Paycheck Fundamentals: Withholding Taxes
Explore federal, state, and local tax withholding essentials for accurate paycheck management.
Employment tax withholding: Federal, state, and local
Goals and takeaways
- Understand how federal employment taxes are calculated, withheld, and deposited
- Learn how the 41 states with income tax handle withholding and deposit requirements
- Get a high-level overview of local income tax (LIT) obligations for employers and employees
Federal employment tax withholding
Taxable wages
Per the IRS, taxable wages include all compensation for services rendered, whether paid in cash or other forms. This includes:
- Regular wages and salaries
- Bonuses, commissions, and severance
- Accrued PTO or vacation payouts
- Taxable fringe benefits (e.g., cash awards, personal use of company vehicle)
Refer to Publication 15, 15-A, and 15-B for full definitions and examples.
Constructive receipt
Wages are considered paid when the employee has unrestricted access to the funds.
Example: A paycheck dated December 30, 2025, but not delivered until January 4, 2026, due to a system outage is not considered constructively received in 2025—it would be taxable in 2026.
Tip taxation
If an employee reports $20 or more in tips in a month, the employer must withhold taxes on the tips.
Order of tax withholding when wages are insufficient:
- Social Security and Medicare on regular wages
- FITW on regular wages
- Social Security and Medicare on tips
- FITW on tips
Uncollected amounts are reported in Box 12 on the W-2 with Codes A and B.
Federal income tax withholding (FITW)
FITW is influenced by:
- Pay frequency
- Employee’s Form W-4 selections
- Pre-tax deductions (e.g., §125, 401(k))
- Whether wages are regular or supplemental
Check uses the percentage method by default.
Four methods of FITW:
Method | Use Case |
Percentage | Default in Check; supports all W-4 formats |
Wage bracket | For manual calculations only |
Flat rate | Optional or mandatory for supplemental pay |
Aggregate | Combines regular and supplemental wages |
Supplemental wage thresholds (2025):
- Optional flat rate: 22% (for total YTD supplemental ≤ $1M)
- Mandatory flat rate: 37% (once YTD supplemental exceeds $1M)
Example (2025):
Employee earns $1,500 in regular wages and $500 in bonus. Using the aggregate method:
- FITW on $1,500 = $112
- FITW on $2,000 = $173
- FITW on bonus = $173 – $112 = $61
If using the optional flat rate instead: $500 × 22% = $110
Social Security and Medicare (FICA)
Tax Type | Rate (2025) | Wage Base or Threshold |
Social Security (EE + ER) | 6.2% each | $176,100 |
Medicare (EE + ER) | 1.45% each | No limit |
Additional Medicare (EE) | 0.9% | On earnings > $200,000 (no match) |
Maximum Social Security tax per employee in 2025:
6.2% × $176,100 = $10,933.20 (employee) and the same for the employer.
Employers should ensure systems are updated with the 2025 wage base to avoid over- or under-withholding. The Additional Medicare tax continues to apply to earnings above $200,000 and does not require an employer match.
State income tax withholding (SIT)
Nexus and registration
Employers must register and withhold SIT if they have nexus in the state. Nexus can be created by:
- Physical offices or facilities
- Remote employees
- Service or sales activity in-state
Even one remote employee can trigger a registration obligation.
Multi-state withholding rules
1. Residency
Most states define residency by:
- Homeownership, voter registration, driver's license
- Spending >183 days/year in the state
2. Reciprocity
Some states have reciprocal agreements that allow employers to withhold only for the resident state. A nonresidency certificate is typically required.
Note: Registering to withhold for a resident state may establish nexus. Coordinate with legal or tax counsel before proceeding.
3. Resident vs. nonresident taxation
If no reciprocity exists, the employer may be required to:
- Withhold based on the worked-in state
- Report income in the resident state (may result in dual W-2s)
Example (2025):
An employee lives in Oregon but works in Idaho. Oregon and Idaho do not have reciprocity.
- Idaho requires withholding if wages exceed $1,000/year
- Oregon allows a credit for taxes paid to Idaho
Local income taxes (LIT)
As of 2025, 15 states have local jurisdictions that assess income tax:
- Alabama
- California
- Colorado
- Delaware
- Indiana
- Kentucky
- Maryland
- Michigan
- Missouri
- New Jersey
- New York
- Ohio
- Oregon
- Pennsylvania
- West Virginia
LIT withholding
Local tax rules vary. They may depend on:
- Where the employee works
- Where the employee resides
- Or both
Administrative complexity
Some local taxes:
- Must be withheld from wages
- Are assessed only on the employer
- Require quarterly or annual filings
Example:
Employees working at the Ark Encounter in Williamstown, Kentucky are subject to a local income tax withheld from their wages. This tax is not collected from ticket sales or donations.
Last updated on June 6, 2025