Employer and Employee Taxes: What You Pay, What You Withhold, and How a Fractional CFO Keeps It Clean

A Bennett Financials Guide for Growing Businesses

Payroll taxes are one of those business realities that feel straightforward—until they aren’t. Most owners know they “have to withhold taxes” and “pay payroll taxes,” but that’s where clarity often ends. When you’re hiring quickly, operating in multiple states, offering benefits, or simply trying to get accurate financials month after month, the distinction between employer and employee taxes becomes more than semantics. It becomes the difference between predictable cash flow and recurring surprises, between clean books and messy reconciliations, between compliance confidence and penalty risk. This guide will clarify the differences between employer and employee taxes, what each party pays, and how to manage them.

This guide is for business owners, finance leaders, and anyone responsible for payroll compliance in a growing company. Understanding employer and employee taxes is critical for business success because it ensures accurate financial planning, prevents costly compliance mistakes, and supports sustainable growth.

At Bennett Financials, we see payroll tax confusion hit businesses at the exact moment they start to scale. Payroll grows from a simple process into a system: schedules, liabilities, filings, classification decisions, benefits, and accounting. And because payroll taxes are both time-sensitive and high-stakes, they’re one of the easiest places for small mistakes to become big problems.

Payroll taxes are taxes paid on wages or salaries that employees earn. They are federal taxes applied to an employee’s paycheck. This article explains what employer and employee taxes are, how they flow through payroll, where business owners get tripped up, and how a fractional CFO helps you build a payroll tax process that’s accurate, auditable, and forecastable.

Payroll taxes in plain English: social security and medicare—two buckets, two responsibilities

Both Social Security and Medicare taxes are collectively known as FICA taxes, which are paid by both employers and employees.

Employee payroll taxes: amounts you withhold from paychecks

Employee payroll taxes are the amounts deducted from an employee’s paycheck and held back to be remitted to tax authorities or other programs. These are not “company expenses” in the traditional sense. Your business is acting as a collection agent.

Common employee-side withholdings include:

• Federal income tax withholding
• Federal tax withholding (based on employees wages and Form W-4 details)
• State and local income tax withholding (where applicable)
• Social Security tax (employee portion, also known as employee FICA contributions)
• Medicare tax (employee portion, also part of employee FICA contributions)
• Any additional Medicare withholding for higher earners (where required)

These payroll tax deductions, including employee FICA contributions, are shown on employees pay stubs and are calculated based on employees wages. Employees pay these taxes directly from their wages, and it is important for employers to accurately calculate and withhold the correct amounts.

Some deductions on a paycheck aren’t taxes (like health insurance premiums or retirement contributions), but they behave similarly operationally: they reduce net pay and become liabilities you must remit.

Employees are primarily responsible for their personal income tax liability and must file annually to reconcile withholdings.

Key point: Employee taxes reduce the employee’s take-home pay. You hold them temporarily, then send them to the correct agency.

Employer payroll taxes: amounts the business pays on top of wages

Employer payroll taxes are separate. They are business costs paid in addition to wages, based on payroll amounts, and they come straight from company funds.

Common employer-side taxes and costs include:

• Social Security tax (employer portion)
• Medicare tax (employer portion)
• FUTA tax (Federal Unemployment Tax Act) – paid by employers
• SUTA tax (State Unemployment Tax Act) – paid by employers
• Other state/local payroll taxes or assessments (varies by jurisdiction)

State unemployment taxes (SUTA) are typically paid by employers to fund state unemployment benefits, though in some states (such as Alaska, New Jersey, and Pennsylvania), employees also contribute. State unemployment insurance is funded by SUTA taxes paid by employers. Employers pay federal unemployment tax (FUTA) under the Federal Unemployment Tax Act, and the FUTA tax rate ranges from 0.6% to 6% depending on state unemployment tax payments. Employers must pay 6% toward FUTA, but can receive a tax credit of up to 5.4% if they pay their state unemployment taxes on time; a FUTA credit reduction may apply in certain states. These taxes are paid by employers and are not withheld from employees’ wages.

Key point: Employer payroll taxes are a real cost of having employees. They add to your “fully loaded labor cost.”

Why this distinction matters: the payroll tax illusion

One reason payroll taxes create confusion is that payroll reports often show a lot of numbers all at once—gross pay, net pay, employee withholdings, employer taxes, and total debits—without clearly separating what is an expense versus what is a pass-through liability. Payroll taxes are distinct from income taxes, which are withheld from employees’ wages to cover their personal tax liabilities.

