Payroll taxes are deducted from an employee's paycheck specifically for Social Security, Medicare, and unemployment. Social Security and Medicare are covered under FICA taxes, while FUTA taxes cover employment. These are unrelated to general income tax, which goes straight to the government’s general fund, used for things like roads or paying emergency service workers.
Like it or not, we’ve all got to pay our taxes. Getting down to the specifics of it all can lead to confusion about different percentages and forms, but if you’re a business owner who operates a payroll, it pays to be aware of what is being deducted from your employees’ paychecks.
What Is Payroll Tax?
Payroll tax is a standard rate paid by legal employees and employers in the United States. These are deducted when a business conducts their payroll. While paying these taxes as a young, healthy worker might seem like a downer, you’ll be thanking yourself as you enter your golden years, as paying these taxes entitles you to take full advantage of Medicare and Social Security benefits.
Payroll taxes are paid by both employers and employees, at identical rates of 7.65%. These taxes are paid every pay period, and exemptions are very rare. There was a recent possibility that workers could take a payroll tax ‘holiday’ as part of the COVID-19 relief effort, but other than that, payroll tax is quite strict and universal.
While both Medicare and Social Security are bundled under one umbrella, known as FICA taxes, there is one more payroll tax – known as the FUTA tax – which is instead intended for unemployment aid. This is paid by businesses only – not employees.
Who Has to Pay Payroll Taxes?
Almost any legally employed citizen working in the USA will need to pay payroll taxes, but there are some exemptions. For example, government employees, disabled workers, or homeworkers may be exempt from FICA or FUTA taxes.
Workers on visas might also be exempt from payroll taxes, but this hinges on what kind of visa they’re using, and what country they come from.
And it’s not just workers – businesses are obligated to pay the exact same amount of FICA tax as their employees.
How to Withhold Payroll Tax
The obligation of paying payroll taxes falls to the employer, not the employee. If your business opts to use an accountant or payroll software, you won’t have to worry about the specifics of withholding payroll taxes, as they will calculate this for you.
However, if you’re filling these out by yourself, you’ll need a couple of different forms.
- For FICA payroll taxes, the employer will need Form 941, which generously encompasses FICA taxes, income tax, and even tipped wages into a single form for each employee.
- Then, for FUTA taxes, the employer will fill out Form 940. This is just for FUTA taxes, so for an average, non-exempt employee, you’ll need to fill out both forms.
These forms are just for payroll tax purposes. Each US state will have different tax requirements and forms, which need to be filled out on top of the federal forms.
Payroll tax rates are flat, meaning that anyone making an income of up to $142,800 will be paying the same percentage of their paycheck towards Social Security – a rate of 6.2%. Anyone making a yearly amount over $142,800 won’t have to pay Social Security taxes on any of the money above $142,800.
However, Medicare is the opposite. The initial Medicare payment rate is only 1.45%, but this increases to 2.35% if the employee makes over $200,000.
This can be quite complicated, so let’s take a look at some examples:
Franky makes $80,000 a year (pre-payroll tax). He would pay a total of 7.65% of his salary ($6,120) toward payroll taxes, leaving him with $73,880 (before income tax). His employer must match this payroll tax, so also pays $6,120.
Robin takes home a yearly salary of $210,000. As this is above the $200,000 Medicare payment rate threshold, she pays the higher Medicare tax rate of 2.35% ($4,935). Then, the first $142,800 is taxed for Social Security at 6.2%, costing $8,853.60. However, the $67,200 remaining is not taxed for Social Security. All in all, Robin pays $13,788.60 in payroll taxes, leaving her with $196,211.40 (before income tax). Robin’s employer also pays $13,788.60 to match her payroll tax.
Don’t forget about FUTA taxes, which fall solely on the business. FUTA tax is 6% for the first $7,000 every employee makes in the calendar year. This means every business will be paying $420 for every FUTA-applicable employee they have.
