Complete Guide to Payroll Tax: Definition, Costs, and Calculation

Payroll taxes include federal, state, and local taxes on employers and employees that fund various government-backed insurance programs, like unemployment benefits, health insurance, and disability insurance.

However, payroll taxes vary between countries, states, and local jurisdictions, creating a compliance obligation for all businesses, whether they operate domestically or internationally. 

For example, U.S.-based employers and employees are subject to national and regional taxation and must comply with each one to avoid fines and other noncompliance penalties. 

Fortunately, navigating payroll tax doesn’t have to be overwhelming or risky.

Read on for a complete breakdown of payroll tax, including key definitions, examples, and a step-by-step guide for calculating employer and employee payroll tax. Plus, find three useful strategies for mitigating risk.

What are payroll taxes?

Payroll taxes are taxes that federal, state, and local jurisdictions impose on employers and employees, often calculated based on a percentage of the employee’s salary or wage, that fund public insurance programs, like retirement, unemployment, and health insurance.

In most jurisdictions worldwide, employers are responsible for withholding and remitting employee payroll taxes from their employees’ monthly earnings. They're also responsible for reflecting employee contributions on the employee's payslip.

Payroll taxes are a critical aspect of calculating total employee cost as they amount to additional per-employee payments on top of base salaries.

Payroll taxes vs. employment taxes

The terms payroll tax and employment tax refer to taxes levied on employers and employees based on employee earnings. However, their meanings vary worldwide, with both terms often referring to a different set of taxes, depending on the country where you operate. 

For instance, in the U.S., employment tax refers to all federal, state, and local taxes on employee earnings, plus income taxes and state and local levies, such as contributions to state disability insurance and paid family medical leave programs.

On the other hand, payroll taxes in the U.S. are a subset of employment taxes, referring only to Medicare and Social Security (FICA), Federal Unemployment Tax (FUTA), and State Unemployment Tax (SUTA).

Payroll tax vs. employee income tax

Payroll tax and employee income tax differ in their purpose and who incurs it.

While both employers and employees are subject to payroll taxes, income tax is an employee-only tax. Employee income taxes fund various public initiatives, like road maintenance, law enforcement, and the justice system.

Consider the U.S. state of Delaware as an example: Employers and employees in Delaware both pay a 6.2% federal Social Security tax, which falls under the umbrella term of payroll tax, while only employees pay a 2.2% to 6.6% graduated state income tax.

Though employers do not pay employee income tax, they are responsible for withholding and remitting both payroll and income taxes from their employees’ monthly earnings.

Which payroll taxes do employers pay?

Employer payroll taxes often cover things like health insurance, unemployment insurance, workers’ compensation, and sick leave compensation. However, employers are subject to various payroll taxes, depending on the country or jurisdiction where they operate.

Below, we outline payroll taxes that employers are subject to in the U.S.

Employer payroll taxes in the U.S.

Employer payroll taxes at the state and local levels vary between jurisdictions in the U.S. 

However, all U.S. employers are subject to Social Security and Medicare (FICA), Federal Unemployment Tax (FUTA), and State Unemployment Tax (SUTA).

The following chart illustrates employer and employee contributions to statutory payroll taxes in the U.S. in 2023. Keep in mind that there are thresholds and caps on certain taxes and social contributions.

*A 0.9% additional Medicare tax applies to employee compensation that exceeds the following threshold amounts based on filing status:

• $250,000 for married filing jointly
• $125,000 for married filing separately
• $200,000 for all other taxpayers

Social Security taxes

Social Security taxes in the U.S. provide individuals with a source of income when they retire or if they can’t work due to a disability. 

Employers and employees share the cost of the Social Security tax evenly, each contributing 6.2% of the employee’s wages. Self-employed professionals pay the full 12.4% themselves.

Medicare taxes

Medicare is a federal health insurance program for people 65 or older, or under 65 with qualifying disabilities. 

Employers and employees in the U.S. share the cost of Medicare evenly, each contributing 1.45% of the employee’s wages. Self-employed professionals pay 2.9%. However, employees whose taxable salary is above a certain threshold pay an additional 0.9% for Medicare.

Federal unemployment tax (FUTA)

FUTA is a 6% employer-only tax on the first US $7,000 of an employee’s annual earnings. It funds the federal unemployment insurance and nationwide job services program.

