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What Are Payroll Taxes?

What Are Payroll Taxes?

Generally speaking, payroll taxes are taxes imposed on both employers and employees. They are usually calculated as a percentage of a company’s salary, which is how payroll taxes work. However, there are some exceptions.

Federal Income Tax

Whether a business owner or an employee, you are liable for federal income taxes. The amount you pay will depend on your situation and the tax rate. However, you can lower the amount you pay by deductions and withholding taxes from your wages.

The federal income tax is the largest revenue source for the United States government. The Internal Revenue Service imposes federal income taxes on businesses, nonprofits, and individuals. It uses a progressive tax rate, meaning that each employee pays different amounts depending on their income.

Most states also have an income tax. Tax rates vary by state, with the lowest rates at the state level and the highest rates at the federal level. Some local governments also impose income taxes. 

Federal income tax and payroll taxes are major sources of revenue for the federal government. However, the payroll tax affects most households harder than the income tax.

Federal income and payroll taxes are a major portion of your tax return calculations. 

Social Security Tax

Generally, the two main funding sources for social insurance programs are payroll taxes and income taxes. Both are important components of the American tax system. They both keep social insurance programs operational, and they both contribute to the funding of government-financed pensions.

Payroll taxes are collected by employers and distributed to employees as a portion of their pay. They are the second largest source of federal revenues after income taxes. Combined, these two taxes account for 88 percent of the Social Security trust funds inflows.

The Social Security tax has gradually increased since the program’s inception in 1935. It has been adjusted twice in the last decade to address economic downturns. It is currently levied 12.4 percent of a worker’s gross taxable earnings. In 2022, a worker earning $147,000 or more will pay $818 more in Social Security taxes than they did in the previous year.

Medicare Tax

Whether you’re employed or self-employed, you must pay a Medicare tax. This tax is part of the FICA, or Federal Insurance Contributions Act, and it helps fund health coverage for Medicare beneficiaries. It also supports health care for elderly and disabled people.

The Medicare tax is a payroll tax withheld from employees’ paychecks. It helps pay for Medicare Part A, also known as hospital insurance, covers hospital care, hospice care, home health care, and other services. It also pays for Part B, which provides outpatient care and preventive services.

The Medicare tax is one of several federal taxes that are withheld from employees’ paychecks. It is a two-part tax, and the amount you owe depends on your annual income and filing status. 

Medicare tax is paid to fund Medicare, a program that provides health care for seniors and people with disabilities. The IRS defines Medicare taxable wages as your gross pay minus any pretax health care deductions. The Medicare tax rate has remained unchanged since 1986. However, the Affordable Care Act introduced a new Medicare tax in November 2013. The tax is known as the Additional Medicare Tax and is levied on incomes above certain thresholds.

In addition, you’re required to file a self-employment tax to cover your share of Social Security and Medicare taxes. The self-employment tax is calculated using IRS Schedule SE.

State Income Tax

Almost all states require employers to withhold income taxes on their employees’ wages. The rate depends on the number of wages earned. Some states offer personal exemptions, while others do not. 

State income tax is based on a percentage of gross wages. In some states, the rate is flat, while others have graduated rates. Some states index deductions for inflation, while others tie standard deductions to the federal tax code. In some states, the tax rate is dependent on the state where the worker lives.

Some states allow the deduction of federal income taxes from state-taxable income. Some states have a three-bracket system, while others have a single-bracket system. In the United States, there are 42 states that tax income, while seven do not. Some cities also tax income, but these taxes are usually based on state income tax calculations.

Most states collect state income taxes on wages. In addition to the federal tax code, some states have reciprocal agreements, which may affect the amount of state income tax that is withheld.

Estimating Payroll Taxes

Getting an accurate estimate of payroll taxes can be daunting. There are so many variables and complex calculations. However, with a little practice, it will become much easier.

When estimating payroll taxes, you will need to know the total wages that your employees earn. You will also need to calculate how much FICA taxes your employees will have to pay. These include Medicare and Social Security.

There are also local payroll taxes, which are additionally levied locally. In addition, depending on where you work, you may have to pay state income taxes and unemployment taxes.

The two largest payroll taxes are Social Security and Medicare. Each has its rates combined, adding up to a 7.65% total payroll tax rate. You may be surprised to learn that these are Federal Insurance Contributions Act taxes.

It’s important to remember that payroll taxes are only one part of the overall tax picture. You also have to consider income taxes, which have progressive rates. However, income tax is not as complicated as FICA taxes.

Unlike income tax, there are no wage base limits for payroll taxes. However, you should know the experience modification factor is typically adjusted by the state each year.