Knowing what payroll tax is and who pays it is an important part of doing business. As an employer, you’re responsible for calculating taxes and other deductions, as well as withholding the correct amounts from employees’ paychecks each month.
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In this article, we’ll take a closer look at the different types of payroll tax and what they include, as well as who’s responsible for paying them, and how they’re spent.
What is payroll tax?
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Payroll taxes are a tax on the salaries and wages of employees. They include Social Security and Medicare taxes, as well as federal, state, and local taxes. Put simply, payroll taxes are a mandatory contribution to the federal government, withheld from an employee’s paycheck each pay period and added to by their employer.
Where does this money go? Payroll taxes are mostly used to fund Social Security and Medicare, as well as to help pay for things like local infrastructure projects, public services, road maintenance, parks, and other government programs. Unlike income taxes, which are also withheld from pay checks, payroll taxes are collected to pay for specific programs. Income taxes are paid into the US Treasury and used for general government spending, while state income taxes end up in the state’s treasury.
Understanding payroll taxes
Payroll tax isn’t a single tax, but is the collective term for a bunch of different taxes used to fund government programs. Some of these are paid by the employer and some are shared equally by both the employee and the employer.
Employees will be most familiar with Federal Insurance Contributions Act (FICA) taxes, which fund Social Security and Medicare, but many states and some cities will have their own local taxes, which may also need to be withheld by employers.
It’s up to the employer to properly calculate these payroll deductions every pay period, notify the employee of the correct amounts, withhold them from their paycheck, and pay them to the IRS.
There are four main types of payroll taxes, which we’ll describe below. Firstly, there are the Federal Insurance Contributions Act (FICA) taxes, which are shared evenly between the employee and the employer.
1. Social Security tax
Social Security tax is used to pay for the retirement, disability, and survivorship benefits of millions of eligible Americans. Employers and employees each pay 6.2% of the employee’s gross salary toward Social Security, up to the Social Security wage base.
The Social Security wage base is the maximum amount of an employee’s wages that are subject to the Social Security tax, which in 2023 is $160,000.
2. Medicare tax
Medicare tax is used to fund Medicare benefits. Employers and employees each pay 1.45% of the employee’s wages toward Medicare, and unlike the Social Security tax there’s no income limit or wage base. Employees who earn more than $200,000 per year have to pay an Additional Medicare Tax of 0.9%. The employer must withhold this amount from the employee’s paycheck as usual, but they’re not required to match it.
3. Federal income tax
Federal income tax is withheld from an employee’s paycheck just like other payroll taxes–which is why we’re mentioning it here–but it’s technically not a payroll tax. Unlike payroll taxes, income tax is only paid by the employee, and the money goes toward general government spending rather than specific welfare programs.
Federal income tax is a progressive tax, meaning employees pay higher percentages of their salary if they earn more. In contrast, payroll taxes are regressive, meaning they remain a flat percentage of an employee’s gross salary.
Employer payroll taxes
Whereas both the employee and the employer pay toward Social Security and Medicare taxes, some payroll taxes are the sole responsibility of the employer to pay. These typically relate to funding unemployment insurance.
1. Federal Unemployment Tax Act (FUTA)
The Federal Unemployment Tax Act (FUTA) is used to fund unemployment insurance at the federal level, which pays benefits to people who get laid off or who find themselves out of work.
This payroll tax is typically imposed on employers, not employees, and varies by industry and location. Employers are responsible for paying 6% of the first $7,000 of each employee’s wages. Employers who also pay state unemployment tax can get a federal tax credit of up to 5.4%, reducing the effective FUTA rate to 0.6%.
2. State Unemployment Tax Act (SUTA)
Similar to the Federal Unemployment Tax Act (FUTA) above, the State Unemployment Tax Act (SUTA) is a payroll tax imposed on employers and is used to fund state unemployment benefits.
This tax is also sometimes referred to as state unemployment insurance or reemployment tax, and each state has its own rate and wage base limit.
How much is payroll tax?
So what do all of these various payroll taxes add up to for an employer? The answer depends on a range of different factors, including how many people the company employs, how much they get paid, the structure of the company, and where the company is based.
Federal Insurance Contributions Act (FICA) taxes are the simplest to figure out. Employer payroll tax rates for Social Security are 6.2% of each employee’s gross taxable wages, up to the wage base limit. Payroll tax rates for Medicare are 1.45% of each employee’s taxable wages. Remember that employers aren’t required to pay any additional tax if an employee’s salary is above $200,000.
Federal Unemployment Tax Act (FUTA) taxes are 6% of the first $7,000 of each employee’s wages, or $420 per employee. However, most companies are based in states that receive federal tax credits in return for paying state unemployment insurance, which can reduce the effective FUTA tax rate to 0.6%.
The payroll tax rate for state unemployment insurance is a little trickier to calculate as it varies by state. It can also be affected by things like the size of the company, how long it’s been in business, and staff turnover.
As well as the ones we’ve mentioned above, there may be other payroll taxes employers are responsible for paying. Check with your state government’s website for the most up to date information.
Steve Hogarty is a writer and journalist based in London. He is the travel editor of City AM newspaper and the deputy editor of City AM Magazine, where his work focuses on technology, travel, and entertainment.