Definition of Payroll Taxes

Payroll Tax Rates and Benefits Plan Limits for 2023

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 that is used 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 max 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:

  • 4%: Social Security Tax
  • 9%: Medicare Tax
  • .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/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 you must know about

  • 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 applied “Failure to Deposit” penalties that are associated with late payroll tax submissions:

  • 1-5 days late: 2% of the unpaid amount
  • 6-15 days late: 5% of the unpaid amount
  • >15 days late: 10% of the unpaid amount
  • >10 days late 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.

Other terms similar to payroll taxes that can assist you

  • FICA: Represents the Social Security tax and Medicare tax an employer must withhold from employees’ paychecks plus the employer’s share of those 2 taxes.
  • FUTA: An employer-paid federal payroll tax that is used to help fund the unemployment insurance system. Also provides a fund that states can borrow from for unemployment benefits purposes.
  • SUTA (State Unemployment Tax): A state payroll tax that is used to help fund the unemployment insurance system. In most states, only the employer pays SUTA tax. A few states, including New Jersey and Pennsylvania, require employees to pay SUTA via payroll deduction.
  • FICA tip credit: A credit that eligible food and beverage establishments can claim on a portion of their FICA taxes paid on employee tips.
  • EFTPS (Electronic Federal Tax Payment System: The free 24/7 system that allows employers to make federal employment tax payments electronically via the Internet or by phone.

Summary of payroll taxes

Payroll taxes are the taxes that are associated with:

  • Social Security
  • Medicare
  • 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 during the remainder of the year.

Similar glossary definitions you must know

  • SDI (State Disability Insurance Tax): A state-administered program that provides partial wage replacement to employees who cannot work because of an illness or injury. Depending on the state, SDI coverage may be funded by the employee, the employer, or both.
  • Wage (Tax) Levy: The legal seizure of an employee’s wages to satisfy delinquent taxes that the employee owes. The taxation agency sends the levy to the taxpayer’s employer, who must withhold the required amount from the taxpayer’s wages.
  • Withholding tax rate: The amount an employer is required by law to take out of an employee’s wages for a specific payroll tax.

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