What Are Payroll Taxes?

What Are Payroll Taxes?
Article by Zarah Ariola
Last Updated: December 01, 2023

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. In this article, we'll discuss what payroll taxes are, who pays them, and some examples. Let's get started.

What Are Payroll Taxes?

Payroll taxes are charged on employee salaries and wages. Taxation is used to fund social insurance programs such as Social Security and Medicare. The social insurance tax comprises 23.05% of combined federal, state, and local government revenue. According to a study conducted by the Tax Foundation, it is the US government's second-largest source of income.

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.

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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.

US tax incidence is determined by the markets and not by law. According to which party is more sensitive to price changes, the market often decides how the tax burden is split between buyers and sellers. Because of this, there is a distinction between the person who must pay taxes to the federal government and the person who bears them.

Also, it has been discovered that the labor supply, which is also the willingness of the employees to work, is less responsive to taxation than the demand for labor or the readiness of the firms to hire. Businesses can search for the best personnel or relocate manufacturing, but those looking for work are not affected by salary adjustments.

As a result, the payroll tax burden is distributed widely by the labor market.

How Do Employer Payroll Taxes Work?

Employers must deduct the appropriate amount of taxes from their employees' wages. Employers are responsible for calculating their share of taxes, depositing payments, and filing returns with government agencies on time. Let's look into how employer payroll taxes work.

The following taxes must be paid with each pay period:

  1. Social Security and Medicare Taxes
  2. Federal Income Tax
  3. State and Local Income Tax
  4. Federal and State Unemployment

1. Social Security and Medicare Taxes

Federal Insurance Contribution ACT (FICA) taxes are used to fund the federal Social Security and Medicare programs. For each pay period, the total due is 15.3% of an individual's wages, half 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 $147,000 and 1.45% for Medicare with no limit. Workers earning more than $200,000 are subject to an additional 0.9% Medicare surcharge, which employers do not match.

2. Federal Income Tax

Only employees are responsible for paying federal income taxes, which are calculated using information from FormW-4 and the compensation earned during the pay period.

3. State and Local Income Tax

These taxes are paid solely by employees and vary depending on location.

4. Federal and State Unemployment

Usually, only the employers are responsible for paying the unemployment taxes. But, in a few American states, 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 Example

An illustration clarifies how payroll taxes work.

You can see how much payroll taxes you as an employee must pay by looking at your paycheck. The total should match 7.65% of the pay period's gross income. IFICA line items include designations such as Social Security, Medicare, SS, SSWT, MWT, Med, FICA SS, or FICA Med.

As an example, if a worker earned $1000 during a pay period, his employer would withdraw $76.50 for payroll taxes, leaving $923.50.

Regardless of whether they outsource payroll services, the employer will probably withhold a portion of wages for income taxes and employee contributions to perks like retirement accounts and health and dental insurance. The money that is left over is the employees' net income.

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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.

Payroll Taxes FAQs

1. What makes up payroll taxes?

Payroll taxes include all taxes levied on a person's income, including salary, bonuses and commissions. These taxes fund Social Security, Medicare, unemployment insurance, government programs and local infrastructure. Employee's total due for each pay period is 15.3% of total income, with the employer and employee each contributing 50% of that total. 

2. What is the FICA tax?

The Federal Insurance Contributions Act, or FICA, is a tax deducted from every employee’s and employer’s paycheck. The funding covers both Social Security and Medicare. Thanks to FICA, the federal government runs programs that help retirees, people with disabilities, and children of deceased workers. 

3. What's the difference between payroll taxes vs. income taxes?

Payroll taxes are automatically withheld from an employee's paycheck by their employer and include taxes for Social Security, Medicare and sometimes state disability and unemployment insurance. Both the employee and employer pay these taxes. 

On the other hand, income taxes are paid to the government directly by the employee either through regular withholding from their paycheck or through estimated quarterly payments. 

The main difference is that payroll taxes are automatically withheld from an employee's paycheck, while income taxes are typically paid directly to the government by the employee. 

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