Here’s a simple mental model:

• Wages (gross pay): company expense
• Employer payroll taxes: company expense
• Employee withholdings: company liability (until remitted)
• Net pay: cash payment to employee
• Tax remittances: cash payments that reduce liabilities

Understanding your tax liability is key to accurate payroll tax management and maintaining healthy cash flow.

If you treat employee withholdings like “extra expenses,” you’ll misunderstand your margins. If you ignore employer taxes in your labor cost calculations, you’ll underprice, overhire, or wonder why cash feels tighter than the P&L suggests.

At Bennett Financials, we focus on making payroll taxes predictable by aligning how they’re processed, paid, recorded, and forecasted.

How payroll taxes move through your business

Even if you outsource payroll processing, the financial mechanics are the same. Employers must calculate payroll taxes and calculate employer payroll taxes accurately using employee information, reported deductions on Form W-4, and IRS forms to ensure compliance and avoid penalties.

The Payroll Process: Step-by-Step

1. Step 1: Calculate Employee Wages and Deductions
2. Start by determining each employee’s gross wages. To calculate gross taxable wages, subtract any non-taxable income or pre-tax deductions (such as HSA or 401(k) contributions) from the gross wages. The resulting amount is the gross taxable wages, which is used to calculate payroll taxes.
3. Step 2: Withhold and Match Payroll Taxes
4. Employers are responsible for withholding payroll taxes from employees’ paychecks every pay period, including federal income tax, Social Security tax, and Medicare tax. Employers must also match payroll taxes for Social Security and Medicare, as required by US law.
5. Step 3: Record and Report Payroll Taxes
6. Employers must report payroll taxes withheld and payroll taxes paid using the appropriate IRS forms. Maintaining detailed recordkeeping of wages paid and taxes withheld is necessary for compliance and audits, and records should be kept for at least four years.
7. Step 4: Deposit Payroll Taxes
8. Employers must deposit payroll taxes electronically through the Electronic Federal Tax Payment System (EFTPS) by specific deadlines every pay period. Meeting deposit deadlines is crucial to avoid penalties.
9. Step 5: File Payroll Tax Returns
10. Employers must file quarterly and annual reports like Form 941 and Form W-2 to report payroll taxes paid and withheld. Form 941 must be filed every quarter to report federal income, Social Security, and Medicare taxes withheld from employees’ paychecks. Forms W-2 must be filed for every employee, and Forms 1099-MISC for independent contractors at the end of the year.
11. Step 6: Stay Compliant and Avoid Penalties
12. Failure to pay or report payroll taxes can result in trust fund recovery penalties, personal liability for unpaid payroll taxes, audits, additional fines, and even criminal charges for tax evasion. Employers who do not collect and pay payroll taxes can face severe consequences.

By following these steps, employers can ensure they calculate payroll taxes, report payroll taxes, and deposit payroll taxes correctly, staying compliant with all payroll tax regulations.

Step 1: Run payroll and calculate pay + taxes

Your payroll system calculates:

• Gross wages
• Employee withholdings (taxes and other deductions)
• Employer payroll taxes
• Net pay

For each pay period, you must calculate payroll tax rates, including federal payroll taxes under the Federal Insurance Contributions Act (FICA). FICA taxes consist of federal insurance contributions for Social Security and Medicare, and are shared between employers and employees. The Social Security tax rate is 12.4%, split evenly between employers and employees at 6.2% each, while the Medicare tax rate is 2.9%, with each side paying 1.45%. Social Security taxes are subject to an annual wage base limit, which for 2026 is $184,500. This wage base limit caps the amount of earnings subject to Social Security tax each year.

Step 2: Pay employees (net pay)

This is the cash your employees receive. It’s only part of the total cash impact.

Step 3: Create payroll tax liabilities

When payroll is finalized, your books should reflect liabilities for:

• Employee withholdings owed
• Employer taxes owed, including the employer’s tax liability for matching employee contributions for Social Security and Medicare taxes (collectively known as FICA taxes). It’s essential to use the correct IRS forms to accurately report these payroll tax liabilities and ensure compliance.

Step 4: Remit payroll taxes on schedule

Depending on your deposit schedule and location, taxes may be debited:

• semiweekly
• monthly
• quarterly
• annually (some unemployment components)

The Internal Revenue Service requires employers to deposit payroll taxes electronically through the Electronic Federal Tax Payment System (EFTPS). This system must be used to deposit payroll taxes according to the federal deposit schedule.

Step 5: File required payroll tax returns

You don’t just pay; you file. Filings reconcile what you withheld and paid to what authorities expect.

