The Basic Formula for Payroll Taxes

Payroll tax calculation starts with gross pay — the total amount an employee earns before any deductions. From that number, you subtract the employee's share of Social Security and Medicare taxes, federal income tax withholding, and any state or local income taxes that apply. The employer then pays a matching share of Social Security and Medicare on top of what the employee receives.

The math itself is straightforward multiplication. Social Security tax is 6.2% of gross pay (up to an annual wage cap that changes each year). Medicare tax is 1.45% of all gross pay with no cap. Federal income tax withholding depends on the W-4 form the employee filed, which tells you how many allowances they claim. State and local taxes vary by location and are calculated differently in each jurisdiction.

The employer's share mirrors the employee's share for Social Security and Medicare — 6.2% and 1.45% respectively. Employers do not withhold federal income tax from their own pocket; they only withhold it from employee pay and send it to the IRS.

Key Takeaways

  • Social Security tax is 6.2% of gross pay up to an annual wage limit (the limit changes yearly), and Medicare tax is 1.45% of all gross pay with no limit.
  • Federal income tax withholding is based on the employee's W-4 form and their gross pay, and varies by the number of allowances they claim.
  • Employers pay a matching 6.2% Social Security and 1.45% Medicare tax on each employee's wages in addition to what they withhold from the employee.
  • State and local income tax rates and rules differ by location and must be looked up for your specific jurisdiction.
  • The Social Security wage cap changes annually, so you must check the current year's limit before calculating taxes on high-earning employees.

Finding the Social Security Wage Cap for Your Year

The Social Security wage cap is the maximum amount of an employee's annual earnings subject to Social Security tax. Once an employee reaches that cap in a calendar year, you stop withholding the 6.2% Social Security tax from their paychecks for the rest of that year. The cap is set by the Social Security Administration and increases most years to account for wage growth.

The IRS publishes the current year's wage cap on its website and on the Social Security Administration website. For 2024, the cap was $168,600. For 2025, it is $176,100. If an employee earns $200,000 in a year, you withhold Social Security tax only on the first $176,100 (in 2025), not on the remaining $23,900.

Medicare tax has no wage cap — you withhold 1.45% on every dollar an employee earns, no matter how high their annual income goes. High-earning employees also owe an additional 0.9% Medicare tax on wages above $200,000 (single filers) or $250,000 (married filing jointly), which you must withhold separately.

Using the W-4 Form to Calculate Federal Income Tax Withholding

The employee's W-4 form tells you how much federal income tax to withhold from each paycheck. The form asks the employee to report their filing status, number of jobs, number of dependents, and other income. Based on those answers, the IRS provides a withholding amount that you use to calculate the deduction.

The IRS publishes tax withholding tables each year that show you the dollar amount to withhold based on the employee's gross pay, pay frequency, and the information on their W-4. You can find these tables on the IRS website under Publication 15-T. The tables are organized by pay period (weekly, biweekly, semimonthly, monthly) and filing status.

If an employee does not file a W-4, you must withhold federal income tax as if they claimed zero allowances, which results in the maximum withholding. When an employee updates their W-4 — for example, after a marriage, divorce, or birth of a child — you use the new form starting with the next paycheck.

Calculating State and Local Income Tax Withholding

State income tax withholding varies significantly by state. Some states have no income tax at all (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming). Others use a flat tax rate, while most use a progressive system with multiple tax brackets. Some states also require local income tax withholding on top of state tax.

Each state publishes its own withholding tables and rules. You must check your state's department of revenue or taxation website to find the correct tables for your location and the current tax year. Many states also require employees to file a state W-4 form (sometimes called a state withholding certificate) that works similarly to the federal form.

If your business operates in multiple states, you withhold based on the state where the employee works, not where your business is located. An employee who works in New York must have New York state tax withheld, even if your company is based in another state.

Step-by-Step Example of a Single Paycheck Calculation

Assume an employee earns $2,000 in gross pay for a biweekly paycheck in 2025. They are single, filed a standard W-4, and work in a state with a 5% flat income tax.