Payroll tax is one kind of deduction that an employee can find on their paycheck, but there are other deductions that both employees and employers should be aware of.
Statutory deductions are deductions required by law, unless there is a specific exemption in place. Payroll taxes are one example of statutory deductions, but there are also federal and state income taxes.
An example of statutory deduction that isn’t related to tax is something called wage garnishment. This is when an employee can be legally required to devote part of their paycheck to a debt they've incurred, such as student or medical debt. These can be a result of a court hearing, and are enforced by law.
Voluntary payroll deductions are related to company-wide programs like health insurance, company pensions, 401 (k)s, dental programs, or other company-related benefits that aren’t legally required, but do need to be paid for out of employees’ paychecks.
Payroll Vs Income Tax
It’s easy to get confused about the difference between payroll tax and income tax. They’re both deducted from your paycheck, and go toward government programs that are supposed to make your life easier.
However, there is a distinction between payroll taxes and income taxes – and you should definitely understand this difference if you run a payroll for your business.
Payroll taxes are intended to go towards two specific systems: Medicare, and Social Security. Medicare is the government system that provides medical care intended for Americans aged over 65, or those with disabilities. Social Security is a similar system, intended to provide financial assistance in regard to retirement, disability, or survivor benefits.
Income tax is a lot broader, instead going straight for the government’s reserves to be used for any number of reasons, like funding education or paying our favorite politicians. Your state may also take state income taxes, which will instead go towards that state’s specific funding.
Payroll taxes are paid at a flat rate. These rates can fluctuate slightly over longer periods of time, but as of now, the Social Security tax rate is 6.2% of an employee’s pay, while 1.45% goes toward Medicare – meaning a total of 7.65% of an employee’s paycheck goes toward payroll taxes.
This is unlike income taxes, which scale with the tax brackets a person is placed in based on their income amount.
Payroll Tax Responsibilities for Employers
That was a lot of information – let’s summarize it in a few easy steps:
- After a standard pay period passes for your business (whether that’s a month or two weeks), calculate your employees’ salaries
- Use government Form 941 to calculate your employees’ payroll taxes and federal taxes. Deduct these amounts from their paychecks, while matching their contributions
- Use government Form 940 to calculate your business’s FUTA taxes. These are only paid by your business, not your employees
- Deduct state taxes from your employees’ paychecks (the amounts will vary from state to state)
- Make any other necessary deductions from your employees’ pay, like healthcare or wage garnishment
- Finally, pay your employees. Remember, throughout each of these steps, you need to be aware of any exemptions your employees may have due to certain circumstances, such as visas or disabilities
How to Use Software for Payroll Tax
Despite the fact that FICA payroll tax can be calculated on one form, it’s quite a daunting prospect knowing that one mistake could mean the IRS breathing down your neck. That’s why businesses often choose to use payroll software.
Payroll software, like QuickBooks, can help with not just payroll tax, but federal and state taxes as well. It can also help with things like company-wide healthcare or benefits, which, when you add them onto salaries and taxes, can start to be a bit tricky to figure out.
When using payroll software, you can input an employee’s salary, role, and relevant information (like visas, tax exemptions, or wage garnishments) into the system.
Using this information, payroll software can handle any calculations or deductions from an employee’s salary, as well as help a business with its own taxes, like FUTA taxes. While larger businesses often have their own accounting departments, smaller businesses can use payroll software to take this load off their shoulders.
Payroll taxes seem complicated, but they’re actually quite easy to get a grip on. Even when different salaries or exemptions enter the mix, it’s a simple percentage that is withheld from the employee and sent to fund social programs.
Employers first calculate payroll tax, then income tax (both federal and state), then any other deductions, then send the rest of the paychecks to their employees. It can be a time consuming process, so many businesses use payroll software or pay an accountant to do it for them.
However, with Medicare, the tax is raised from 1.45% to 2.35% if the employee makes over $200,000 a year.