Employers must report payroll taxes by filing Form 941 quarterly to report federal income, Social Security, and Medicare taxes withheld from employees’ paychecks. At the end of the year, employers are required to file Forms W-2 for every employee and Forms 1099-MISC for independent contractors.

Additionally, employers must report withholding to the Social Security Administration annually, which helps maintain accurate employee records for social security purposes.

Step 6: Reconcile payroll tax accounts monthly

This is where many businesses fall behind. If liabilities aren’t reconciled, you can’t tell whether:

• everything got paid
• something was paid twice
• a filing mismatch exists
• a tax debit is coming that you didn’t anticipate

Fractional CFO oversight often focuses heavily here because reconciliations protect both cash flow and compliance.

Understanding taxable wages: what counts, what doesn’t, and why it matters

When it comes to payroll taxes, everything starts with taxable wages—the portion of an employee’s pay that’s subject to federal income tax, Social Security tax, and Medicare tax. For both employers and employees, understanding what counts as taxable wages is the foundation for accurate payroll tax withholding and compliance with federal and state tax laws.

What’s included in taxable wages?

Most of the compensation you pay your employees is considered taxable wages. This includes:

• Regular salary or hourly wages
• Overtime pay
• Bonuses and commissions
• Tips (if applicable)
• Certain fringe benefits (like non-cash awards or personal use of a company car)
• Retroactive pay increases

These amounts are used to calculate how much federal income tax, Social Security tax, and Medicare tax should be withheld from each paycheck. They also determine the employer’s share of Social Security and Medicare taxes.

What’s not included?

Not every payment to an employee is taxable for payroll tax purposes. Common exclusions from taxable wages include:

• Qualified health insurance premiums paid by the employer
• Employer contributions to retirement plans (like 401(k) matches)
• Certain expense reimbursements (when properly documented)
• Some fringe benefits that are specifically excluded by the IRS

Why does it matter?

If you misclassify taxable wages, you risk under- or over-withholding payroll taxes, which can lead to compliance issues, IRS penalties, and unhappy employees at tax time. Both employers and employees rely on accurate payroll tax withholding to meet their federal income tax obligations and to ensure proper credit for Social Security and Medicare benefits.

Key takeaway: Getting taxable wages right is the first step in calculating payroll taxes, including federal income tax, Social Security tax, and Medicare tax. It’s also essential for accurate payroll tax withholding and for meeting your responsibilities under federal income and employment tax laws. For employers and employees alike, understanding what counts as taxable wages helps keep payroll clean, compliant, and predictable.

The “fully loaded labor cost” view: what payroll taxes do to margins

A common growth-stage problem is that owners price services and plan hiring based on wages only. But wages are the tip of the iceberg.

Your real labor cost includes:

• Gross wages
• Employer payroll taxes
• Employer-paid benefits (if applicable)
• Workers’ comp impacts (often payroll-based)
• Payroll processing fees
• Incentive compensation patterns (bonuses/commissions)

Employer payroll taxes alone can meaningfully shift labor economics. That’s why CFO-level planning doesn’t use “salary” as the full measure. It uses loaded cost.

At Bennett Financials, we often help clients build a standard “burden rate” (a percentage added to wages) for forecasting and pricing. That way, when you say, “We’re hiring someone at $70K,” you automatically understand the likely all-in impact on cash and margins—not just the headline salary.

Where business owners get burned: the most common payroll tax mistakes

1) Mixing up expenses and liabilities

Employee withholdings are not payroll expense. They are payroll liabilities. When companies accidentally code these incorrectly, financial statements become misleading and reconciliations become painful.

2) Underestimating timing impacts

A business might feel fine after payroll is paid, then get hit by tax debits days later. If you don’t model tax remittances, you’ll have recurring “mystery cash drains” that are actually perfectly normal tax payments.

3) Wrong tax setup for new states or localities

Hiring an employee in a new state can create new registration requirements, new tax rates, and new filings. You may need to register for state income tax and local income taxes, as well as comply with any local taxes that apply based on the employee’s work location. If setup lags, you can end up late—sometimes without realizing it until penalties arrive.

4) Misclassification (employee vs. contractor)

This is a big one. The payroll tax structure is different for contractors, but contractors can still trigger compliance issues if treated incorrectly. A contractor relationship that functions like employment can become a costly problem if challenged.

5) Federal unemployment tax surprises

Unemployment taxes can change with experience ratings, wage bases, and state rules. These taxes, such as those under the Federal Unemployment Tax Act (FUTA) and State Unemployment Tax Act (SUTA), fund government unemployment programs that provide benefits to workers who lose their jobs. Businesses sometimes budget for wages and forget the unemployment structure is not flat or static.

