Payroll Taxes 101: A Small Business Owner’s Guide to What Comes Out of a Paycheck and Why

The first time you really look at a payroll register, it’s a wall of numbers with abbreviations you half-recognize. An employee sees gross pay at the top, something much smaller at the bottom, and a handful of line items in between. When they come to your desk asking why their raise feels invisible, you need to be able to explain payroll taxes in plain English.

If you can walk a new hire through gross-to-net in five minutes, you’ll save yourself hundreds of HR tickets over the course of a year. This is that five-minute explanation, with a little extra for the person running payroll.

The Three Numbers That Drive Every Payroll

Gross pay. The total amount the employee earned in the period: salary, hourly wages, overtime, bonuses, commissions. The number on their offer letter, annualized. This is where payroll starts.

Taxable wages. Gross pay, minus certain pre-tax deductions like traditional 401(k) contributions and Section 125 health premiums. Taxes are calculated on this number, not on gross. That’s why an employee who raises their 401(k) contribution sees more than just the contribution disappear. They also lower their tax bill.

Net pay. Taxable wages, minus taxes, minus any post-tax deductions (Roth 401(k), garnishments, voluntary benefits). The number that hits the employee’s bank account. Also known as take-home pay, and the only number most employees actually care about.

Employee Payroll Taxes: What Comes Out of Their Check

There are typically five buckets of employee taxes. Not every employee sees every bucket, but most see at least the first four.

• Federal income tax. Withheld based on the employee’s W-4 elections and IRS withholding tables. It’s an estimate, reconciled on their tax return each April.
• Social Security (FICA). 6.2% of wages up to an annual wage base that Social Security updates each year. The wage base is the cap, which is why high earners see their paycheck increase late in the year.
• Medicare. 1.45% of all wages, no cap. An additional 0.9% applies to wages above a threshold for higher earners.
• State income tax. Withheld based on state rules and the state version of the W-4. A handful of states have no income tax at all.
• Local taxes. Some cities and counties add their own income tax (Philadelphia, New York City, Columbus, and others). This is one of the most common sources of multi-state payroll mistakes.

Employer Payroll Taxes: What You Pay on Top

This is the part new founders are often surprised by: the employee’s gross pay isn’t the full cost of the employee. You also owe, roughly:

• Employer FICA match. 6.2% Social Security and 1.45% Medicare, identical to the employee’s share. You match, dollar for dollar.
• FUTA (federal unemployment). A small percentage on the first $7,000 of each employee’s wages per year, typically a fraction of a percent after state credits, but the return is mandatory.
• SUTA (state unemployment). A percentage on a state-set wage base. Rates are experience-rated: the more former employees who collect unemployment, the higher your rate climbs.
• Local employer taxes. Occupational license fees, local unemployment taxes, paid family leave assessments. These depend heavily on where your employees live and work.

For a rough rule of thumb, employer taxes add roughly 8 to 10% to base salary, before benefits. Budget accordingly.

Pre-Tax vs. Post-Tax Deductions (and Why Order Matters)

When you run payroll, deductions are applied in a specific order, and that order changes the math. A simplified version:

• Start with gross pay.
• Subtract pre-tax deductions (traditional 401(k), Section 125 health/dental/vision premiums, FSA and HSA contributions). The result is taxable wages.
• Calculate taxes on taxable wages.
• Subtract taxes.
• Subtract post-tax deductions (Roth 401(k), garnishments, voluntary life insurance, charitable contributions).
• What’s left is net pay.

The most common payroll error in spreadsheets built by hand: taxes calculated on gross pay instead of on taxable wages. It slightly overstates what the employee owes and understates their take-home. Your payroll system handles this automatically, but an employee asking why their check is bigger than expected after enrolling in benefits deserves the explanation.

The W-4, Demystified

The W-4 was overhauled in 2020 and no longer uses allowances. Employees now specify filing status, multiple-job adjustments, dependent credits, and optional extra withholding directly in dollars. Three practical things to know:

• An employee can submit a new W-4 anytime. Major life events like marriage, a new child, or a spouse starting or stopping work should prompt a review.
• “Exempt” on a W-4 is a specific status for employees who expect no tax liability. It’s rare and expires annually. Do not let an employee write “exempt” to stop withholding simply because they don’t like the number.
• A second W-4 for state purposes may be required. States with income tax typically have their own version.

Year-End Forms That Keep the IRS Happy

At year end, you owe a short list of forms. The details depend on your workforce, but the core three are:

• W-2 for every employee, showing annual wages and taxes withheld. Due to employees and the Social Security Administration by January 31.
• 1099-NEC for non-employee compensation of $600 or more paid to a contractor during the year. Same January 31 deadline.
• 1095-C for applicable large employers reporting health coverage offers. See our ACA article for the details.

Missing or late filings trigger penalties that scale with how late they are. The mistakes that actually cost money, though, are usually earlier: wrong SSNs, incorrect addresses, missed state withholding in a state an employee moved to mid-year.

The Bottom Line

Payroll taxes follow a sequence, not a formula. Start with gross pay, subtract pre-tax deductions to get taxable wages, calculate taxes on that, subtract taxes and post-tax deductions, and what’s left is net. Remember that your real cost is roughly 8 to 10% above base for employer taxes alone. Train yourself to explain it to an employee in five minutes. It’s the most common HR conversation you’ll have, by a wide margin. Netchex automates every step of that sequence, calculating, withholding, and remitting federal, state, and local payroll taxes across every jurisdiction your employees work in, so your deductions are accurate and your filings stay on schedule.

Frequently Asked Questions

This guide reflects publicly available product information and independent reviewer data (G2, Capterra, Trustpilot, Yelp, Better Business Bureau, Reddit, Software Advice, GetApp) as of 2026. Feature availability and pricing may vary by plan. Contact each provider for current details.

Disclaimer: Any product roadmap or future plans provided herein are for informational purposes only. They do not represent a commitment to deliver any material, code, feature, or functionality. Plans may change without notification. The development, release and timing of any features or functionality described remain at the sole discretion of Netchex, its affiliates, and partners. Netchex does not give legal, tax, or accounting advice. You are responsible for ensuring your use of Netchex product meets your individual business and compliance requirements.

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