Takeaways
- Payroll taxes are automatically withheld from every one of your paychecks.
- Payroll taxes fund essential programs for retirees like Social Security and Medicare.
- Social Security taxes are a flat rate of 6.20% for employers and employees.
- Medicare taxes are a flat tax rate of 1.45% for employers and employees.
- Self-employed individuals, like sole proprietorships, might have to pay the individual and company portion of payroll taxes.
What Are Payroll Taxes?
Payroll taxes are taxes withheld from an employee's paycheck by their employer. These taxes fund government programs such as Social Security, Medicare, and unemployment insurance. Employers are also responsible for matching a portion of these taxes.
You pay individual taxes on ordinary income, and your Form W-4 elections can change what is deducted from each paycheck. You will settle up with Uncle Sam when you file your annual income taxes. The IRS uses Form W-2 to check for accurate individual income reporting.
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How Payroll Taxes Work
Employers need to calculate payroll taxes each time you are paid. Here is how the process of calculating and withholding payroll taxes actually works:
1. Determine Gross Wages: The employer calculates employees' gross wages, the total amount earned before deductions. Gross wages can include salaries, bonuses, commissions, and more.
2. Calculate Payroll Taxes: The employer calculates the Social Security, Medicare, and federal income taxes to be withheld from the employee's paycheck.
3. Withhold Taxes: The employer withholds the calculated taxes from the employee's paycheck. These taxes are paid regularly to keep the business in compliance.
4. Match Employer's Share: The employer matches a portion of the Social Security and Medicare taxes withheld from the employee's paycheck.
5. File Tax Returns: Your business or company files tax returns with the appropriate federal, state, and local governments to report the wages paid to employees and the taxes withheld.
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Types of Payroll Taxes
- Social Security Payroll Tax: The Social Security tax is a payroll tax that funds the Social Security program, which provides retirement benefits, disability benefits, and survivor benefits. Both you and your employer or business contribute to the Social Security tax. The current Social Security tax rate is 6.2% for both the employee and 6.2% for the employer, up from a 2024 wage base limit of $168,600. [1]
- Medicare Payroll Tax: The Medicare payroll tax funds the Medicare program, which provides health insurance coverage for people aged 65 and older and those with disabilities. Both the employee and the employer contribute to the Medicare tax. The current Medicare tax rate is 1.45% for both the employee and 1.45% for the employer. For high-income earners, an additional Medicare tax of 0.9% applies in 2024 for wages over $200,000. (Read more about HENRYs).
- Unemployment Tax: Unemployment taxes fund state unemployment insurance programs, which provide temporary benefits to workers who lose their jobs through no fault of their own. Employers are responsible for paying unemployment taxes; the tax rate varies by state.
- Self-Employment Taxes: Self-employed individuals are responsible for paying the employee and employer portions of Social Security and Medicare taxes. Having to pay both is known as self-employment tax. Self-employment tax can apply if you are a sole proprietorship. Self-employed individuals must file quarterly tax returns and pay estimated taxes to the Internal Revenue Service.
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What Is the FICA Tax?
The Federal Insurance Contributions Act (FICA) tax is a U.S. federal payroll tax. FICA tax is a combination of the Social Security and Medicare tax and is deducted from each of your paychecks and matched by your employer.
Every time you pay the FICA tax, you will earn credits for Social Security benefits in the future. Your contributions today help fund payments for today's Social Security beneficiaries. According to the Social Security Administration, over 180 million workers are covered under Social Security. [2]
Understanding FICA Tax Implications
- Employee Impact: FICA taxes reduce your take-home paycheck. However, the contributions made to Social Security and Medicare provide valuable benefits in the future. (Read more about how to budget).
- Employer Impact: Employers are responsible for withholding FICA taxes from employee paychecks and matching employee contributions. Businesses must also file tax returns and pay the taxes to the government. (Read more about C Corporations and LLCs).
- Tax Planning: Understanding FICA taxes can help individuals and businesses plan their finances and minimize tax liability. For example, self-employed individuals can deduct some of their self-employment taxes as a business expense. (Read more about the best tax software programs).
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Payroll Taxes vs. Income Taxes
While payroll taxes and income taxes are both types of earned income taxes, they have distinct characteristics:
- Payroll Taxes are primarily designed to fund specific government programs, such as Social Security and Medicare. They are calculated as a percentage of an employee's wages and are typically split between the employee and the employer. Payroll taxes are generally straightforward and are calculated based on fixed rates.
Payroll taxes are withheld from your paycheck by your employer. They are typically calculated as a percentage of the employee's wages. These taxes are a significant expense for businesses. Employers must carefully calculate and withhold payroll taxes to ensure compliance with federal, state, and local tax laws.
- Income Taxes, on the other hand, are based on your taxable income, which is calculated by subtracting tax credits and deductions from gross income. Federal income tax rates are progressive, meaning that higher income levels are taxed at higher rates. Income taxes fund various government programs and services, including education, infrastructure development, and national defense spending.
Your tax filing status, charitable donations, dependents, capital gains, and earned income determine your total tax bill. You have to pay federal income taxes to the IRS each year.
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Smart Summary
Payroll taxes are taxes withheld from your paycheck by your employer. They include funding for programs like Social Security and Medicare. If you run your own company, understanding the intricacies of payroll taxes is critical to maintaining compliance with federal, state, and local tax laws. As an employee, understanding payroll taxes can help you read your paycheck for accuracy and plan your personal finances better.
(1) Internal Revenue Service. Topic no. 751, Social Security and Medicare withholding rates. Last Accessed January 12, 2025.
(2) Social Security Administration. What is FICA? Last Accessed January 12, 2025.
