According to the Tax Policy Center, payroll taxes made up 35.2% of federal tax revenue in fiscal year 2018. That’s more than $1 trillion. How are those taxes collected and how are they used? Glad you asked. Payroll taxes are a burden shared by employees and employers. If you’ve ever taken a close look at your earnings statement you’ll notice that payroll taxes take a serious bite out your paycheck.
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A Payroll Tax Definition
Payroll taxes are part of the reason your take-home pay is different from your salary. If your health insurance premiums and retirement savings are deducted from your paycheck automatically, then those deductions (combined with payroll taxes) can result in paychecks well below what you would otherwise get. When you start a new job and fill out a W-4 tax withholding form, your employer starts deducting state and federal payroll taxes from your earnings. Someone has to pay for Social Security, right?
Social Security taxes began in 1937, at a modest rate of 2%. Medicare hospital insurance taxes didn’t kick in until 1966, at a rate of 0.7%. Rates have climbed since then, of course, with the rate climb for Social Security taxes outpacing the rise in Medicare hospital insurance taxes.
In 2019, payroll taxes only apply to the first $132,900 of income. The income cap on payroll taxes has led some to criticize the payroll tax. Those who want to reform the payroll tax call it a regressive tax – one that doesn’t require the rich to pay more.
In tough economic times like the Great Recession, Congress cuts payroll taxes to give Americans a little extra take-home pay. When these cuts expire, as they did recently, it reignites the debate over how payroll taxes work. President Obama and others in government have proposed raising the income cap on payroll taxes, but that hasn’t happened yet.
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Employer Payroll Tax
Employers pay a share of some payroll taxes for their employees. That’s why if you go from being an employee of someone else to being self-employed your payroll tax liability will double. It’s something to budget for if you’re thinking of making the jump to self-employment.
Before 1989, the tax rate for self-employed people was less than the combined tax rate on employers and employees. Those days are over, though. The IRS recently announced that it will be cracking down on employers who don’t collect enough money in payroll taxes. If you’re a business owner, take note.
Under the umbrella term “payroll taxes,” employers are required to withhold state and federal income taxes from their employees’ earnings, as well as Social Security and Medicare taxes. These last two taxes are known as FICA taxes, after the Federal Insurance Contributions Act. Federal payroll taxes are consistent across states, while state payroll taxes vary according to the income tax rates in each state.
The portion of payroll taxes that the employer withholds on behalf of the employee are liabilities for business accounting purposes. The employer is playing the role of an agent for the government, collecting taxes from employees and remitting them to the state and federal government. However, the matching share of FICA taxes that the employer pays on is considered a business expense, not a liability. Because it’s a business expense it can be written off at tax time.
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Payroll Tax Rates
The current tax rate for Social Security is 6.2% for the employer and 6.2% for the employee, for a total of 12.4%. The current rate for Medicare is 1.45% for the employer and 1.45% for the employee, for a total of 2.9%. That means that combined FICA tax rates for 2015 are 7.65% for employers and 7.65% for employees, bringing the total to 15.3%.
A recent report from the Congressional Budget Office suggests that raising Social Security payroll taxes is necessary to extend the solvency of the Social Security Trust. As discussed, raising the maximum taxable income might be a complement or an alternative to raising payroll tax rates.
Since 2013, high-income folks have had to pay a little extra in Medicare payroll taxes under a provision of the Affordable Care Act. This Additional Medicare Tax adds 0.9% to the employee-paid portion of payroll taxes above a certain income threshold.
For single filers, that threshold is $200,000. For married couples filing jointly the income threshold is $250,000. Married filing separately? Your income threshold is $125,000. Say you’re a single filer. The first $200,000 of your salary will be subject to the regular 1.45% employee-paid Medicare tax. Every dollar above $200,000 will then be taxed at 2.35 % (1.45+0.9=2.35).
Payroll taxes may seem like a bummer. After all, they reduce your take-home pay. Still, the fact that your payroll taxes are deducted from your earnings means that you don’t pay a huge tax bill once a year. That can make it easier to manage your money and it may even mean you get a refund come tax time.
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