Learn more: What Is the FUTA Tax?

State unemployment tax (SUTA)

In addition to FUTA, each U.S. state also levies an employer-only SUTA to support state-funded unemployment benefits. 

States calculate SUTA based on a percentage of the employee wage base. SUTA rates vary between states, depending on various factors, like a business’s age, its industry, and its turnover rate. Each state also sets its own wage base, which caps employees’ taxable earnings. 

Take South Dakota for example: The new-employer SUTA tax rate is 1.2%, and the wage base is US$15,000. To calculate their SUTA tax for any employee with annual earnings above US$15,000, a new employer would multiply 1.2% by US$15,000.

Employer payroll taxes in other countries

Because payroll tax rates, rules, and calculations vary worldwide, global employers must take extra precautions to ensure they understand payroll taxes in each country where they operate or hire local talent if they want to avoid fines and other non-compliance penalties.

For example, businesses operating or running payroll in the Philippines are subject to the following payroll taxes:

• Social Security System (SSS). The SSS is a government-guaranteed fund that provides financial support for employees who can’t work due to disability, maternity, sickness, old age, and other contingencies. The monthly contribution rate for employers is 9.5%, capped at ₱1,900. For employees, it’s 4.5%, capped at ₱900.
• Philippine Health Insurance Corporation (PhilHealth). Employers in the Philippines must contribute to PhilHealth, the state health insurance fund. The total contribution rate is 4% of the employee’s monthly earnings, with an income ceiling of ₱80,000. Employers and employees share the cost equally.
• Home Development Mutual Fund (HDMF). The HDMF is a savings fund for employees in the Philippines, and its primary goal is to help employees finance a new home. Employers contribute 2% of their employee’s monthly earnings, while employees contribute 1% on salaries up to ₱1,500 and 2% on salaries over ₱1,500.

However, businesses operating or running payroll in the U.K. are subject to the following payroll taxes:

• National Insurance Contributions (NIC). NICs help fund numerous state benefits and services, such as health care and retirement. NIC tax rates vary according to the U.K.’s category and earnings schedule, with employees paying 12% and employers paying 13.8% on average.
• Workplace Pension. Employees between 22 and 66 who earn at least £10,000 annually must contribute to the federal retirement fund or workplace pension. The contribution rate for employers is 5%. For employees, it’s 3%.

How to calculate employer payroll taxes

While the process for calculating employer payroll taxes varies worldwide, the following guide gives you a general idea of how to calculate monthly payroll taxes. 

1.  Determine employee’s gross wages

Your employee’s gross wages are their total earnings before you withhold non-taxable wages and pre-tax deductions.

2. Subtract non-taxable wages and pre-tax deductions

Subtract the non-taxable wages and pre-tax deductions from the employee’s gross wages to get their gross taxable income. 

Non-taxable wages are additional payments from employers to employees, such as gifts or disability wages, that are tax-exempt. Pre-tax deductions are percentages the employer withholds from employee earnings for supplemental benefits, like additional health insurance or retirement plans. 

3. Calculate employer tax contributions

Multiply the rate of each employer tax contribution against the employee’s gross taxable income to determine how much you owe for each tax.

Remember that employer contributions vary per jurisdiction, and there may also be thresholds and caps on certain taxes that could impact how much you owe.

Use our employee cost calculator below to accurately calculate payroll contributions and annual costs for your global team.

Payroll tax example

The following example illustrates how to calculate employer payroll taxes:

Sam earns a US$4,000 gross monthly salary as a legal assistant in Alaska. To calculate payroll taxes on Sam’s July earnings, her employer performs the following calculations:

1. They subtract Sam’s pre-tax contribution of US$125 to the company health insurance plan from her gross salary to reach a gross taxable income of US$3,875.
2. Next, they calculate total employer contributions based on her gross taxable income:
    

The total employer payroll tax for Sam’s July income is US$645.19. 

Remember, this doesn’t include Sam’s employee contributions, which her employer must withhold and remit from her salary on her behalf and ensure the appropriate amount is reflected on Sam's payslip.

How to ensure global payroll tax compliance

Global companies use different strategies to ensure global payroll compliance when doing business or hiring talent overseas. Below, we outline the three primary ways to mitigate compliance risks when running payroll for a global workforce.

