The Employer and Employee Guide to Payroll Taxes: Federal vs State, FUTA vs SUTA, Withholding, and Multi‑State Challenges

Payroll taxes are one of the most consequential and persistent obligations for both employers and employees. They fund core social safety-net programs, support unemployment insurance, and determine how much of each paycheck actually lands in a worker’s bank account. While many people focus on federal income taxes, payroll taxes—both federal and state—are an everyday reality that affects hiring costs, take-home pay, compliance burdens, and business planning. This guide walks through how payroll taxes work, who pays what, how federal and state systems interact, and practical approaches to reduce risk when you operate across state lines or manage remote teams.

What are payroll taxes and why they matter

Payroll taxes are taxes withheld from employee wages and often matched by employers to fund specific programs. At the federal level, the primary payroll taxes are Social Security and Medicare (often called FICA taxes), plus federal unemployment insurance (FUTA). States impose their own payroll-related obligations—most importantly state unemployment taxes (SUTA)—and many also require state payroll withholding, disability or family leave payroll contributions, and local payroll taxes in certain jurisdictions.

Payroll taxes are distinct from income taxes: they are primarily earmarked for benefits like retirement (Social Security), health insurance for seniors (Medicare), and temporary income replacement for unemployed workers (unemployment insurance programs). That earmarking makes payroll taxes politically and administratively different from general revenue taxes, and it means employers play a central role as collectors and remitters.

Federal payroll taxes explained

Social Security and Medicare (FICA)

The Federal Insurance Contributions Act (FICA) covers Social Security and Medicare. For employees, Social Security tax is withheld on wages up to an annual wage base (the Social Security taxable maximum), while Medicare tax applies to all earned income without a cap and has an additional surtax for high earners. Employers match employee FICA with an equal employer portion:

• Social Security: a percentage withheld from employee wages up to the annual cap; employers match that amount. (Rate and cap adjust periodically.)
• Medicare: a percentage withheld on all wages; employers match the basic Medicare rate. Employees earning above a threshold pay an additional Medicare surtax that employers must withhold but do not match.

FICA tax reporting and deposits

Employers report FICA taxes on Form 941 (quarterly) or 944 (annual for eligible small employers) and deposit withheld taxes via electronic funds transfer using deposit schedules determined by the size of payroll tax liabilities. Timely deposits and accurate reporting are critical—penalties and interest can be severe for missed deposits.

Federal Unemployment Tax Act (FUTA)

FUTA funds federal unemployment benefits and administrative costs. FUTA is paid entirely by employers (not employees) on the first portion of each employee’s wages up to the FUTA wage base. Employers who pay state unemployment taxes and keep timely state compliance can receive a credit against FUTA, effectively lowering the federal tax rate. FUTA is reported on Form 940 annually, with deposits required if the liability exceeds certain thresholds.

State payroll taxes explained

State Unemployment Taxes (SUTA)

State unemployment systems are funded mainly by employer-paid SUTA taxes. Each state sets its own taxable wage base, rate schedules, experience-rating systems, and reporting rules. New employers often have a standard new-hire rate until they accumulate an experience rating based on layoffs and claims. SUTA experience rating rewards employers that limit layoffs with lower rates and penalizes those with larger claims with higher rates.

State payroll withholding

Most states require employers to withhold state income tax from employee wages. Withholding rates, brackets, and exemptions vary by state, and filing frequencies are tied to withholding amounts. Some states have flat withholding rates; others use progressive brackets tied to state income tax rules. Employers must register with the state tax authority, collect employee withholding forms (state equivalents to federal forms), and remit withheld amounts per the state’s schedule.

Other state and local payroll taxes

Beyond SUTA and state withholding, several states and localities impose other payroll-related levies: state disability insurance (SDI) contributions, paid family leave contributions, local occupational taxes, municipal transit levies, and city-level payroll taxes. These can be set as employee-only, employer-only, or shared contributions.

