Today marks the start of National Payroll Week! To do our best to honor one of our favorite topics around, we want to dedicate this week to answering common payroll questions.
To kick us off– have you ever wondered how the payroll taxes you deduct and match from employee’s salaries are allocated? Where does the money go and why?
Here’s a primer on payroll taxes at work for you and your employees. There are three main taxes assessed to employees and business:
In 1913, the 16th Amendment, allowing for an income tax, took effect. At that time the tax rate of 1% of income affected less than 1% of the American population. Over the past 100+ years, the tax has certainly changed. The maximum, passed under the name The American Taxpayer Relief Act of 2012, raised the highest bracket to 39.6%. With the addition of The Patient Protection and Affordable Care Act, another 3.8% drove the rate to 43.4%. Under the 2017 Tax Cuts and Jobs Act, the highest rate is now 37%.
Federal withholding tax is broken into three categories: mandatory, discretionary and interest spending. Mandatory spending includes payments for Medicare, Social Security, unemployment, some veteran’s benefits, food and agriculture, labor and transportation. Discretionary spending includes the military (which accounts for more than half of discretionary spending), housing, education, energy, environment, internal affairs and more. Interest payments account for a small portion of the overall spending, which pay down the debt the US owes.
FICA, or the Federal Insurance Contributions Act, was enacted in 1935. The Act created the Social Security Administration, a safety net for retirees. Originally assessed at 1% of the first $3,000.00 of income, today employers match an employee contribution of 6.2%.
FICA was amended in 1965 to create the Medicare/Medicaid programs. Medicare provides national health care coverage for senior citizens and is funded by federal tax dollars. Medicaid provides coverage for low-income Americans of all ages. Medicaid is jointly funded by the federal government and states.
The largest budget expenditure for the federal government is Social Security payouts. They represent 24% of the income tax revenue collected and payout retiree, disability and dependent benefits. As the massive Baby Boomer generation retires, Social Security is expected only to be able to cover 75% of its obligation by 2035.
Currently taxed at 1.45% of wages, Medicare disbursements include payments for medical expenses for retirees over age 65. At 15% of the overall federal budget, it’s estimated that by 2028, Medicare will only be able to cover 87% of its obligations under its Plan A hospital insurance.
State taxes vary, with California the highest at an income tax rate of 13.3%. Today, seven states have no income tax at all, including Alaska, Texas and Florida. By 2021, Tennessee will phase out its own income tax by 2021.
Local withholding taxes can vary by community. At 10%, seven school districts in Arkansas have the highest rate to date. In Washington D.C., with no state tax to subsidize spending, the bracketed rate caps out at 8.5%.
The majority of state and local taxes go to education, but the payments are also used to fund health care services, infrastructure (roads and bridges) as well as public employees, parks, and economic development.
Separate, but still mandated, are unemployment insurance taxes. Federal unemployment tax (FUTA) is 6% of each employee’s first $7,000 in earnings and is paid to the federal government.
State unemployment tax (SUTA) or State Unemployment Insurance (SUI) varies by state. In 2017, Pennsylvania had the highest minimum rate at 2.8%; Massachusetts the highest maximum rate at 11.3%. FUTA can be reduced by the amount of SUTA paid, up to 5.4%.
FUTA is a fund the federal government holds for oversight of state programs. If a state is underfunded and cannot pay benefits, the federal program will loan them money. State funds are paid out directly to unemployed workers.
For small businesses to large, payroll taxes support a variety of services provided by states, the federal government, and municipalities. Employee and business contributions work together to assure governments run smoothly at all levels.