Social Security tax: $2,000 × 6.2% = $124 (assuming they have not yet hit the annual wage cap).

Medicare tax: $2,000 × 1.45% = $29.

Federal income tax withholding: Using the IRS Publication 15-T table for biweekly pay, single filer, standard W-4, the withholding on $2,000 is approximately $156 (the exact amount depends on the current year's table).

State income tax: $2,000 × 5% = $100.

Total employee deductions: $124 + $29 + $156 + $100 = $409.

Net pay (what the employee receives): $2,000 − $409 = $1,591.

Employer's share of payroll taxes: Social Security $124 + Medicare $29 = $153. This is a cost to the employer in addition to the $2,000 gross wage.

Common Mistakes to Avoid When Calculating Payroll Taxes

One frequent error is forgetting to check whether an employee has reached the Social Security wage cap. If you continue withholding 6.2% after the cap is met, you will owe the employee a refund and may face penalties. Track cumulative gross pay for each employee throughout the year and stop Social Security withholding once the cap is reached.

Another mistake is using outdated withholding tables or wage caps. Tax rates and limits change annually. Download the current year's IRS Publication 15-T and check the Social Security Administration website for the current wage cap before the year begins. Payroll software typically updates automatically, but if you calculate by hand, you must update manually.

Misreading the W-4 form is also common. Make sure you understand the difference between the old W-4 (used through 2019) and the new W-4 (introduced in 2020). The new form does not use "allowances" — it uses dollar amounts and other information. If an employee files the old form, clarify which version they are using before calculating withholding.

Finally, do not assume all employees owe the same state tax. If you have employees in multiple states, each one's withholding must be calculated using that state's rules and tables. Mixing up state withholding tables is a common source of errors.

Where to Find Official Tax Tables and Rates

The IRS website (irs.gov) publishes Publication 15-T, which contains federal income tax withholding tables for all pay frequencies and filing statuses. The site also lists the current Social Security wage cap, Medicare tax rates, and any changes to tax law.

The Social Security Administration website (ssa.gov) confirms the annual wage cap and provides historical caps if you need to reference past years.

Your state's department of revenue or taxation website publishes state income tax withholding tables, state W-4 forms, and state tax rates. Search "[your state] department of revenue" to find the correct office.

If your locality has income tax, the city or county tax office website will have local withholding tables and rules. Some large cities (New York City, Philadelphia, Columbus) have their own income tax systems separate from state tax.

Frequently Asked Questions

What if an employee's W-4 says "exempt"?

An employee who claims exempt status on their W-4 should have no federal income tax withheld. However, the IRS limits who can claim exempt status — generally only employees who had no tax liability in the prior year and expect none in the current year. If an employee claims exempt, you withhold no federal income tax, but you still withhold Social Security, Medicare, and state/local taxes.

Do I withhold payroll taxes on bonuses and commissions?

Yes. Bonuses and commissions are treated as wages and are subject to the same Social Security, Medicare, federal income tax, and state/local tax withholding as regular pay. Calculate withholding on the total gross pay (regular wages plus bonus) for that pay period using the same methods and tables.

What happens if I withhold the wrong amount of federal income tax?

If you withhold too much, the employee receives a refund when they file their tax return. If you withhold too little, they owe additional tax. Either way, the employee's annual tax return (Form 1040) reconciles what you withheld against what they actually owe. Consistent use of the current W-4 form and IRS withholding tables minimizes errors.

Do I need to withhold payroll taxes on tips?

Yes. Employees must report tips to you, and you withhold Social Security, Medicare, and federal income tax on reported tips just as you do on wages. Some employers also withhold state and local taxes on tips. Tips are included in the employee's gross pay for withholding purposes.

How do I handle an employee who works part of the year?

Calculate payroll taxes on each paycheck using the same method as any other employee. The Social Security wage cap applies to the calendar year, so if an employee starts in June, you track their cumulative pay from June onward and stop Social Security withholding once they reach the cap in that calendar year, not based on how long they have worked.