FUTA vs SUTA: how they differ and work together

At a glance, FUTA is federal and employer-paid, while SUTA is state-level and employer-paid. They share the same policy goal—funding unemployment benefits—but have distinct rules:

• Tax base differences: FUTA applies to a federal wage base that may be lower or higher than state wage bases; SUTA bases differ by state and sometimes by industry.
• Rate differences: FUTA has a statutory rate reduced by credits for state unemployment contributions; states set SUTA rates using experience-rating systems and may levy supplemental taxes during high unemployment or insolvency periods.
• Credit interaction: States that meet federal compliance requirements allow employers a credit (commonly up to 5.4 percentage points) against the FUTA rate, meaning effective FUTA is lower for employers current on state payments.

How payroll taxes are split: who pays what

Payroll taxes can be split between employees and employers in different ways:

• FICA: split equally for Social Security and Medicare (employer matches employee withholding). The Medicare surtax for high earners is employee-only.
• FUTA: employer-only federal unemployment tax.
• SUTA: usually employer-only, although a few states have employee contributions for unemployment or workforce programs; paid family leave or SDI may require employee contributions.
• State withholding and local payroll taxes: typically employee withholding, remitted by the employer, but contribution structures vary.

Employers factor payroll taxes into labor costs and must keep clear records to meet deposit schedules, handle employer matching, and calculate taxable wages correctly.

Withholding explained: mechanics and forms

Federal withholding and the W-4

Federal income tax withholding is based on employee-provided information on Form W-4. The W-4 determines allowances, filing status, additional withholding amounts, and adjustments for dependents and credits. Employers use IRS withholding tables or payroll software to calculate the correct federal withholding each pay period. If insufficient withholding occurs, employees may owe a large tax bill or face estimated payment penalties.

State withholding forms and differences

Most states have their own withholding certificates similar to the W-4. Some states automatically conform to federal W-4 data; others require separate state forms with unique allowances or flat rates. Employers must collect state forms when applicable and update withholding when employees move between states or change their tax situation.

How withholding works in practice

Withholding aims to approximate tax liability so employees pay taxes gradually throughout the year. Employers withhold and remit income and payroll taxes to federal and state authorities, deposit payroll taxes on schedules set by the IRS and state agencies, and report wages and taxes via W-2s and other forms at year-end. Errors in withholding or deposits expose both employee and employer to penalties—employees for underpayment of tax, employers for failure to deposit or report.

Reporting: Forms employers must know

Key federal forms:

• Form W-2: annual statement to employees summarizing wages and taxes withheld.
• Form W-3: transmittal of W-2s to the Social Security Administration.
• Form 941: quarterly federal payroll tax return reporting FICA and income tax withholding.
• Form 944: annual return alternative for small employers meeting IRS criteria.
• Form 940: annual FUTA report.

States have their own quarterly and annual returns for unemployment and withholding. Employers must register with state departments of revenue and workforce agencies, and follow state-specific filing and deposit requirements.

Multi-state payroll: how moving, remote work and multiple jurisdictions complicate withholding

Remote work and geography make payroll rules complex. Employees may live in one state, work for an employer based in another, and perform services in several jurisdictions during a year. This can trigger obligations across states:

• State income tax withholding generally follows where the work is performed, but resident-based taxation means employees still owe tax to their home state; credits or reciprocal agreements can prevent double taxation.
• Unemployment tax obligations depend on where services are performed, where the employer is located, and specific state rules; employers with workers in multiple states may need to register and pay SUTA in each state.
• Local payroll taxes apply where localities impose occupational or payroll levies—cities, counties, and transit authorities sometimes have separate registration and withholding rules.

Reciprocal agreements and credits

Some neighboring states have reciprocal agreements allowing residents to pay income tax only to their home state despite working across the border. Employers must understand these rules and apply withholding correctly. When reciprocity doesn’t apply, employees may receive credits on their resident tax return for taxes paid to other states to avoid double taxation.

