Payroll taxes are an essential part of your responsibilities as an employer, and they impact both your business operations and your employees. Payroll taxes can be complex, but compliance with federal, state, and local tax laws is crucial to keep your business running smoothly. 

Types of Payroll Taxes

Because there are many types of payroll taxes, it can be difficult to understand exactly what is required of you as an employer. The first step is understanding each payroll tax type and how it is reported. 

Federal payroll taxes include Social Security tax and Medicare tax, collectively known as FICA (the Federal Insurance Contributions Act), as well as federal unemployment tax and federal income tax.1 Both FICA and federal employment tax are withheld from employee wages, but federal unemployment tax must be paid annually by the employer using an IRS form.2 There are also state payroll taxes, which you will need to pay to any state in which you have employees. State payroll taxes include state income tax, if your state imposes income tax, and state unemployment tax.

At the state level, payroll taxes become increasingly complex because of varying state laws and continuously changing requirements. Potential state payroll tax requirements include withholding tax, unemployment tax, Paid Family and Medical Leave (PFML), worker’s compensation, and state mandated retirement plans.  Paid Family and Medical leave contributions and reporting are now required in over 15 states, while state retirement savings programs are currently mandated in 10 states. Depending on state laws, a company may register with a state’s plan, or apply for an exemption if the company can provide proof of comparable private insurance or a private retirement option, respectively. Worker’s compensation, on the other hand, is required in nearly every state. In Ohio, North Dakota, Washington, and Wyoming, a company must  purchase worker’s compensation insurance through the state funded program. In all other states, however, private insurance coverage is allowed with proof provided to the state. 

Individual income tax can also be imposed at the state level, and in a variety of ways. New Hampshire, for example, only taxes dividend and interest income, while Washington only taxes income from capital gains.3 Some states impose income tax at only one rate, while others use a graduated scale similar to the federal income tax structure.4 There are also a number of states that do not impose any individual income tax at all.5 Like state income tax, state unemployment taxes can be equally complicated. The amount of state unemployment tax that employers owe depends on many factors, including minimum and maximum rates, wages that are subject to tax, weekly earnings that are disregarded, and more, all set individually by each state.6

As if the complexities of federal and state payroll taxes are not enough, localities within a state can also impose various types of payroll taxes. These local tax types usually depend on where your employees live and work. Types of local payroll taxes include Earned Income Tax (EIT), Occupational Tax or Business and Occupation Tax (B&O), Local Services Tax (LST), Local School District Tax (LSD), Transit Tax, and more.7 Because there are so many types of local payroll taxes, it can be easy to overlook these requirements as an employer. 

Compliance Responsibilities 

Now that we’ve looked at payroll taxes on a federal, state, and local level, it’s important to understand how to satisfy your compliance responsibilities. For payroll tax types that require withholding tax from your employees’ paychecks, be sure that you are calculating the correct amount to withhold. Miscalculations can lead to overpayments or underpayments, which can lead to extra compliance costs, penalties, or fines. 

For state and local payroll taxes specifically, employers are required to report payroll taxes on a return filed with the state. This may require you to register your business with the state Department of Revenue and any localities that require a separate return or registration. If you have employees in multiple states, you will need to register in each state. This is especially tricky if you have employees that live in one state and work in another, or work remotely from a state that your business does not otherwise have a presence in. In those cases, it is especially clear why understanding individual state laws is essential for state payroll taxes. 

Common Payroll Mistakes 

As an employer, it’s easy to become disorganized and lose track of important deadlines or filings for payroll taxes. At the state level specifically, a common mistake made by employers is failing to understand certain state-specific requirements. Tax types like state unemployment tax depend on factors that can change frequently, such as turnover rates, making them prone to oversight. You may also overlook local payroll tax types that are not as commonly understood as federal and state payroll taxes. These things are easy to miss, but frustrating to correct. 

Another common error for employers involves the classification of employees versus independent contractors. While employers are required to withhold or pay payroll taxes on payments made to their employees, independent contractors are considered self-employed, and employers do not need to withhold and pay taxes on payment to independent contractors. Clear expectations and classifications of your employees will prevent any misclassification that could cause past due taxes, penalties, interest, or fines. 

Steps for Your Business

Investing time and resources into payroll tax compliance not only builds a stable financial foundation for your business, but also improves your employees’ work environment. If you own a growing business and your payroll tax obligations are becoming too confusing or time-consuming for you to handle on your own, State Tax Advisors can guide you through the process. Maintaining proper tax compliance can be more straightforward – and far less stressful – with our help.  

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1 https://www.ssa.gov/people/materials/pdfs/EN-05-10297.pdf.

2 https://oui.doleta.gov/unemploy/docs/factsheet/Tax_FactSheet.pdf.

3 https://taxfoundation.org/data/all/state/state-income-tax-rates-2024/.

4 Id. 

5 Id. 

6 https://oui.doleta.gov/unemploy/content/sigpros/2020-2029/January2024.pdf

7 https://www.wolterskluwer.com/en/expert-insights/local-payroll-taxes-101