Payroll Taxes
Payroll taxes are monies deducted from an employee’s wages to satisfy federal, state, or local Social Security taxes, Medicare tax, and unemployment tax requirements.
What are payroll taxes?
Payroll taxes should not be confused with income taxes. Although income tax is withheld from an employee’s check, it is not considered to be a portion of the deductions officially known as payroll taxes. Payroll taxes involve:
- Social Security tax (a portion of the Federal Insurance Contributions Act deduction)
- Medicare tax (the remaining portion of the FICA deduction, typically noted as MedFICA)
- Unemployment tax(es)
Payroll taxes are used to fund specific governmental programs. In contrast, income tax deductions are deposited into the general treasury fund for broader use. Additionally, payroll taxes are generally deducted at a flat rate and have a maximum cap, unlike income tax. It is possible to meet your FICA contribution maximum before year-end. Income tax, however, is deducted from every paycheck regardless of how much has been collected throughout the year.
Why is understanding payroll taxes important to my business?
Payroll taxes are second only to income tax as the highest revenue source of the federal government. It is critical that you understand the role payroll taxes play, when the responsibilities are solely on the employer, when they’re shared with the employee, and when they are the sole responsibility of the person completing work on your behalf (contractors). Payroll taxes are broken down as follows:
- 6.2%: Social Security Tax
- 1.45%: Medicare Tax
- 0.9%: Additional Medicare Tax for those earning over $200,000
- 6%: FUTA Tax on the first $7,000 paid to the employee
The employer’s responsibilities
As the employer, you are accountable for withholding the employer and employee portion of the payroll tax deductions and filing that information with the IRS quarterly. The employer must pay 50% of the Social Security and Medicare taxes, which is generally 7.65%, as well as the 6% Federal Unemployment Tax Act (FUTA) tax.
The employee’s portion of the payroll tax
Although the employer withholds the deduction from an employee’s paycheck, the worker is responsible for contributing 50% of the total expense of the payroll tax — typically 7.65%.
Self-employed (Contractor) responsibilities
The contractor or self-employed individual is responsible for both portions of the payroll tax since they are both the employer and employee in this situation.
Mandatory federal payroll tax forms
- Form W-4: Employee’s withholding certificate
- Form W-2: Wage and tax statement
- Form W-3: Transmittal of wage and tax statements
- Form 941: Employer’s quarterly federal tax return
- Form 944: Employer’s annual federal tax return
- Form 940: Employer’s federal unemployment (FUTA) tax return
The IRS also applies “Failure to Deposit” penalties associated with late payroll tax submissions:
- 1–5 days late: 2% of the unpaid amount
- 6–15 days late: 5% of the unpaid amount
- More than 15 days late: 10% of the unpaid amount
- More than 10 days after the first notice of late payment is received: 15% of the unpaid amount
The bottom line is that payroll taxes are part of anyone’s equation regardless of how monies are earned.
What is the history of payroll taxes?
Payroll taxes in the U.S. can be traced back to the mid-19th century when the Revenue Act of 1861 was passed to help fund the expense of the Civil War. In 1943, more payroll taxes were introduced due to the increased jobs created in response to World War II. Medicare was added as part of the payroll tax in 1965 when Title XVII of the Social Security Act was implemented.
Summary
Payroll taxes are the taxes associated with Social Security, Medicare, and unemployment. They generally have a consistent flat amount throughout the year and a maximum cap. This means that, depending on how much the employee earns, there may be a period of time during the year when neither the employee nor the employer will be responsible for contributing payroll taxes for the remainder of the year.