Practical steps for multi-state payroll

• Track employee work locations day-by-day when possible; document telework arrangements and temporary assignments.
• Register with state tax and workforce agencies in all states where payroll obligations are triggered.
• Use payroll software or a payroll service with multi-state capability and local tax updates.
• Consider PEOs or professional payroll providers to centralize compliance—but verify the provider’s state registration and experience.

Independent contractors vs employees: payroll tax consequences

Classification matters. Employers typically withhold payroll taxes for employees but do not withhold FICA or income tax for properly classified independent contractors. Instead, contractors receive 1099-NEC forms and are responsible for self-employment taxes (the equivalent of both employer and employee portions of FICA). Misclassification risks: tax liabilities, back taxes, penalties, and interest. States also enforce worker classification, and penalties can be imposed if workers are incorrectly labeled to avoid payroll taxes.

How payroll tax rates and bases vary by state

Each state sets the SUTA taxable wage base—some are low, others high. SUTA rates vary widely and can change due to experience-rating adjustments or emergency legislations. Additionally, states may exempt certain types of compensation or apply unique wage definitions. Employers must monitor state updates annually and budget for year-to-year volatility, especially for seasonal industries or during economic downturns when unemployment claims surge.

State payroll tax programs beyond unemployment

Many states have payroll-related programs beyond SUTA and withholding:

• State disability insurance (e.g., California SDI, New York DBL) often funded through employee payroll deductions.
• Paid family leave programs funded via employee and, sometimes, employer contributions.
• State-specific workforce training or employer assessment taxes used to fund local employment services.

Understanding these can prevent surprise liabilities. Employers must ensure correct deduction codes and remittance paths for each program.

Deposit schedules and penalties: federal and state differences

Deposit schedules are critical for avoiding penalties. The IRS sets deposit frequency for federal deposits (semi-weekly, monthly, or for FUTA, commonly quarterly or annually depending on liability). States have their own schedules for withholding and SUTA deposits—typically determined by the amount withheld or owed. Missing a deposit or late remittance can trigger interest, late-payment penalties, and trust fund recovery penalties for willful failure to remit withheld employee taxes.

Trust fund recovery and employer liability

Withheld income and FICA taxes are considered trust funds. Employers who fail to remit withheld taxes may face personal liability for responsible parties under the Trust Fund Recovery Penalty (TFRP). States have analogous provisions to hold responsible parties personally liable for unremitted state withholding taxes.

Payroll tax audits and notices: how they differ at federal and state levels

The IRS and state departments conduct payroll tax audits focusing on classification, deposit history, wage definitions, and filing accuracy. State audits may emphasize SUTA eligibility, taxable wage bases, and benefits charged to employer accounts. Employers should respond promptly to notices, provide requested documentation, and consider professional representation for contested issues.

How to reduce audit and compliance risk

• Keep meticulous payroll records: pay stubs, timekeeping, tax forms, and job classification documents.
• Use reliable payroll software or a reputable payroll provider to stay current with tax rate and rule changes.
• Conduct periodic internal reviews to ensure proper classification of workers and accurate withholding.
• Maintain timely deposits and file returns by deadlines.
• When expanding into new states, seek guidance on registration and nexus rules before hiring.

Remote work and evolving tax rules

The rise of remote work accelerated multi-state payroll complexity and prompted new guidance and audits. States increasingly assert taxing rights based on where work is performed, regardless of employer location. Employers must track telecommuting locations, adapt withholding, and, where feasible, include tax residency clauses in employment agreements. Some employers implement withholding policies based on employee residence, provide tax equalization, or require notification for work performed in other states to manage compliance and cost.

Temporary work and return-to-office transitions

Temporary assignments and hybrid policies can create short-term nexus in multiple states. Employers should set clear protocols for reporting out-of-state work, adjust payroll systems to handle short-term withholding changes, and consider advance planning for tax registrations if the employee will work in a new state regularly.

