Payroll tax basics for employers: what to withhold and file

Hiring your first employee adds more than a salary to the budget. It starts a cycle of withholding, deposits and payroll returns that runs every pay period, every quarter and every year.

This guide walks through the federal basics in order. It is general information, so check current IRS and state guidance and talk to a CPA about your own situation.

What do you need before the first paycheck?

You need an Employer Identification Number (EIN) and a completed Form W-4 from each new employee, which tells you how much federal income tax to withhold. Employers also complete Form I-9 to verify the employee's eligibility to work in the United States.

Most states require a new-hire report and their own withholding registration. Confirm early whether the person is an employee or an independent contractor, since contractors are handled differently. Our who needs a 1099-NEC guide covers the contractor side.

What do you withhold from each paycheck?

From gross pay, you generally withhold:

• Federal income tax, based on the employee's Form W-4
• Social Security tax at 6.2%, up to the annual wage base
• Medicare tax at 1.45%, plus 0.9% Additional Medicare Tax on wages over $200,000
• State and local income tax, where it applies

What remains is net pay. The Social Security wage base changes each year, so check the current figure rather than reusing an old one. For a rough look at take-home pay, try our paycheck calculator; it gives an estimate and does not replace a payroll system.

What does the employer pay on top?

The employer matches the employee's Social Security and Medicare taxes, so the federal FICA cost is 7.65% of covered wages on each side. The employer also pays federal unemployment tax (FUTA), which is 6.0% on the first $7,000 of each employee's wages, generally reduced by a credit of up to 5.4% for state unemployment taxes paid.

State unemployment insurance is a separate employer cost with rates set by the state. The total cost of an employee is gross pay plus these employer taxes and any benefits you provide.

Which federal payroll forms are due, and when?

Withheld income tax and both shares of FICA are deposited on a monthly or semiweekly schedule and reported quarterly on Form 941. FUTA is reported once a year on Form 940.

After year-end, give each employee a Form W-2 and file Forms W-2 with Form W-3 with the Social Security Administration, all by January 31. Late deposits and late returns can bring penalties, which is why many owners hand this off to a payroll service.

What happens when an employee leaves?

Pay final wages according to your state's rules and run them through payroll as usual. The departing employee's wages are included on your regular Form 941 and on the W-2 you issue after year-end.

Keep employment tax records for at least 4 years after the tax is due or paid, whichever is later. Our how long to keep tax records guide lists the other retention periods.