How to Calculate Employee Taxes: A Step-by-Step Guide for HR & Payroll Teams

In the fiscal year 2023, the IRS assessed over $25.6 billion in additional taxes for late-filed returns and collected nearly $2.8 billion in delinquent returns. This indicates the penalties small businesses may have to pay when payroll calculations aren’t handled accurately. This guide breaks down employee tax calculations and shares tips to help you stay compliant while managing your payroll. 

What are Employee Payroll Taxes?

Payroll taxes are deductions made from an employee’s paycheck by the employer, covering federal, state, and local income taxes, and Social Security and Medicare taxes. Payroll taxes apply only to W-2 employees—you’re not responsible for withholding or paying taxes on payments made to independent contractors. However, you must properly classify your workers as employees or contractors from the start, or you could face financial penalties and back taxes. 

How to Calculate Your Employee’s Payroll Taxes

You might wonder, "I know employees need to pay taxes per check, but how are these taxes really calculated?" Start by collecting the right information and necessary paperwork for employee onboarding. This will help you perform an accurate payroll tax calculation from the start. Since every employee’s tax calculation varies based on multiple factors, follow the step-by-step guide below to help navigate through the process:

Federal Income Tax: Have the Employee Complete a Form W-4

Form W-4, or an Employee’s Withholding Certificate, determines how much federal income tax should be withheld from each paycheck. This tax applies to all taxable compensation, including wages, salaries, commissions, and bonuses. 

The withholding amount varies for each employee based on their filing status, exemptions, income bracket, and tax credits. Employees aren’t required to submit a new W-4 every year, but they should update it if their financial or personal situation changes, such as a change in filing status.

State Income Tax: Have the Employee Complete a State Withholding Form

Form W-4 applies only to federal income tax, but some states require their own withholding forms. If applicable, have the employee complete the state-specific form to calculate the correct withholding amount. Some states, including Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming, do not impose income taxes. Check state regulations to ensure compliance.

Determine any Additional State, City, or Local Tax Contributions

Tax requirements vary by state, city, and locality, so when onboarding a new employee, check for any additional taxes that may apply. For example, some cities impose taxes such as public transportation or unemployment insurance taxes that are employee-paid. Understanding these requirements is essential for accurate withholdings and employer payroll tax compliance.

Calculate Federal Tax Contributions

Both employees and employers contribute to the Federal Insurance Contributions Act (FICA), which funds Social Security and Medicare. These taxes are shared equally, with each party covering half of the total contribution per paycheck.

Since FICA tax rates can change annually, staying informed is essential. Here’s the breakdown of contribution calculations as of 2025:

• Social Security-  Total requirement: 12.4%. The employer pays 6.2% and the employee pays 6.2%.    

• Medicare- Total requirement: 2.9%. The employer pays 1.4% and the employee pays 1.4%.

Track Wage Base Thresholds

While the above table shows the baseline payroll tax rates, you’ll still need to track each employee’s taxable income since certain taxes are subject to wage base limits that impact the withholding amount.

• Social Security: For 2025, the Social Security Tax has a wage base of $176,100. Employer and employee contributions stop once an employee reaches this earnings threshold.

• Medicare: Unlike Social Security, Medicare taxes have no wage base limit. Employees who earn over $200,000 in the calendar year are subject to an additional Medicare Tax.

• Additional Medicare Tax: As of 2025, employees (not employers) must pay an extra 0.9% in Medicare tax once their taxable income exceeds $200,000. 

Submit Payroll Taxes

While employees ultimately pay these payroll taxes, it's your responsibility to withhold the correct amounts and submit their tax contributions to the IRS on their behalf. Payroll tax deposits must be made monthly or semi-weekly, depending on your business. Review IRS Publication 15 at the beginning of each calendar year to determine your deposit schedule. 

Failing to submit payroll taxes on time can result in penalties and interest, including the Failure to Deposit penalty, which ranges from 2% to 15% of the deposit amount. 

How Justworks Can Help Calculate Your Employees' Payroll Taxes

Many small business owners can be hit hard by unexpected tax burdens and penalties due to payroll tax mistakes or oversights. But Justworks lets you rest easy by handling your compliance duties. It automatically withholds the correct tax contributions, files deposits on your behalf, and tracks those wage base limits. Ready to learn more about how Justworks can help you stay compliant while growing your team? Contact us today to get started.