How Payroll Works for a Small Business
From Tax Guide.
Tax Guide · Arab, Alabama
Payroll Taxes Explained: FICA, Withholding and More
What payroll taxes are, who pays each one, and how FICA, income tax withholding and unemployment taxes work for employers and employees in Alabama.
The short answer
What are payroll taxes?
Payroll taxes are the taxes tied to paying employees: some are withheld from the employee's pay, and some are paid by the employer on top of wages.
When you have employees, you become a tax collector for the government. You hold back part of each paycheck, add your own share of certain taxes, and send it all in on a schedule. Getting this right matters, because payroll taxes are an area that agencies take seriously.
A practical habit is to keep payroll tax money separate from everyday operating cash. Withheld amounts are not available to spend, and employer taxes are a predictable cost of every paycheck. Businesses that budget for the full cost of an employee, wages plus the employer share of payroll taxes, are less likely to be surprised when a deposit comes due.
This guide covers the main pieces. To see how they fit into a pay cycle, read how payroll works for a small business.
The main taxes
Who pays which payroll tax?
Some payroll taxes are shared between employer and employee, and some are paid only by the employer or only withheld from the employee.
The table below gives the general picture. The rates and wage limits are set by law and change, so we leave them out here and use the current published figures when we prepare payroll.
| Tax | Paid by | What it funds |
|---|---|---|
| Social Security (part of FICA) | Employee and employer share it | Retirement, disability and survivor benefits |
| Medicare (part of FICA) | Employee and employer share it | Health coverage for older adults and others |
| Federal income tax withholding | Withheld from the employee | Applied to the employee's income tax |
| Federal unemployment tax (FUTA) | Employer only | The federal unemployment system |
| Alabama income tax withholding | Withheld from the employee | Applied to the employee's Alabama tax |
| Alabama unemployment tax | Employer, under state rules | State unemployment benefits |
Some Alabama cities and counties also have occupational taxes on wages.
FICA
What is FICA on a paycheck?
FICA stands for the Federal Insurance Contributions Act, and it is the combined Social Security and Medicare tax taken from wages.
The employee pays a share through withholding, and the employer pays a matching share. That is different from the self-employed, who pay both halves through self-employment tax. There are wage limits and special rules for some workers, and those details change, so we check the current ones.
FICA amounts appear on a pay stub, so employees can see what was taken out. The employer's matching share does not appear on the employee's check but is part of the cost of having an employee.
Withholding
How much income tax do I withhold from employees?
The amount depends on the employee's pay, filing status and the information the employee gives on Form W-4, and you use the current IRS and Alabama tables to figure it.
The employer does not choose the amount. An employee who wants more or less withheld updates Form W-4. Our guide to W-2 and W-4 forms for employers covers the paperwork.
Alabama has its own withholding rules and forms, and we check how they apply. See Alabama withholding and unemployment tax for more.
Why it matters
What happens if I do not pay payroll taxes on time?
Late or missed payroll taxes can bring penalties and interest, and in serious cases the people responsible can be held personally liable.
The taxes withheld from employees are held in trust for the government. Using that money for other business costs is a common way owners get into trouble. The IRS can assess a penalty against responsible individuals, not just the business.
If you are behind, do not wait. Read payroll tax deposits and Form 941 for how deposits work, and call the office to review where you stand.
- Deposit withheld taxes on the schedule the IRS assigns
- File payroll returns even if you cannot pay in full
- Keep payroll records and proof of each deposit
- Open every agency notice as soon as it arrives
Contractors
Do I pay payroll taxes on independent contractors?
Generally no, because independent contractors are not employees and pay their own taxes, but the label alone does not decide it.
The IRS looks at the real working relationship. Treating an employee as a contractor to avoid payroll tax is a serious problem. See our guide to payroll mistakes to avoid for how it comes up.
Employers give employees a W-2 and contractors a 1099-NEC. If you are unsure which applies to a worker, ask before you pay them.
How we can help
How Melton Tax Services can help with payroll taxes
Our payroll and bookkeeping service can calculate withholding, keep track of what is owed and prepare the records that support your deposits and returns.
Through payroll and bookkeeping, we help small businesses handle the recurring payroll paperwork. If you are behind or have received a notice, our office can also review it and explain your options.
We serve Arab and the surrounding area. Call 256-586-4635 or use our contact page. Bring your paperwork to the office, and please do not send Social Security numbers or documents through the website.
Answers
Questions about payroll taxes explained
What is the difference between payroll tax and income tax?
Payroll taxes are tied to paying employees and include Social Security, Medicare and unemployment taxes. Income tax withholding is one piece of payroll, applied toward the employee's income tax return.
Does the employee or the employer pay FICA?
Both. The employee has a share withheld from pay, and the employer pays a matching share.
What is FUTA?
FUTA is the Federal Unemployment Tax Act tax, paid only by the employer. It is filed annually, and Alabama has its own unemployment tax on top of it.
Are payroll taxes deductible for the business?
The employer's share of payroll taxes is generally a deductible business expense. The employee's share is not, because it was withheld from wages, which are the deductible cost.
What is a trust fund tax?
It refers to the income tax and employee share of Social Security and Medicare taxes held back from wages. The employer holds them in trust for the government.
Do I have to pay payroll tax on my own wages?
If you are an owner-employee of a corporation, yes, wages are subject to payroll tax. Sole proprietors and partners are treated differently and pay self-employment tax.
Read next
Related reading
Payroll Tax Deposits and Form 941
From Tax Guide.
Alabama Withholding and Unemployment Tax
From Tax Guide.
Payroll Mistakes to Avoid and How to Fix Them
From Tax Guide.
Payroll and Bookkeeping
A service Melton Tax Services provides.
Melton Tax Services
Questions about your taxes or your business?
Our team in Arab is just a phone call away, and we are glad to talk it through with you.