Why is an employee's net pay so much smaller than their gross pay?

Gross pay is reduced by pretax deductions (health premiums, retirement contributions), then by employee-side taxes: federal income tax withholding, Social Security, Medicare, and often state income tax. A typical employee takes home roughly 70 to 80 percent of gross, though the exact figure depends on the W-4, the state, and the benefit elections.

What does an employer pay on top of an employee's gross wages?

The employer pays its own matching share of Social Security and Medicare taxes, federal unemployment tax (FUTA), state unemployment tax (SUTA), and usually workers' compensation premiums and any benefit contributions. Together these commonly add roughly 8 to 12 percent or more on top of gross wages, before benefits.

Where do the withheld taxes go after payroll runs?

Withheld income tax and both halves of Social Security and Medicare sit in payroll liability accounts until the employer deposits them with the Treasury through EFTPS, on a monthly or semiweekly schedule set by IRS rules. The amounts are then reported quarterly on Form 941.

Is withheld payroll tax the employer's money?

No. Withheld income tax and the employee's share of Social Security and Medicare are trust fund taxes — the employer holds them for the government. Using them for operating cash exposes the responsible individuals personally to the trust fund recovery penalty under Section 6672, which the IRS pursues aggressively.

What is the difference between a payroll expense and a payroll liability?

Expenses are the employer's costs: gross wages and the employer's own taxes. Liabilities are amounts owed to someone else: net pay owed to the employee until paid, withheld taxes owed to tax agencies, and withheld benefit premiums owed to the plan. Withholdings are never the employer's expense — they are the employee's money passing through.

From gross to net: the anatomy of one paycheck

A paycheck is a small machine with four compartments. Gross pay goes in one end. Pretax deductions come out first. Employee taxes come out next. What remains — net pay — goes to the employee's bank account. Meanwhile, invisibly to the employee, the employer stacks its own costs on top: matching payroll taxes, unemployment taxes, and usually insurance and benefits.

If you keep the books for a business with employees, this article is the map. Every payroll question you will ever field — why the W-2 doesn't match the final paystub, why the payroll expense on the P&L exceeds what anyone got paid, why there is money sitting in accounts called "payroll liabilities" — traces back to this anatomy.

Start with gross pay

Gross pay is everything the employee earned before anything is taken out: salary or hourly wages, overtime, bonuses, commissions, and most taxable fringe benefits. For an hourly employee, it is hours times rate, with overtime at time-and-a-half for hours over 40 in a workweek under the Fair Labor Standards Act (the Department of Labor's Wage and Hour Division administers those rules; some states are stricter).

For the rest of this article, follow one worked example: an employee earning $2,000 gross per biweekly pay period.

Pretax deductions come out first

Certain deductions come out of gross pay before taxes are computed, which is why they save the employee money. The common ones:

Deduction	Reduces federal income tax?	Reduces Social Security/Medicare?
Health insurance premiums (Section 125 cafeteria plan)	Yes	Yes
Traditional 401(k) deferrals	Yes	No
HSA contributions through a cafeteria plan	Yes	Yes
FSA contributions	Yes	Yes
Roth 401(k) deferrals	No	No

Note the asymmetry: a traditional 401(k) deferral escapes income tax withholding but not Social Security and Medicare. This single fact explains most of the gap between a W-2 and a final paystub — see /bookkeeping/payroll-compliance/w2-vs-final-paystub.

In our example, say the employee defers $100 to a traditional 401(k) and pays $80 in pretax health premiums. Income-taxable wages drop to $1,820; Social Security/Medicare wages drop to $1,920.

Employee taxes come out next

Three or four taxes come out of the employee's side:

Federal income tax withholding. Computed from the employee's Form W-4 elections and the withholding tables in Publication 15 and its companion Pub 15-T. This is an estimate of the employee's eventual income tax, not a flat rate — do not state or memorize a number; the tables change annually. The employee controls it via Form W-4.
Social Security tax (employee share). A flat percentage of Social Security wages up to an annual wage base that the Social Security Administration indexes each year; Pub 15 states the current rate and base.
Medicare tax (employee share). A flat percentage of Medicare wages with no cap, plus an additional Medicare tax the employer must withhold once wages pass $200,000 in the calendar year.
State (and sometimes local) income tax withholding, where applicable, under the state's own tables and its own employee certificate.

For the worked example, assume illustratively that withholding comes to $180 federal income tax, $119 Social Security, $28 Medicare, and $60 state income tax. (These are illustrative figures for the arithmetic; the real numbers come from the current-year tables.)

Net pay is what's left

$$2,000 − $180 pretax deductions − $387 employee taxes = $1,433 net pay. That is the direct deposit. Everything else that came out of gross is now sitting in your liability accounts, owed to someone.