Research payroll tax laws in your target market

The first option is to take payroll compliance responsibility upon yourself and spend time researching payroll tax laws, rules, and rates in each country where you plan to operate. 

On the one hand, familiarizing yourself with your target market’s payroll tax laws in advance can save you from a world of trouble down the line, and it serves as a cost-effective option for some firms. However, the risks involved with going it alone almost always outweigh the potential cost-benefits.

The complexities of payroll tax legislation worldwide make it difficult for businesses to fully grasp the breadth of the law in each country where they operate, leaving them exposed to major compliance risks. 

Partnering with a third party that has local expertise is almost always safer. 

Set up legal entities to operate payroll in-house

If you already plan to set up entities in your target markets, you may consider decreasing your risk exposure by hiring local experts in each of your target markets to form in-house finance teams that handle local payroll in each jurisdiction.

While this approach reduces your risk exposure to some degree, it still requires you to have the necessary resources to handle compliance on your own. Plus, it leaves you responsible for employing and paying your global talent, which is costly, time-consuming, and difficult to scale. 

Outsource payroll to a global payroll partner

Reduce payroll compliance risk while maintaining cost-effectiveness and scalability; enlist the help of a centralized global payroll outsourcing partner. 

A global payroll partner is a single organization that coordinates with local payroll vendors on your behalf in each jurisdiction where you operate, streamlining each aspect of global payroll into a single management system, thereby reducing errors, compliance risks, and inefficiencies. 

Even better, employers can engage and pay talent in multiple countries without setting up entities when they outsource global payroll to an employer of record (EOR). An EOR serves as the legal employer of your international workforce and handles onboarding, payroll, benefits administration, and compliance while you continue to own daily tasks and responsibilities.

Learn more: What Is an Employer of Record?

If you choose this route, remember to carefully vet each global payroll partner to choose one that is trustworthy, reliable, and has the capabilities to ensure compliance.

Simplify payroll tax with Velocity Global

Global expansion offers businesses access to lucrative new markets, a larger talent pool, regional trade agreements, and many other opportunities. However, the complexities of running global payroll deter businesses from starting. Fortunately, the right partner can make a world of difference.

Velocity Global’s Employer of Record (EOR) solution eliminates the risk and complexities of running payroll for a global team. Our integrated workforce management platform consolidates the entire payroll process into a single interface that facilitates timely, accurate, and compliant payroll and reporting for distributed teams in over 185 countries.

Lean on us to onboard, pay, and manage your global workforce so you can focus on your day-to-day activities stress-free.

Contact Velocity Global today to learn how to compliantly hire and pay global talent with ease.

Payroll tax FAQs

Below, you can find answers to frequently asked questions about payroll taxes.

Who pays payroll taxes?

Employers, employees, and self-employed professionals are all subject to payroll taxes. However, each party is subject to different rates and rules, which vary worldwide.

In most jurisdictions, employers and employees share the cost of some taxes, while other taxes apply only to one party. Employers must withhold relevant taxes from their employees’ monthly salaries and remit payments to the relevant entity on their employees’ behalf. 

Self-employed professionals are responsible for covering the entire cost of all relevant payroll taxes and making remittances themselves.

What does tax withholding mean?

Tax withholding refers to an employer deducting and remitting a percentage of their employee’s monthly earnings to fulfill their employee’s payroll tax obligations.

What is FICA?

FICA, or the Federal Insurance Contributions Act, is the mandatory federal payroll tax in the U.S. that funds Social Security and Medicare, two state-backed insurance funds that provide income for retired or disabled individuals, and health insurance for people 65 and older. 

What percentage of salary is payroll taxes?

The percentage of an employee’s salary that comprises payroll tax varies worldwide. In the U.S., payroll taxes amount to 7.65% of the employee’s monthly earnings, 6.2% of which goes to Social Security and 1.45% to Medicare.

Disclaimer: This information does not, and is not intended to, constitute legal or tax advice and is for general informational purposes only. You should contact your attorney or tax advisor to obtain legal and/or tax advice with respect to your particular situation. Only your individual attorney or tax advisor can provide assurances that this information—and your interpretation of it—is applicable or appropriate to your specific situation. All liability with respect to actions taken or not taken based on this information is hereby expressly disclaimed. All content is provided "as is" and Velocity Global makes no representations or warranties concerning this information.