What Are Payroll Taxes? A Guide for Employers and Business Owners
We saw this great primer on payroll taxes and while it is of course not for payroll companies who are Nimble clients (or should be), it is a fantastic tool to send to your clients… those companies that depend on you to handle their payroll. After all an educated client is a profitable client. Wouldn’t it be great to avoid some of those elementary questions that you seem to get over and over again:? Just pass this along to them.
Understanding payroll taxes is crucial, whether you have just one employee or many. Payroll taxes began in response to the Great Depression, when the government began social welfare programs. The federal government passed the Federal Insurance Contributions Act (FICA) in 1935, and employers began withholding money from employees’ paychecks to fund Social Security. Payroll taxes expanded to finance Medicare in 1965.
As a business owner, withholding the right amount of payroll taxes and paying them on time helps you avoid penalties and fines from the IRS.
What are payroll taxes?
Payroll taxes are taxes on employee wages that business owners pay to the IRS. Most payroll taxes are withheld from employee wages, reducing their salary. The exception is the federal unemployment tax, which is the employer’s responsibility and is not taken from employee wages.
The US government uses payroll taxes to fund its programs. Payroll taxes appear as a Federal Insurance Contributions Act—or FICA—tax on employee paychecks. This federal law requires employers to calculate and collect taxes to fund Social Security and Medicare, which provide pension benefits and health insurance for the elderly, respectively.
Employers withhold payroll taxes from employee wages every pay period. As a business owner, you must withhold and pay the employee’s portion of payroll taxes as well as your share of the taxes. You can hire a tax professional to calculate and remit payroll taxes. Still, as the business owner and employer, you are responsible for paying taxes on time.
A payroll tax payment to the IRS is known as a federal tax deposit. The amount due determines how often you must remit payment—either a monthly or semi-weekly deposit may be required, depending on how much you owe.
Self-employed individuals must also submit payroll taxes. Individuals withhold portions of their wages as both the employer and the employee. The federal tax rate for self-employed individuals is 15.3%—the same percentage a business pays for an employee, plus the employee's share of the payroll tax.
Four types of payroll taxes
Federal income
Social Security
Medicare
Federal unemployment
When thinking about payroll taxes, people mainly consider federal payroll tax withholdings. However, depending on the state where you operate, other taxes may need to be withheld by the employer, such as state income taxes, taxes for disability, or taxes for paid leave. The four federal payroll taxes are:
1. Federal income
The employee pays federal income tax on their wages, but it’s the employer's responsibility to withhold the taxes due from an employee’s paycheck and to remit the payment to the IRS.
The amount of tax depends on how much the employee earns, and the information they provided on their W-4 IRS form, also known as the Employee’s Withholding Certificate. Employees typically fill out this form when they start a new job or when their circumstances have changed, such as claiming another dependent. The number of dependents, filing status, and amount of income all affect an employee’s withholding.
2. Social Security
Both the employer and employee pay Social Security taxes. Each is responsible for paying tax equal to 6.2% of employee wages for a total of 12.4%. The Social Security tax only applies to wages up to $147,000, as of 2022. Any wages above this amount are not subject to the Social Security taxes. Types of taxable income include salaried wages, hourly wages, bonuses, commissions, and paid time off, among others.
3. Medicare
Both the employer and employee pay Medicare taxes. An employee has 1.45% of their wages withheld, and the employer must also pay 1.45% of the employee's wages. There’s no income limit for Medicare taxes, in contrast to the Social Security wage base limit. Employees who earn more than $200,000 per year must pay an additional 0.9% in Medicare taxes. Employers do not have to match this amount but are responsible for collecting it from employee wages.
4. Federal unemployment
Federal unemployment taxes are the sole responsibility of an employer, meaning they don’t withhold this tax from worker paychecks. The money funds unemployment insurance, which pays benefits to people who are out of work. An employer must pay tax equal to 6% of up to $7,000 of an employee’s annual wages. An employer can receive a credit of up to 5.4% if they pay state unemployment taxes, reducing the federal unemployment tax to as little as 0.6% of total employee pay of up to $7,000.
Payroll taxes vs. income taxes
What are the similarities?
Based on wages. Payroll taxes and income taxes are calculated based on employee wages.
Withheld by the employer. The employer withholds a percentage of employee income for payroll taxes and income taxes.
What are the differences?
Responsible party. The employer and employee share responsibility for paying Social Security and Medicare taxes. For income taxes, only the employee is responsible for the payment, but the employer withholds both kinds of taxes from employee paychecks.
Flat rate vs. progressive. The payroll taxes for Social Security and Medicare are a flat percentage rate for every employee. For income taxes, the rate is different for each employee and is progressive, meaning those earning more pay more.
Purpose of funds. Payroll taxes fund federal programs for the elderly and the disabled through Social Security and Medicare. Federal income taxes fund the US government’s general operations.
Payroll taxes FAQ
What are payroll taxes?
Payroll taxes are the funds employers withhold to pay for various services and benefits the federal government provides. An employer must withhold payroll taxes whether the business owner is self-employed or has multiple employees. Payroll taxes include payments for programs such as Social Security and Medicare.
What are the main types of payroll taxes?
The main types of payroll taxes are:
Federal income taxes
Social Security taxes
Medicare taxes
Federal unemployment taxes
Who pays payroll taxes?
Employers and employees pay payroll taxes. The employer withholds federal income taxes, but only the employee pays this tax. The employer and employee pay equally for Social Security and Medicare taxes—except for the additional Medicare tax for high earners, which the employee alone pays. Only the employer pays federal unemployment taxes.
How much is the Federal Insurance Contributions Act (FICA) tax?
FICA tax equals 15.3% of an employee’s pay and includes the Social Security and Medicare tax. An employee has 7.65% of their wages withheld to cover their share. The employer pays the remaining 7.65%