What are Payroll Taxes: Understanding How Payroll Taxes Work

Looking at your latest pay stub, you will see two essential lines among the taxes taken out of your wages. FICA and MEDFICA stand for Federal Insurance Contributions Act and Medicare Federal Insurance Contributions Act, respectively. Together, they comprise about 7.65% of your wages.

These are known as payroll taxes, and in this article, we shall discuss what payroll taxes are, who pays them, and some examples.

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What are Payroll Taxes?

Payroll taxes are taxes paid on the salaries and wages of employees. The taxes are used to finance social insurance programs like Social Security and Medicare. The social insurance tax comprises about 23.05% of combined federal, state, and local government revenue. According to the Tax Foundation research, it is the second largest source of government revenue in the US.

The two federal payroll taxes, the FICA and MEDFICA, take up the central part of the social insurance tax. FICA is a 12.4% tax to fund Social Security, and MEDFICA is a 2.9% tax to fund Medicare, for a combined rate of 15.3%.

Half of the payroll taxes, 7.65%, are remitted by the employers or employers of record, while the other half is taken from the workers' paychecks.

Who Pays the Payroll Taxes?

It is said that a well-kept secret about payroll taxes is that employees pay almost the entire payroll tax, though the matter is debated.

Let's understand why.

Generally, the marketplace determines the division of the tax burden between the buyers and sellers, depending on which side is more sensitive to price changes. Tax incidence in the US is determined by the markets and not by law. That is why the person who must pay the taxes to the federal government and the one who bears it is different.

It is also found that the labor supply, which is also the workers' willingness to work, is less sensitive to taxes than the demand for labor or the willingness of the employers to hire.

Companies can look around for the best employees or shift production to different locations, but workers who need jobs are not responsive to wage changes.

Thus, the labor market broadly distributes the payroll tax burden.

How do Employer Payroll Taxes Work?

Employers are responsible for deducting the right amount of taxes from the employees' wages. Employers must calculate their share of taxes, deposit the payments, and file returns with government agencies on time. Let's look into how employer payroll taxes work.

The taxes to be paid in every pay period include:

Social Security and Medicare Taxes

Federal Insurance Contribution ACT (FICA) taxes to support the federal Social Security and Medicare programs. For each pay period, the total due is 15.3% of an individual's wages, half of which is paid by the employer and the other half by the employee.

This implies that each party pays 6.2% for Social Security up to a base limit wage of $147000 and 1.45% for Medicare with no limit. Workers who earn more than $200,000 are charged an additional 0.9% of Medicare, which does not match the employers.

Federal Income Tax

Federal income taxes are paid only by employees and are calculated based on the salary earned over the pay period along with FormW-4 details.

State and Local Income Tax

These taxes are paid only by the employees and vary by location.

Federal and State Unemployment

The unemployment taxes are typically paid by the employers only. In a few US states, however, the employees also contribute.

The federal rate ranges from 0.6% to 6%, based on how much the employer pays in the state unemployment tax.

Payroll Taxes Examples

An example can better establish how payroll taxes work.

Looking at your pay stub, you can understand how much you pay as an employee in payroll taxes. The amount should reflect 7.65% of the gross income for the pay period. In the line item for FICA, you will find designations like Social Security, Medicare, SS, SSWT, MWT, Med, FICA SS, or FICA Med.

For instance, if an employee earned $1000 during a pay period, his employer deducts $76.50 for payroll taxes, leaving behind $923.50.

Whether or not they outsource the payroll services, the employer will likely deduct a wage percentage for income taxes and employee contributions to benefits like health and dental plans and retirement accounts. The employees' net income is the amount of money left over.

What are Payroll Taxes Takeaway

Summing up, payroll taxes are a crucial source of government revenue. However, employees are often unaware of the burden of payroll taxes and the government program they pay for.

This is due to the way the taxes are levied, which is not entirely transparent. Employers can seek the help of the best payroll service providers too.

That is why it is even more critical for employers and employees to know what payroll taxes are and how they work.

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