Either way, accurate withholding matters. It protects both you and your team from avoidable tax headaches.

‍How often should payroll taxes be remitted to the IRS?

It depends on your payroll size. Most small businesses deposit monthly, while larger operations may need to deposit semi-weekly. Refer to your IRS deposit schedule and Publication 15 to stay compliant. Late deposits = late penalties, so mark your calendar and set those reminders.

‍What’s the difference between withholding tax and payroll tax?

Good question. Withholding tax refers to the money you subtract from employee paychecks—mainly federal income tax, state income tax, Social Security, and Medicare. Payroll tax, on the other hand, includes what you withhold from employees plus the employer payroll taxes you pay on their behalf, like your share of FICA and unemployment taxes. Understanding this difference is key to accurate reporting.

‍Should your employees choose 0 or 1 on their W-4?

Choosing “0” means more taxes withheld from each paycheck—less take-home pay now, but less risk of owing money later. Choosing “1” means less taxes withheld, which can boost paycheck size but increases the risk of under-withholding.

‍Example:

Let’s say an employee earns $1,000 per week:

• Claiming 0 might withhold ~$180 in federal taxes.
• Claiming 1 might withhold ~$150.

It adds up fast—so employees should choose based on their actual tax situation, not just for a fatter paycheck today.

‍What percentage of a paycheck is typically withheld?

Here’s a ballpark breakdown for a standard full-time employee:

• Federal income tax: 10%-22% (depends on bracket & W-4)
• Social Security tax: 6.2% (matched by employer)
• Medicare tax: 1.45% (also matched by employer)
• State income tax: Varies by state (0%–10%+)

‍Example:

If an employee earns $1,000/week, expect about $170–$250 total withheld, depending on location and filing status.

Want to skip the math? Use a payroll tax withholding calculator or automated payroll software to handle it all for you—accurately and stress-free. 

Get withholding right the first time

Payroll tax withholding isn’t just a back-office task—it affects everything from your team’s take-home pay to your business’s compliance record. Withholding too little can lead to IRS penalties. Withholding too much? That’s money your employees could’ve used today.

Getting it right means staying current with tax rules, understanding W-4 forms, and calculating with precision—every single pay run. That’s a lot to manage manually, especially as your team grows.

Tools like Homebase can help automate the process and reduce risk. With integrated time tracking, payroll, and tax filing, it’s easier to stay compliant and avoid costly mistakes—without spending hours buried in spreadsheets.

Because accurate withholding isn’t optional—and doing it manually doesn’t scale.