Understanding Payroll Tax

Drivers of Employer Expenses

Payroll Tax Definition

Every time you are issued a paycheck, a percentage of your earnings is withheld for government use. This withheld portion of your paycheck goes to the Internal Revenue Service and helps to finance local, state, and federal government programs. Your payroll tax rate — the exact percentage withheld from your wages — is based on the total amount of money you earn during each pay period.

Payroll taxes in the United States help pay for Medicare and Social Security, respectively abbreviated as MEDFICA and FICA on your paystub. You’ll also notice various regional and state taxes deducted from your paycheck, which help sustain local government operations.

As an employee, you are legally obligated to contribute payroll tax whenever you’re paid. Taxes are automatically collected from your paycheck before you receive it, and represent your contribution toward local, state, and federal tax-funded projects.

Examples of Payroll Taxes

In general, most payroll taxes go towards the State Unemployment Tax Act (SUTA) and the Federal Insurance Contributions Act (FICA). Among other payroll taxes, you’ll make contributions toward the State Unemployment Tax Act (SUTA). Your exact SUTA tax rate will vary depending on where you live, but the premise is the same: SUTA funds help satisfy costs for unemployment benefits in your state.

Employees who are laid off are eligible to receive unemployment funds from the state, through payments sourced from SUTA payroll taxes.

Whenever you receive a paycheck, you’ll also find payroll taxes contributing to the Federal Insurance Contributions Act, commonly known as FICA. FICA helps to finance two separate trusts: the Disability Insurance Trust Fund and the Old Age and Survivors Insurance Trust Fund.

Individuals who are eligible for disability, survivor, or retirement benefits will receive FICA funds sourced from payroll taxes.

What Are Payroll Taxes Used for?

Payroll taxes are used to find a wide variety of programs and projects, depending on the government behind the tax.

Your payroll taxes might be used in one or more of the following ways:

  • Social Security — Funding that supports retired employees, widows and widowers, and disabled individuals.
  • Medicare — Federal health insurance support for contributing individuals 65 years of age and older, and for younger individuals challenged by some disabilities.
  • Unemployment benefits — Weekly benefits paid to employees currently out of work, through no fault of their own.
  • Education — Finances paid to school districts that fund curriculum development and other academic expenses public schools face.
  • Public employee salaries — Taxes that fund the salaries of government workers.
  • Publicly accessible lands — Local or state taxes that help governments preserve parks and other publicly available spaces.

Generally speaking, payroll taxes paid to the federal government often fund unemployment programs, or other larger-level initiatives. By comparison, payroll taxes paid to local governments often help finance projects closer to home.

Who Pays Payroll Taxes?

Employers and employees are legally required to satisfy payroll taxes. Traditionally, you and your employer will share payroll tax burdens, splitting contributions evenly.

Social Security and Medicare represent two of the largest payroll tax withdrawals. Together, Social Security and Medicare are taxed at a rate of 15.3%. Your employer typically covers half of these taxes, while the other 7.65% is automatically withdrawn from your paycheck.

Payroll tax obligations are also slowly increasing in the United States. In 2020, the first $137,700 of your earnings were eligible to be taxed. In 2021, that figure has increased: The first $142,800 you earn is all subject to social security taxation. No matter how much you earn, your total earnings are all subject to Medicare taxes.

In certain cases, employees might be exempt from some payroll taxes. For example, cooks, gardeners, and other homeworkers can earn income exempt from federal tax withholdings, FICA, and FUTA payments.

Important Considerations for Payroll Taxes

To ensure complete payroll tax contributions — and to avoid the serious penalties that result from a lack of payroll tax payments — make sure you understand how and why payroll taxes are withdrawn.

If you’re an employee, there’s a high chance that your payroll tax contributions are automatically withdrawn. Each time you receive a paycheck at the end of a pay period, you should see payroll tax deductions listed. Check with your company’s human resources department if you’re not sure which payroll taxes you should be paying, or if you’re uncertain how payroll taxes use your funds.

Employers are responsible for regularly submitting federal payroll taxes to the IRS through the Federal Electronic Tax Payment System. Tax payment deadlines are set according to employer size: larger employers make biweekly payroll tax contributions, while small companies make monthly tax payments.

Many employers are also required to submit local or state-level payroll taxes. Check with state government representatives to determine how, and when, to submit payroll taxes.

To make more immediate tax contributions and further compete in their market, some companies will sell their accounts receivable. In particular, medical staffing and nurse staffing agencies will participate in factoring healthcare, or medical receivables to accelerate their payment processes. Home health care agencies with factorable invoices can similarly benefit from expedited, “factored” funds.

If an employee or employer intentionally fails to pay payroll taxes, they can incur some serious penalties. Under Section 7202 of the Internal Revenue Code, the willful failure to contribute payroll taxes can result in a $10,000 fine. You may also be subject to up to five years in prison.

It’s just as important to pay taxes as a business as it is for employees. Although unpaid taxes won’t immediately injure your business’s credit score, unpaid payroll taxes could result in tax liens and other problems which can significantly impact your corporate credit score.

Other Employment Taxes

In addition to payroll taxes, you might also be subject to other employment taxes. Employment taxes are withheld from your paycheck similar to payroll taxes and fund various programs.

Depending on your location, employer, total income, and other factors, you might be subject to one or more of the following employment taxes:

  • Personal income tax — Taxes paid on all personal income, including your salary, earned interest, and any other types of personally generated revenue.
  • Corporate income tax — Taxes paid by companies, based on the year’s profits.
  • Workers’ compensation — Taxes paid into funds that help employees cover costs of injury or disease received during work.
  • Capital gains tax — Taxes paid after you sell property, including homes, stocks, and precious metals.

Employment taxes differ from payroll taxes in a few ways. Unlike payroll taxes, which are covered by both employees and employers, employment taxes are only sourced from employee income.

Comparatively, employee and payroll taxes also fund entirely different projects. Most income taxes help finance general government projects, while payroll taxes primarily support Medicare and Social Security.