Understanding Payroll Taxes

Paycheck Planning
Understanding Payroll Taxes

Payroll taxes are taxes that both employees and employers pay based on employees' wages, tips, commissions and salaries. The employees' portion is deducted from each paycheck, and the employer pays their portion directly to the IRS.

Types of Payroll Taxes

Payroll taxes fund federal social insurance programs such as Social Security, Medicare and unemployment. While you will also see payroll deductions on your pay stub for federal, state and local income taxes and deductions to pay for things like health insurance or 401(k) contributions, they are not considered payroll taxes and have no corresponding employer payments.

The following are payroll taxes:

Social Security and Medicare. Social Security and Medicare taxes make up the Federal Insurance Contributions Act (FICA). Employers and employees pay FICA taxes, supporting Medicare and Social Security programs. Your paycheck will include a deduction of 6.2 percent of your total compensation for Social Security and an additional 1.45 percent to pay for Medicare. Together, they total 7.65 percent.

Your employer is also responsible for making equal contributions, meaning they will pay an additional 6.2 percent of your total wages and salaries for Social Security and an additional 1.45 percent for Medicare.

Only the social security tax has a wage base limit. That wage base limit is the maximum subject to tax for that year. For 2022, the base limit is $147,000. That limit is adjusted each year by the IRS. There is no wage base limit for Medicare tax payments.

Additional Medicare. An employee's income must exceed $200,000 to have an additional Medicare tax withheld. The additional tax rate is 0.9 or 2.35 percent of all income over the threshold ($200,000 for single filers, $250,000 for joint filers and $125,000 for married persons filing separately). The employee is solely responsible for paying the additional amount.

Tax Federal Unemployment Tax (FUTA). FUTA supports terminated employees. The program helps states fund their unemployment programs and is not part of federal income tax. The employer is solely responsible for paying this tax. In 2022, the FUTA rate is 6 percent with a taxable wage base of $7,000.

Your employer is responsible for making all payroll tax payments to the IRS.

If You are Self-Employed

Self-employment tax is a Medicare and Social Security tax for self-employed individuals. In addition, self-employed individuals must pay both the employer and employee portion of Medicare and Social Security taxes.

The self-employment tax rate is 15.3 percent of net earnings, consisting of a 12.4 percent Social Security tax and a 2.9 percent Medicare tax on net profits. The same 2022 wage base limit of $147,000 applies to self-employed individuals to pay Social Security taxes.

Takeaway

Unfortunately, payroll taxes reduce your total gross income, so your listed salary won't necessarily reflect the amount you take home. Additional income tax payments and automatic deductions for retirement and healthcare will further reduce your take-home pay. Unlike some other taxes, payroll taxes fund your future Social Security and Medicare benefits when you retire.

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