Payroll taxes are the taxes employees and employers must pay to the government based on their earnings. The earnings will include standard salary or wages, tips, bonuses and any supplemental income from employer to employee.
The employee will typically pay payroll taxes via a payroll deduction and the employer will match their contribution and pay it directly to the IRS. However, not all employment taxes are payroll taxes in the United States.
Payroll taxes are mainly those required by the Federal Insurance Contributions Act (FICA). The following are the main types of payroll taxes you should know about:
Social Security Tax
One of the main payroll taxes you should know is social security tax. President D. Roosevelt signed the Social Security Act in 1935 and people have been paying social security tax since 1937.
The tax was only 1% when it was imposed in 1937. However, it is adjusted for inflation hence it increases every year.
The tax is levied to the employer but the employee also has to make a contribution. The social security tax rate is 12.4% which the employer and employee contribute half.
The majority of social security tax goes to the Old-Age and Survivors Insurance (OASI) Trust Fund, which pays for retirement and survivor benefits, and the Disability Insurance Trust Fund, which pays for disability benefits.
The social security tax only applies to income up to $147,000 in 2022. If you earn more than that, the rest of your income will not be subject to the tax.
Medicare Tax
Most businesses are required to provide their employees with medical insurance. If not, it is a great incentive that helps to attract and retain employees. Medical insurance for employees is a smart investment every business owner should make.
Medicare taxes fund the national hospital insurance program hence it is also referred to as the hospital insurance tax. The employer and employee make matching contributions to the fund based on the employee’s income.
The employer and employee both contribute 1.45% which amounts to a total contribution of 2.9%.
For self employed individuals the tax rate is still 2.9% but only 92.35% of earnings or income is subject to the tax. Firms, on the other hand, pay the Medicare tax rate on 100% of their earnings.
Federal Unemployment Tax
The other type of payroll tax you should know about is the federal unemployment tax. The Federal Unemployment Tax Act (FUTA) is a 6% payroll tax levied on employers.
The tax includes a 0.6% rate which is imposed on every $7,000 employers spend on employees compensation. The state keeps the rest as tax credits. It contributes to state funds that help pay unemployed benefits to those that cannot find work.
The state unemployment agencies collect federal unemployment tax hence employers can pay it at the state level instead of to the federal government.
Income Tax
It is important to make a distinction between income and payroll taxes. There is a lot of confusion between the two and many assume income tax are payroll taxes because both types of taxes appear on your paycheck and are employment taxes.
Income taxes go directly to the funds at the treasury. On the other hand, payroll taxes contribute funds to certain programs as seen above. Use a payroll tax calculator to find out what you owe the authorities.
Most will be calculated by your employer and indicated on your paycheck. However, the calculations will be vital when filing your tax returns and when ascertaining that you paid the correct amount.
There are three main types of payroll taxes which you should know about which are medicare tax, social security tax and federal unemployment tax. Be sure to know the difference between income tax and payroll taxes. Use a tax calculator to ensure you pay the right amount.