The employer's stack on top

Here is the part the employee never sees. The employer owes, out of its own pocket:

Employer Social Security and Medicare match — the same amounts as the employee shares (the regular ones; there is no employer match of the additional Medicare tax).
FUTA — federal unemployment tax, a small percentage of the first $7,000 of each employee's annual wages, typically reduced by a credit for state unemployment taxes paid.
SUTA — state unemployment tax, at an experience rate the state assigns, on a state-specific wage base.
Workers' compensation premiums, in most states, priced per $100 of payroll by job classification — see /bookkeeping/payroll-compliance/workers-comp-basics.
Employer benefit contributions — the company share of health premiums, 401(k) match, and similar.

Where an illustrative payroll dollar goes, combining the employee's paycheck and the employer's add-on costs into one picture:

Where a payroll dollar goes (illustrative, per $1 of gross wages)¢

Illustrative allocation for a mid-wage employee with modest benefits; actual splits depend on the W-4, state, wage level, and benefit elections.

The first four bars sum to the $1 of gross. The last two bars are additional employer cost — which is why "fully loaded" labor cost runs meaningfully above the salary number, before you even count benefits.

The journal entry for a payroll run

Now book it. One payroll run produces two entries (or one combined entry — but learn them separately first). The first records the wage expense and splits gross into its destinations:

Journal entry — Payroll run — wages and withholdings (per our worked example)

Account	Debit	Credit
Wages expense	2,000
Federal income tax withheld payable		180
Social Security/Medicare withheld payable		147
State income tax withheld payable		60
401(k) deferrals payable		100
Health premiums withheld payable		80
Net payroll payable (or Cash)		1,433

The debit is gross pay. Every credit is money owed to someone: the Treasury, the state, the 401(k) plan, the insurer, or the employee.

The second records the employer's own taxes — the ones stacked on top:

Journal entry — Payroll run — employer payroll taxes (illustrative)

Account	Debit	Credit
Payroll tax expense	180
Social Security/Medicare payable (employer share)		147
FUTA payable		8
SUTA payable		25

Employer-side taxes are the company's expense; the employee-side withholdings in the first entry are not.

When the deposits and remittances go out, you debit each liability and credit cash — the full set of payment entries is worked through in /bookkeeping/payroll-compliance/payroll-journal-entries.

Deposit obligations: the clock starts at payday

Withheld income tax and both shares of Social Security and Medicare do not wait for a quarterly filing. They must be deposited with the Treasury — electronically, through EFTPS — on a schedule the IRS assigns each year based on your past liability:

Monthly depositors deposit each month's accumulated taxes by the 15th of the following month.
Semiweekly depositors deposit within a few business days of each payday, on a Wednesday/Friday rhythm.
Accumulate $100,000 or more of liability on any day and a next-business-day deposit rule overrides everything.

The mechanics and the "lookback period" that determines your status are in Publication 15 and covered in /bookkeeping/payroll-compliance/payroll-deposit-schedules. Then, quarterly, Form 941 reports the wages, withholdings, and taxes and reconciles them against the deposits already made.

Two things make deposit discipline non-negotiable. First, deposit penalties scale with lateness and apply per deposit, so a broken habit compounds quickly. Second, the withheld amounts are trust fund taxes — the government's money in your custody. If a business fails to remit them, the IRS can assess the trust fund recovery penalty under Section 6672 personally against owners, officers, and even bookkeepers who had the authority to pay and didn't — see /irs-controversy/trust-fund-recovery-penalty.

When this picture gets more complicated

The clean anatomy above bends in predictable places, and it is worth knowing where:

Owner pay is not always payroll. Sole proprietors and partners do not run themselves through payroll at all — they take draws and pay self-employment tax (see the IRS Self-Employed Individuals Tax Center). S corporation shareholder-employees, by contrast, must be on payroll for reasonable compensation — see /bookkeeping/payroll-compliance/owner-payroll-scorp.
Contractors bypass the machine entirely. No withholding, no employer taxes — but a 1099 obligation and a classification question with teeth. See /bookkeeping/payroll-compliance/employee-vs-contractor.
Tips, fringe benefits, and multi-state work each add their own layer — taxable fringes flow into gross even though no cash moves, and a remote employee in a new state creates registration obligations before the first paycheck.
Household employees (a nanny, an in-home caregiver) follow a different regime entirely and do not belong on the business payroll.

What to do with this

If you are setting up or reviewing a payroll ledger, check five things:

Confirm the chart of accounts has separate liability accounts for each withholding destination — federal taxes, state taxes, retirement, benefits — not one undifferentiated "payroll liabilities" bucket.
Verify that the P&L payroll expense equals gross wages plus employer taxes, and nothing else.
Trace one recent payroll run from the payroll report to the journal entry to the bank: gross to the expense, withholdings to liabilities, net to the cash withdrawal.
Confirm the liability accounts drain to zero (or near it) after each deposit and remittance cycle; a liability balance that only grows means something is not being paid.
Confirm you know your deposit schedule for the current year, and that deposits are actually going out through EFTPS on that schedule.

A payroll system where those five checks pass will survive a Form 941 reconciliation, a workers' comp audit, and most IRS notices without drama. The rest of this desk's payroll series takes each moving part in turn.