What Are Payroll Taxes? An Employee’s Guide

What Are Payroll Taxes? An Employee’s Guide
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If you’re wondering why your paycheck is smaller than your salary suggests it should be, the answer may be payroll taxes. Businesses collect these taxes regularly and pay them on behalf of their employees.

The money is used to fund vital government programs. You may not like the shrinkage in your paycheck, but you may appreciate the benefits the taxes provide.

What Are Payroll Taxes?

Your employer withholds a portion of each of your paychecks to cover payroll taxes, which support Social Security, Medicare and, in some cases, unemployment benefits. Your employer is responsible for paying the taxes to the IRS and state and local tax authorities on your behalf.

What Are the Different Types of Payroll Taxes?

In general, payroll taxes fall into three categories.

1. Social Security Taxes

The primary payroll taxes are called “FICA taxes,” because they were created by the Federal Insurance Contributions Act, the law that funds the federal Social Security and Medicare programs.

Social Security provides income for older retirees and younger Americans who are unable to work. FICA payroll taxes take 6.2% of your wages for Social Security, while your employer kicks in an equal amount that does not come out of your pay.

In 2022, the tax is applied only to the first $147,000 of your earnings. Your employer withholds the money from your paychecks and submits it to the government. You pay into the Social Security trust fund while you’re able to work, then collect benefits once you retire or if you ever become disabled and can’t work.

2. Medicare Taxes

Medicare, also funded by FICA taxes, provides health insurance to people 65 or older and certain younger people.

The payroll taxes for Medicare siphon off 1.45% from your total earnings, and your employer pays a matching amount that does not come out of your wages.

If you earn more than $200,000 per year, then you’ll pay an additional 0.9% of your wages toward Medicare. There’s no employee match for the additional Medicare payroll tax.

3. Unemployment Taxes

Unemployment taxes fund unemployment insurance benefits, which you may collect if you lose a job. There are two types of unemployment taxes:

  • Federal Unemployment Tax Act (FUTA) taxes: The FUTA tax rate is 6.0%, and it’s applied to the first $7,000 of an employee’s annual wages. Employers are responsible for covering these taxes in their entirety, so—importantly—they won’t come out of your paychecks.
  • State Unemployment Tax Act (SUTA) tax: The SUTA tax rate and wage base vary by state. Some states require employees to cover a portion of the taxes, so money may come out of your pay for unemployment insurance, depending on where you live.

Payroll Tax vs. Income Tax

Employers deduct both payroll taxes and income taxes from your paycheck each pay period, and there are key differences between the two.

While payroll taxes fund the specific programs we’ve talked about, income taxes go to the U.S. Treasury to support broad government spending. If your state levies its own income tax, any funds collected will be applied to the state treasury.

Payroll taxes are generally levied at flat rates, but the rate of your income tax withholding can vary, based on how much you earn.

Handling Payroll Taxes When You’re Self-Employed

If you’re self-employed, you’re responsible for paying both the employer and employee portions of the payroll taxes. In these situations, the taxes are referred to as SECA taxes, named for the Self-Employment Contribution Act.

For the 2022 tax year, the self-employment tax rate starts at 15.3%. Here’s how it breaks down:

  • Social Security portion: In 2022, the first $147,000 of your self-employment earnings are subject to a 12.4% tax, representing the 6.2% Social Security tax paid by employees plus the 6.2% match from employers.
  • Medicare portion: In 2022, all your earnings are subject to a 2.9% tax, representing the 1.45% Medicare tax that comes out of employee paychecks plus the 1.45% employer match. Your self-employment income is subject to the additional 0.9% Medicare tax if you earn more than $200,000 ($250,000 for joint filers).

Unemployment taxes are not paid by self-employed Americans because they typically aren’t able to collect jobless benefits, though the government provided that money to some self-employed people in 2020, during the height of the Covid-19 pandemic.

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