The True Cost of an Employee: Payroll Taxes, Benefits and Payroll Entries

What you'll learn

The difference between gross pay, net pay and the total cost of an employee.
What's withheld from a paycheck and what the employer pays on top: FICA, FUTA, SUTA, workers' comp and benefits.
How to record a payroll with double-entry, including employer taxes and benefits.
How to calculate the cost per billable hour to price services and decide on hiring.
When a worker is an employee and when a contractor.

"I pay her $4,000 a month" is one of the most misleading sentences in small business. The employee takes home less than $4,000, and the business spends quite a bit more. In between sit payroll taxes, withholdings, insurance and benefits. Not knowing the gap leads to underpriced services, hires the business can't sustain and surprise bills from the IRS or the state.

Figures and states vary

The federal rates below are verified for 2026. State unemployment tax, workers' compensation, state income tax and paid leave rules differ from state to state, and your own rates come from your state and your insurer. Use a payroll provider or a CPA for the real numbers; this lesson teaches the method.

Three different numbers

Number	What it is	Brightside's shift lead (monthly)
Gross pay	The salary or hourly wages agreed with the employee	$4,000
Net pay	What lands in the employee's bank account after withholdings	$3,034
Total employer cost	Gross pay + employer payroll taxes + benefits and insurance	About $4,990 on average

What comes out of the paycheck

The employer withholds these amounts from gross pay and sends them where they belong. They're part of the employee's pay, not an extra cost for the business:

Federal income tax, based on the employee's Form W-4.
State and local income tax, where they exist (Texas has none).
Social Security: 6.2% of wages, up to the $184,500 wage base for 2026.
Medicare: 1.45% of all wages, plus an additional 0.9% the employer must withhold on wages above $200,000.
Voluntary deductions: 401(k) contributions, the employee's share of health insurance premiums.

Withheld taxes are "trust fund" money

Income tax and FICA withheld from employees belong to the government from the moment you withhold them. If a business fails to deposit them, the IRS can hold the owners and other responsible people personally liable through the Trust Fund Recovery Penalty. Never use payroll tax money to cover a cash crunch.

What the employer pays on top

Employer FICA: a matching 6.2% Social Security (up to the 2026 wage base) and 1.45% Medicare, 7.65% in total.
FUTA (federal unemployment tax): 6.0% on the first $7,000 of each employee's wages, reduced by a credit of up to 5.4% for paying state unemployment tax on time, so most employers pay 0.6%, or $42 per employee per year. Employers in states that owe federal unemployment loans pay more; for 2025 those were California and the U.S. Virgin Islands.
SUTA (state unemployment tax): each state sets the wage base and your rate. In Texas the taxable wage base is $9,000 per employee, and new employers have typically been assigned 2.7% until they build an experience rating.
Workers' compensation insurance: required for most employers in most states (Texas is the notable exception where private employers may opt out), priced per $100 of payroll by job type.
Benefits: health insurance (employers with 50 or more full-time-equivalent employees must offer affordable coverage under the Affordable Care Act or risk a penalty), retirement plan matches and paid time off. Federal law doesn't require paid vacation, but some states and cities require paid sick leave.

Benefits add up. According to the Bureau of Labor Statistics, in June 2026 benefits made up 30.0% of private-industry employers' compensation costs: $14.07 of an average $46.89 per hour worked.

The full calculation

Brightside promotes a barista to shift lead at $4,000 a month ($48,000 a year). Assumptions for this example: Texas SUTA at 2.7% on $9,000; workers' comp at $1.00 per $100 of payroll; Brightside pays $500 a month toward health insurance; and it matches 401(k) contributions up to 3% of salary.

Item	Calculation	Per year
Salary	$4,000 × 12	$48,000
Employer FICA	$48,000 × 7.65%	$3,672
FUTA	$7,000 × 0.6%	$42
SUTA	$9,000 × 2.7%	$243
Workers' compensation	$48,000 ÷ 100 × $1.00	$480
Health insurance (employer share)	$500 × 12	$6,000
401(k) match	$48,000 × 3%	$1,440
Total employer cost		$59,877

The real cost is about 1.25 times the salary: $59,877 a year, or $4,989.75 a month on average, versus the $48,000 someone would budget by multiplying $4,000 by 12. And that still excludes training, uniforms, equipment and the payroll service itself.

Breakdown of $59,877: salary 80.2%, employer FICA 6.1%, health insurance 10.0%, 401(k) match 2.4%, and FUTA, SUTA and workers' comp together 1.3%.

1. Why are Brightside's employer payroll taxes higher in January than in July for the same salary?

Because the IRS raises rates every January
Because FUTA and SUTA only apply to the first $7,000 and $9,000 of each employee's wages in the year
Because FICA is only charged in the first quarter

Unemployment taxes have low wage bases, so they're paid early in the year and stop once each employee passes the base. For pricing and budgets, use the annual average cost.

Recording a payroll

January payroll for the shift lead. The employee's W-4 results in $310 of federal income tax withholding, and they contribute 5% to the 401(k) and $150 toward their health premium.

1. Wages and withholdings

Account	Debit	Credit
Wages Expense	$4,000
Federal Income Tax Withheld Payable		$310
FICA Payable (employee: $248 + $58)		$306
401(k) Contributions Payable		$200
Health Premiums Payable		$150
Wages Payable (net pay)		$3,034

2. Employer payroll taxes (January: all $4,000 is under the FUTA and SUTA wage bases)

Account	Debit	Credit
Payroll Tax Expense	$438
FICA Payable (employer: $248 + $58)		$306
FUTA Payable ($4,000 × 0.6%)		$24
SUTA Payable ($4,000 × 2.7%)		$108

3. Employer-paid benefits

Account	Debit	Credit
Employee Benefits Expense	$660
Health Premiums Payable		$500
401(k) Contributions Payable (3% match)		$120
Workers' Comp Payable		$40

January's cost: $4,000 + $438 + $660 = $5,098, above the $4,989.75 average because of the front-loaded unemployment taxes. In February FUTA drops to $18 (only $3,000 left under its base), in March SUTA is $27, and after that both are zero.

