A payroll tax encompasses the various taxes imposed on wages, tips, and salaries, payable by both employees and employers. For employees, these taxes are deducted from their paychecks and passed on to the government by their employer. The typical components include federal, state, and local income taxes, as well as the employee’s share of Social Security and Medicare taxes (FICA). Employers, on the other hand, contribute their own share of FICA taxes and also cover federal and state unemployment taxes.
Key Takeaways
- Payroll taxes are deducted from an employee’s paycheck and remitted to the government.
- In the U.S., such taxes fund crucial programs like Social Security and Medicare.
- Both employers and employees contribute equally to Social Security and Medicare taxes.
- Payroll taxes support government spending, specific programs, Social Security, Medicare, local infrastructure, and more.
Understanding Payroll Taxes
Federal payroll taxes in the U.S. are mainly for Social Security and Medicare contributions, which form part of the Federal Insurance Contributions Act (FICA) tax. These components are often listed as MedFICA and FICA on employees’ pay stubs. Federal income tax, also withheld from paychecks, is allocated to the U.S. Treasury’s general fund.
Many states, and even some cities and counties, impose additional income taxes, which are paid directly to state and local governments. Furthermore, employers, not employees, are required to pay federal unemployment taxes for each of their employees.
Employee pay stubs itemize these deductions, detailing the amounts withheld for federal, state, and municipal income taxes, as well as allocations for Medicare and Social Security. These revenues are used to fund specific programs, such as Social Security, healthcare, and workers’ compensation, and to maintain local infrastructure like first responders, road maintenance, and parks.
Tax Amounts
Social Security and Medicare contributions during working years qualify an individual to withdraw these funds after retirement or under certain medical conditions. An employee contributes 7.65% (6.2% for Social Security and 1.45% for Medicare), and an employer matches this 7.65%. For those earning over $200,000, an extra 0.9% for Medicare applies. In 2023, Social Security tax only applies to earnings up to $160,200. This cap will increase to $168,600 in 2024.
Unemployment Taxes
The responsibility of funding unemployment insurance falls mainly on employers. In the event of layoffs, employees may claim unemployment benefits. The unemployment tax rate varies depending on the industry, state, and federal guidelines. Some states additionally require employees to contribute to unemployment and disability insurance.
Self-Employment Taxes
Self-employed individuals, such as contractors and small business owners, are responsible for their own payroll taxes, often referred to as self-employment taxes. Unlike salaried workers, self-employed individuals must cover both the employer and employee portions of the tax. The self-employment tax rate is 15.3%, which includes 12.4% for Social Security and 2.9% for Medicare. An additional 0.9% Medicare tax applies to earnings exceeding $200,000.
Social Security Payroll Tax
Social Security taxes flow into two trust funds: the Old-Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance Trust Fund. These funds are managed by key figures like the Secretary of the Treasury and the Commissioner of Social Security. The tax rate for Social Security is 6.2% from both the employer and the employee, totaling 12.4%. Earnings above $160,200 in 2023 ($168,600 in 2024) are not subject to this tax.
Initiated by President Franklin D. Roosevelt with the signing of the Social Security Act on August 14, 1935, this program was designed to offer a safety net for disabled individuals and retirees.
Medicare Payroll Tax
Similar to Social Security, payroll taxes also contribute to Medicare, directed into two trust funds. The Hospital Insurance Trust Fund covers Medicare Part A, which supports hospital care, skilled nursing, and home care. Most people pay no premium for Part A due to previous contributions through payroll taxes. The tax rate for Medicare is 1.45% from each party, totaling 2.9%, with an additional 0.9% on earnings over $200,000.
The Supplementary Medical Insurance Trust Fund assists in covering Medicare Parts B and D, funded by congressional authorization, enrollee premiums, and interest earned on investments.
Payroll Taxes vs. Income Taxes
Payroll and income taxes differ in their applications. Payroll taxes fund specific programs, whereas income taxes feed into general funds in the U.S. Treasury. Everyone pays a flat payroll tax rate, whereas income tax rates vary depending on an individual’s earnings.
What Makes Up Payroll Taxes?
Payroll taxes encompass taxes on an employee’s salary, wages, bonuses, commissions, and tips. These taxes support Social Security, Medicare, unemployment insurance, numerous government programs, and local infrastructure.
What Is the FICA Tax?
The FICA tax, representing the Federal Insurance Contributions Act, is used for Social Security and Medicare funding. The total tax is 15.3%; an employer and employee each cover 7.65%. This amount includes 6.2% for Social Security and 1.45% for Medicare.
Does Everyone Pay a Payroll Tax?
Yes, almost everyone pays a payroll tax, automatically deducted from their paycheck. Social Security and Medicare taxes are regressive, while income taxes are progressive, with higher earners paying higher rates.
The Bottom Line
Payroll taxes are vital components deducted from employees’ wages, paid by both employees and employers. These taxes fund wide-ranging areas, including Social Security, healthcare, defense spending, government salaries, and workers’ compensation. Additionally, local governments may levy small payroll taxes to maintain and improve community infrastructure and services.
Related Terms: Social Security, Medicare, Federal Income Tax, State Income Tax, Self-Employment Tax, FICA.
References
- U.S. Department of the Treasury. “Accounting & Budget FAQs”.
- Internal Revenue Service. “Federal Unemployment Tax”.
- Center on Budget and Policy Priorities. “Policy Basics: Federal Payroll Taxes”.
- Internal Revenue Service. “Topic No. 751 Social Security and Medicare Withholding Rates”.
- Social Security Administration. “Contribution and Benefit Base”.
- Internal Revenue Service. “Questions and Answers for the Additional Medicare Tax”.
- Internal Revenue Service. “Self-Employed Individuals Tax Center”.
- Internal Revenue Service. “Self-Employment Tax (Social Security and Medicare Taxes)”.
- Social Security Administration. “Social Security/Medicare Trustees”.
- Social Security Administration. “Status of the Social Security and Medicare Programs”.
- Social Security Administration. “Contribution and Benefit Base”.
- Social Security Administration. “Historical Background And Development Of Social Security”.
- Social Security Administration. “The Social Security Act of 1935”.
- Social Security Administration. “The Evolution of Social Security’s Taxable Maximum”.
- Medicare.gov. “How Is Medicare Funded?”.
- Internal Revenue Service. “Understanding Employment Taxes”.