6) Poor reconciliation discipline

Even with a great payroll provider, errors happen: timing mismatches, manual adjustments, benefit funding differences, or simple mapping issues between payroll and accounting software. If you don’t reconcile, you won’t catch these early.

What a fractional CFO does about payroll taxes (and what they don’t)

A fractional CFO is not your payroll clerk. At Bennett Financials, the value is in designing and overseeing the system so that payroll taxes don’t become a recurring stress point. Using payroll software can automate payroll tax calculations, filings, and compliance, streamlining the process and reducing errors.

Here’s how small business tax software fractional CFO support typically shows up:

Build a payroll tax cash calendar

We map:

• pay dates
• tax withdrawal dates
• unemployment payments
• quarterly/annual filing deadlines
• benefit drafts that behave like tax pulls

Then we integrate those into a weekly forecast (often a 13-week rolling cash forecast), so cash planning reflects reality.

Establish consistent accounting treatment

We ensure your accounting system records; if you are considering financial leadership for growth, see our complete guide to hiring a CFO for your tech startup.

• wages as expenses
• employer taxes as expenses
• employee withholdings as liabilities
• remittances as liability reductions

This improves reporting accuracy and reduces reconciliation time.

Set controls around changes

Payroll tax issues often start with change: raises, bonuses, hiring in new states, new benefit plans, reclassifications, or terminations. We build workflows so these changes have:

• approvals
• documentation
• proper tax handling
• consistent accounting mapping

Monitor compliance risk areas

We help you identify and manage risk areas such as:

• multi-state expansion
• contractor-heavy workforces
• commission/bonus complexity
• aggressive growth and hiring velocity

Create executive-level reporting

Payroll taxes shouldn’t be a black box. CFO-level reporting answers:

• What is our payroll tax burden rate?
• How is it trending over time?
• How does labor cost (loaded) compare to revenue?
• Are we accruing and remitting correctly?
• Are liabilities clean at month-end?

Employer taxes: the hidden price of growth

Employer payroll taxes become more visible as you scale because they rise in direct proportion to payroll. Employers pay the employer portion of Social Security and Medicare taxes, and must match the payroll taxes withheld from employees’ wages for these programs. This matters in several common growth scenarios:

Scenario: hiring ahead of revenue

When you hire in anticipation of growth, employer taxes increase immediately—even before revenue arrives. Without a clear view of loaded labor cost, cash runway projections become overly optimistic.

Scenario: raising wages to compete

Higher wages increase:

• employer Social Security/Medicare amounts
• unemployment tax impacts (depending on wage bases)
• workers’ comp premiums (often)

A fractional CFO helps you model these costs so compensation decisions are made with full visibility.

Scenario: adding benefits

Benefits aren’t always “taxes,” but they change payroll economics and cash timing in similar ways. If you add an employer-paid benefit, you may change total labor burden and the rhythm of monthly debits.

Employee taxes: compliance and trust live here

Employees care deeply about taxes being correct. If withholding is wrong, they may owe at year-end—or get unexpected refunds. Either way, payroll trust can be damaged quickly.

Employee-side tax issues can arise from:

• incorrect withholding setup (W-4 equivalents, state forms)
• changes in employee status (marriage, dependents, second job)
• pre-tax vs post-tax deduction handling
• bonus or supplemental wage treatment
• incorrect work location setup for remote employees

Employers are required to withhold Medicare taxes from employees’ paychecks and report all Medicare taxes withheld on Form 941. Additionally, for employees earning over $200,000 in a calendar year, employers must withhold an additional 0.9% Medicare tax from wages above that threshold. This additional Medicare tax must also be reported and deposited according to IRS deadlines.

While employees own their personal tax choices, the employer owns accurate administration and remittance. A strong process protects both the employee experience and the employer’s compliance posture.

The Bennett Financials approach: fewer surprises, cleaner books

At Bennett Financials, our fractional CFO work around payroll taxes usually comes down to three outcomes. If you’re interested in understanding the differences between a CFO and a Controller and how they impact your business finances, read our article on CFO vs Controller: Understanding the Key Differences for Your Business:

1. Predictable cash flow
   Payroll taxes stop being “surprise debits” because they’re calendarized and forecasted.
2. Clean, auditable accounting
   Payroll liabilities reconcile cleanly, month after month, and your financial statements reflect reality.
3. Reduced compliance risk
   Multi-state growth, classification decisions, and payroll changes are handled with controls and documentation—reducing penalty exposure.

Payroll taxes are unavoidable. But chaos around payroll taxes is optional.