Practical payroll tax strategies for employers

• Centralize payroll functions and choose a payroll partner capable of multi-state compliance and frequent tax updates.
• Document telework arrangements and require employees to certify primary work location periodically.
• Review worker classifications annually and seek legal counsel for ambiguous roles.
• Budget for worst-case SUTA rate increases and maintain a reserve to cover payroll tax volatility.
• Train HR and payroll staff on recognizing nexus triggers and the importance of timely registration in new jurisdictions.

Employees’ perspective: what to watch for

Employees should monitor withholding to avoid surprises at tax time. Key actions include:

• Completing and updating federal W-4 and state withholding forms when life events change (marriage, births, job change, or a significant change in income).
• Understanding how remote work affects residency and tax obligations; notify employers if living or working in a new state.
• Seeking a review if classification changes (employee vs contractor) or if tax withholdings appear incorrect.

Payroll software and outsourcing: what to expect

Modern payroll systems automate tax rate updates, multi-state withholding calculations, and filing and deposit schedules. When choosing software or a payroll service, evaluate these capabilities:

• Multi-state registration and maintenance.
• Support for local taxes and special state programs (SDI, paid family leave).
• Accurate tax deposit scheduling and electronic filing.
• Robust reporting for audits and year-end reconciliation.

Outsourcing to a payroll provider or PEO can shift administrative burdens, but verify who retains legal responsibility for tax deposits and filings and confirm service-level guarantees for compliance.

Year-end responsibilities and reconciling payroll taxes

As year-end approaches, employers must reconcile payroll tax accounts, issue W-2s and 1099s, reconcile Form 941 to Form W-3 and Form 940, and correct any discrepancies. If you find mistakes, amended filings (e.g., Form 941-X) and corrected Forms W-2c help resolve issues. Prompt correction reduces audit risk and potential penalties.

Special topics: state credits, offsets, and multi-state credits

Employees filing in multiple states should be aware of credits for taxes paid to other states to avoid double taxation. Employers navigating multi-state SUTA should track benefit charges and reimburse or taxable wage adjustments carefully to prevent misattribution of unemployment claims. State offsets and intercepts can apply to wages or tax refunds when debts exist; employers may be notified to implement garnishments or withholding adjustments.

When things go wrong: liens, levies, and payment plans

When payroll tax liabilities accumulate, both federal and state authorities have enforcement tools: liens on property, levies against bank accounts, wage garnishments, and referrals for criminal investigation in severe cases. Employers facing cash flow problems should proactively contact tax authorities to arrange deposit schedules or installment agreements. Federal Offer in Compromise is limited for employment taxes; however, penalty abatements or installment plans can sometimes be negotiated. Promptly addressing notices and communicating with tax authorities reduces escalation risk.

Final considerations for employers and employees

Payroll taxes may feel like an operational detail, but they shape labor costs, influence hiring decisions, and create compliance obligations that span local, state, and federal governments. Employers who maintain accurate records, stay updated on multi-state rules, and use robust payroll systems reduce risk and create predictable cash flow. Employees who check their withholding and understand how remote work affects residency are less likely to face unpleasant surprises during tax season. The landscape continues to change as work becomes more mobile and states adjust tax rules to capture revenues and fund benefits, so continuous vigilance—and a proactive approach—are essential for anyone responsible for payroll.

Payroll taxes are the connective tissue between workers, employers, and public programs. Managing them well requires a mix of technical knowledge, disciplined recordkeeping, and sound systems. When employers and employees collaborate—updating withholding data, documenting work locations, and taking advantage of payroll technology—they can minimize risks, maintain compliance, and keep the focus on productive work rather than tax headaches. Thoughtful planning, periodic reviews, and professional advice when expanding across state lines will pay dividends in lower administrative friction and greater financial predictability for your business and your people.