Starting a new business can feel like a whirlwind of excitement, challenges, and learning curves. One of the trickiest areas for many new business owners is payroll. When you hire employees, paying them correctly is just one part of the job—you also need to handle taxes the right way.

If you’re feeling overwhelmed, you’re not alone. Many business owners find this to be among the most difficult parts of running a business, especially since there is so much confusion around this topic. But the good news is that learning a few basic payroll tax terms can go a long way in cutting through all the noise and clearing up the confusion. In this article, we’ll break down three important payroll tax terms every new business owner should know, using plain language and helpful examples.

1. Withholding Tax

Let’s start with the big one—withholding tax. This is the amount of money that you, the employer, hold back from your employees’ paychecks and send to the government. It includes federal income tax, and in many cases, state and local income taxes, too.

Here’s how it works: When someone starts a job, they fill out a W-4 form. This form helps you figure out how much tax to withhold from each paycheck. You then subtract that amount before you give the employee their pay and send it to the IRS or state revenue office.

Why is this important? If you don’t withhold the correct amount, your business—not just the employee—can get into legal trouble. Mistakes can lead to fines or even audits. That’s why many small business owners use payroll software or work with accountants to make sure everything is done right.

Want help figuring out what an employee’s paycheck should look like after taxes? Try using a paycheck calculator that will help you when you are learning how to create an invoice.

2. FICA

FICA stands for Federal Insurance Contributions Act, and it’s a major part of payroll taxes. It’s made up of two taxes:

  • Social Security tax
  • Medicare tax

As an employer, you share the cost of FICA with your employee. For example, in 2025, both you and your employee each pay:

  • 6.2% for Social Security (up to a wage limit)
  • 1.45% for Medicare (no wage limit)

So, if your employee earns $1,000 in a pay period, you would withhold $76.50 from their paycheck (6.2% + 1.45%), and then you would also pay $76.50 yourself. That’s a total of $153 in FICA taxes for that one paycheck.

FICA taxes help fund programs that support people when they retire or become disabled. They’re not optional. Even if your employee says they don’t want to pay, the law says they must—and so must you.

Understanding FICA is essential because these taxes add up fast. If you miss a payment, you could owe the IRS not only the back taxes but also interest and penalties.

FICA taxes apply to all employees, but not to independent contractors. Be careful how you classify workers—calling someone a contractor when they meet the legal definition of an employee can also get your business in trouble.

3. FUTA

FUTA stands for Federal Unemployment Tax Act. This tax helps pay for unemployment benefits for people who lose their jobs through no fault of their own.

Unlike FICA, FUTA is paid only by the employer. Your employees don’t have any money withheld from their paychecks for this tax. As of 2025, the FUTA tax rate is 6.0% on the first $7,000 you pay to each employee in a year. That means the maximum you’ll usually pay per employee is $420 annually.

Here’s a quick breakdown:

  • If you pay an employee $5,000 in a year, you pay 6% of $5,000, which equals $300 in FUTA tax.
  • If you pay an employee $10,000 in a year, you pay 6% of the first $7,000, which equals $420 in FUTA tax.

In many cases, you can earn a credit of up to 5.4% for also paying state unemployment tax, which reduces your effective FUTA rate to just 0.6%. That’s why it’s important to understand both state and federal rules.

To keep track of what you’ve paid and what you owe, consider using a time tracking system. If you want to convert time cards to hours easily, check out this helpful tool that will make the time card conversion process easier.

Why These Terms Matter

Payroll taxes aren’t just about checking a box—they’re about protecting your business and your employees. If you misunderstand or ignore these key terms, the consequences can be costly. But when you understand them, you can:

  • Stay compliant with federal and state laws
  • Avoid unexpected fines or audits
  • Keep employees happy and confident in your professionalism
  • Focus more energy on growing your business

And the more you grow, the more important it becomes to have good payroll habits in place.

Bonus Tips for New Business Owners

If you’re still learning the ropes, here are a few extra things to keep in mind:

  • Stay organized: Keep track of payroll records, tax forms, and payment deadlines.
  • Automate when possible: Payroll software can make life much easier and help avoid human error.
  • Know your state laws: State payroll tax rules can vary. Some states don’t have income tax while others do.
  • Ask for help: You don’t have to do it all alone. A trusted accountant or payroll provider can be a game-changer.

Running a business means wearing a lot of hats—and payroll manager is one of them. Understanding payroll tax terms like withholding tax, FICA, and FUTA will help you build a strong foundation and avoid mistakes that can slow your growth. Remember, every expert was once a beginner. You don’t have to learn everything overnight, but getting a solid grip on these three terms is a great place to start.

Take the time to learn, stay curious, and don’t be afraid to ask questions. Your future self—and your employees—will thank you.

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