Understanding US income tax for employers
Reviewed by Mellow Editorial Team, HR & payroll content team
Federal income tax is the employee's liability, not the employer's — but employers are legally required to withhold it from wages and remit it to the IRS on the employee's behalf. Getting that process right matters: errors trigger penalties, interest, and audit risk.
How the withholding system works
Employees complete Form W-4 when they start a job. The information on that form — filing status, dependents, any additional withholding amounts — tells you how much federal income tax to withhold from each paycheck.
Tax is calculated using a progressive rate structure. Rates run from 10% on the lowest taxable income through to 37% at the top. You do not need to apply these brackets manually. The IRS publishes withholding tables and a computation method in Publication 15-T each year, and most payroll software applies the correct calculation automatically based on the W-4 data you enter.
One practical point: if an employee does not submit a W-4, you must withhold at the default rate as if they are a single filer claiming no adjustments. Do not skip withholding because the paperwork is missing.
FICA: what employers actually owe
Unlike income tax, FICA (Federal Insurance Contributions Act) taxes create a direct cost for you as the employer.
FICA has two components:
- Social Security tax is 6.2% of wages up to the annual wage base. The employee pays 6.2% and you, the employer, match that with another 6.2%.
- Medicare tax is 1.45% for the employee, with no wage cap. Again, you match 1.45%.
There is also an Additional Medicare Tax of 0.9% on high-earning employees, but this is the employee's liability only — you withhold it once wages cross the applicable threshold, but you do not match it.
In practical terms, for every dollar of wages you pay, you are contributing an additional 7.65% in employer-side FICA on top of your payroll cost. That figure is worth building into your compensation budgeting from the start.
Depositing and reporting: the timelines that matter
Withholding tax and FICA must be deposited with the IRS on a schedule — either monthly or semi-weekly, depending on your total tax liability in a defined lookback period. New employers generally start on the monthly schedule. The IRS assigns your deposit schedule; you can confirm it in Publication 15.
Missing deposit deadlines is one of the most common employer payroll mistakes and the penalty structure scales quickly — from 2% for deposits a few days late up to 15% for amounts unpaid more than ten days after an IRS notice.
Beyond deposits, the core reporting obligations are:
- Form 941 — filed quarterly, this reports wages paid, federal income tax withheld, and both the employee and employer share of FICA for that quarter.
- Form W-2 — sent to each employee and filed with the Social Security Administration by January 31 following the tax year. This reports total wages, tips, and all taxes withheld for the year.
If you use contractors rather than employees, the relevant form is 1099-NEC, also due by January 31, for any contractor paid $600 or more during the year. Contractors handle their own income tax and self-employment tax — you do not withhold for them.
State income tax: an additional layer
Federal withholding is only part of the picture. Most states levy their own income tax, and each has its own rate structure, forms, and deposit rules layered on top of the federal requirements.
A handful of states — including Texas, Florida, and Washington — have no state income tax, which simplifies the employer obligation considerably. Everywhere else, you need to register with the state tax agency, withhold at the applicable state rate, and file state payroll returns on whatever schedule that state requires.
If you have employees working in multiple states, you may have withholding obligations in each of those states. This is a common complication for remote workforces and worth reviewing carefully — state tax authorities do audit for proper registration and withholding.
Common mistakes to avoid
A few errors come up repeatedly:
Misclassifying workers. Treating an employee as an independent contractor to avoid withholding and FICA is one of the IRS's highest-priority enforcement areas. The classification test looks at the economic and behavioral relationship, not just what a contract says.
Stale W-4 data. Employees can update their W-4 at any time. Make sure your payroll reflects the most current version submitted.
Ignoring supplemental wages. Bonuses, commissions, and severance are subject to withholding. The IRS allows a flat supplemental withholding rate for these payments — check Publication 15 for the current method.
Missing the January 31 deadline. W-2s and 1099-NECs are due on the same date. Late filing penalties apply per form, which adds up fast if you have a large workforce.
Understanding these mechanics — and keeping your deposit schedule, quarterly filings, and year-end forms on track — is the baseline of compliant US payroll.
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