When cash goes out, you debit each liability and credit Cash: net pay on payday; federal income tax and both halves of FICA through electronic deposits on the IRS schedule (monthly or semiweekly); 401(k) and insurance to their providers. Each quarter you file Form 941 and your state unemployment report; each year, Form 940 and a W-2 for every employee by January 31.

2. Is the $248 of Social Security withheld from the employee's pay an extra expense for Brightside?

Yes, because Brightside sends it to the IRS
Only for new employees
No: it's part of the $4,000 of gross wages already expensed; Brightside just withholds and remits it

The employee's share is withheld from wages. Only the employer's matching $248 (and $58 of Medicare) is an additional cost, recorded as payroll tax expense.

Cost per billable hour: the number that sets prices

If you sell services (HVAC repairs, design, bookkeeping, cleaning), you need to know what each hour of an employee's time costs. Use hours actually available, not calendar hours. Take an employee with the same $59,877 total cost:

Paid hours:          40 h × 52 weeks          = 2,080 h
− Vacation:          2 weeks × 40 h           =    80 h
− Paid holidays:     8 days × 8 h             =    64 h
= Available hours                             = 1,936 h

Cost per available hour:  $59,877 ÷ 1,936         = $30.93
If 75% of time is billable:
Cost per billable hour:   $59,877 ÷ (1,936 × 0.75) = $41.24

Hourly cost of the same employee, three ways

Salary ÷ 2,080 h$23.08

Full cost ÷ available h$30.93

Full cost ÷ billable h$41.24

Someone pricing with the naive $23.08 thinks billing $35 an hour is profitable. In reality each billable hour costs $41.24 in labor alone, before rent, vehicles, software and admin (lesson 15 adds those).

3. An employee costs $60,000 a year and has 2,000 available hours, 75% of them billable. What is the cost per billable hour?

$40.00
$30.00
$22.50

Billable hours = 2,000 × 0.75 = 1,500. Cost per billable hour = $60,000 ÷ 1,500 = $40.

Employee or contractor?

W-2 employeeYou control how the work is done

Employer taxes: FICA match, FUTA, SUTA, workers' comp
Paperwork: Form W-4 at hire, payroll every period, W-2 each year
Makes sense if: There's steady work to fill their hours.

Stable work

1099 contractorIndependent business, own methods

Employer taxes: None; the contractor pays self-employment tax
Paperwork: Form W-9, then a 1099-NEC if over the threshold
Makes sense if: Work is project-based or irregular.

Flexible work

The label you choose doesn't decide it; the facts do. The IRS looks at behavioral control, financial control and the type of relationship, and some states, such as California, apply a stricter "ABC" test. Calling an employee a contractor to skip payroll taxes can lead to back taxes, penalties and interest.

4. A cleaning company sets its workers' schedules, supplies all equipment, trains them in its methods and pays them by the hour. It issues them 1099s. What's the likely problem?

None: a signed contractor agreement settles the question
They look like employees under the IRS control tests, so the company risks back payroll taxes and penalties
They should receive both a W-2 and a 1099

Control over schedules, methods and tools points to an employee relationship. The facts decide the classification, not the paperwork.

Practice exercise: can Brightside afford another barista?

Maya wants to hire a full-time barista at $16 an hour, 40 hours a week, paid 52 weeks a year. Use employer FICA of 7.65%, FUTA of $42, SUTA of 2.7% on $9,000 and workers' comp of $0.80 per $100 of payroll. Brightside doesn't offer health insurance yet (with fewer than 50 employees it isn't required to). Each drink leaves a contribution margin of $3.50 (lesson 8).

Calculate the barista's annual and monthly cost.
How many extra drinks a month must Brightside sell to cover it?

See solution

Wages             $16 × 40 × 52              = $33,280.00
Employer FICA     $33,280 × 7.65%            =  $2,545.92
FUTA                                         =     $42.00
SUTA              $9,000 × 2.7%              =    $243.00
Workers' comp     $33,280 ÷ 100 × $0.80      =    $266.24
Annual cost                                  = $36,377.16
Monthly cost      $36,377.16 ÷ 12            =  $3,031.43

Extra drinks: $3,031.43 ÷ $3.50 = 866.1 → 867 drinks a month
(about 33 a day over 26 open days)

The right question isn't "can I pay $16 an hour?" but "will this barista help sell about 33 more drinks a day," for example by shortening the morning line or letting the shop open an hour earlier?

Summary

Gross pay, net pay and total employer cost are three different numbers; decisions should use the total cost.
Employee withholdings (income tax, the employee's FICA, 401(k)) come out of gross pay; they're not an extra cost.
The employer adds 7.65% FICA, FUTA, SUTA, workers' comp and benefits; in the shift lead example the total was about 1.25 times the salary.
Record payroll in three parts: wages and withholdings, employer taxes, and employer-paid benefits.
Price services on the cost per billable hour, and classify workers by the facts, not the label.

Next lesson: Cost Accounting: How to Calculate Product Cost and Set Your Prices. You'll add materials, labor and overhead to find what a product really costs and set a price that leaves a profit.