Payroll tax is a tax paid on the wages of employees to fund social programs like Medicare, Social Security, and unemployment benefits. For most employers, payroll is one of the biggest items in the budget—and payroll tax is a significant portion of that line item.
How Payroll Taxes Work
Employers are required to withhold a percentage of employees’ paychecks to cover payroll taxes. These taxes cover the employee’s portion of FICA taxes, named for the Federal Insurance Contributions Act. FICA taxes are about 15.3% of an employee’s pay, and the employee and employer are each responsible for half of that amount. Additional payroll taxes will vary based on the state, county, and municipality in which your business is located.
In addition to withholding the correct amount of payroll tax from each employee’s paycheck, an employer is also responsible for paying its own portion of payroll taxes. This portion includes the remaining half of FICA taxes for each employee, as well as state and federal unemployment taxes.
What’s the Difference Between Payroll and Income Tax?
Payroll tax is a tax the government charges to employers and employees, and income tax is levied on individuals’ salaries, wages, and other incomes.
Payroll tax is sometimes confused as income tax because employers typically withhold both payroll tax and income tax from an employee’s paycheck. However, employers withhold income tax as a service to employees to help them pay their income tax bill incrementally throughout the year, while employers are required to withhold payroll taxes.
Types of Payroll Taxes
Payroll tax is an umbrella term that refers to multiple taxes like self-employment, social security, and unemployment taxes. Here are common types of payroll taxes:
Self-Employment Taxes
Self-employment tax is the tax that self-employed individuals owe to the federal government to help fund Medicare and Social Security. Employees split these taxes with their employer, as each one pays half the FICA taxes. But self-employed individuals must pay the full 15.3%.
Social Security Payroll Taxes
Social Security taxes are 12.4% of an employee’s wages. Employed individuals split this tax with their employers, so each is responsible for paying 6.2%. Employers are required to withhold the employee’s Social Security tax, equal to 6.2% of their pay, from each paycheck.
Medicare Payroll Taxes
Medicare taxes are 2.9% of an employee’s wages. Employees split this tax with their employers, so each is responsible for paying 1.45%. Employers must withhold the employee’s Medicare tax, equal to 1.45% of their pay, from each paycheck and pay it to the federal government.
Unemployment Taxes
The federal unemployment tax (FUTA) rate is 6% of each employee’s wages. Employers are responsible for paying this amount to the federal government with each payroll.
State and Federal Taxes
Most states also levy payroll taxes on employers, in addition to their federal payroll obligations. Many employers must pay state unemployment taxes (SUTA), and some may have to pay additional taxes, depending on their state regulations.
In some cases, employers that must pay state unemployment taxes may receive a credit on federal unemployment taxes.
How to Calculate Payroll Taxes
Calculate payroll taxes by starting with an employee’s gross pay and multiplying it by each tax rate (Social Security, Medicare, FUTA, and SUTA). Here’s how it works:
- Social Security tax formula: Employee income x 6.2% = Social Security tax
- Medicare tax formula: Employee income x 1.45% = Medicare tax
- FUTA tax formula: Employee income x (FUTA tax rate – state credit reduction) = FUTA tax
- SUTA tax formula: Employee income x SUTA tax rate = SUTA tax
After calculating each of these taxes, the employer must pay 50% of the Social Security and Medicare taxes and 100% of the FUTA and, in the majority states (47 of the 50) SUTA totals. The employer must also withhold the remaining 50% of Social Security and Medicare taxes from the employee’s paychecks.
Payroll Tax Withholding Example
As an example, imagine an employee earns $100,000, or $4,166.67 of gross pay per semi-monthly pay period. To determine Social Security tax, multiply $4,166.67 by .124 (12.4%). The resulting Social Security tax is $516.67. Because the employer and the employee split that total, each will be responsible for paying $258.33 each pay period.
To determine Medicare tax for the same employee, multiply $4,166.67 by .029 (2.9%) for a total of $120.83. The employer and the employee will both pay half, or $60.42 per pay period. The employee’s total FICA responsibility, including Social Security and Medicare, will be $318.75.
FUTA and SUTA taxes for this employee would depend on the employer’s location and the state taxes to which it is liable.
Additional Payroll Tax Requirements
In addition to withholding payroll taxes, employers must also deposit the payroll taxes withheld and the employer’s payroll taxes based on IRS regulations. Employers are required to make federal tax deposits via electronic funds transfers.
When an employee’s wages and compensation exceed $200,000 in a calendar year, employers are responsible for withholding the Additional Medicare Tax from the employee’s paychecks. Additional Medicare Tax is equal to 0.9% of the employee’s wages. There is no employer match required for the Additional Medicare Tax.
Payroll Tax Credits
During the Covid-19 pandemic, employers were able to qualify for payroll tax credits if they kept workers employed throughout the pandemic. However, payroll tax credits may not be available for everyone moving forward, something for business owners to consider.
Many small business owners are looking for ways to reduce their tax burden and payroll tax credits could provide some relief. While there is not a significant number of available credits related directly to payroll, there are a number of other credits that small business owners should consider. Speak to your accountant to see if any of the following credits are relevant for your business:
- Work Opportunity Tax Credit
- Credit for Employer-Provided Childcare Facilities and Services
- Child and Dependent Care Credit
- Credit for Small Employer Health Insurance Premiums
- The Premium Tax Credit
- Retirement Plan Startup Costs Tax Credit
- Plug-In Electric Drive Vehicle Credit
- Research and Development Tax Credit
How Payroll Tax Credits Works
If you qualify for a payroll tax credit, you can directly subtract the amount of the credit from the amount of taxes you owe. That means if your business owes $10,000 in taxes and you qualify for a $7,000 payroll tax credit, you will only be responsible for paying $3,000.
Payroll Tax Credits vs Deductions
While tax credits can be subtracted directly from the taxes you owe, deductions work a little differently. Tax deductions allow you to reduce your taxable income, which will also lower your tax bill. It’s possible for a small business to qualify for both tax credits and tax deductions. Talk to your tax professional to make sure you’re maximizing all your potential credits and deductions to lower your tax liability.
Payroll Tax FAQs
What is the FICA tax rate?
The FICA tax rate, named for the Federal Insurance Contributions Act, is 15.3% of an employee’s wages. For employed individuals, the responsibility for paying FICA taxes is split evenly between the employee and the employer, so each one pays 7.65%. Self-employed individuals have no employer with whom to split FICA taxes, so they are responsible for paying the full 15.3%. This amount is referred to as self-employment tax.
Is payroll tax based off net or gross income?
Payroll tax is based off an employee’s gross income, the original wage amount before any withholdings.
Who pays payroll taxes?
Employers pay the payroll taxes, but the money comes from both the employer and the employee. The employer withholds 7.65% of the employee’s wages from their paycheck to cover the employee’s portion of FICA taxes. The employer matches that amount, paying the additional 7.65% of the employee’s pay for the employer portion of FICA taxes. The employer also pays federal and state unemployment taxes.
