What Are Payroll Taxes?

A business owner calculates payroll taxes.

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Payroll taxes are amounts of pay withheld from an employee’s paycheck during the payroll process, and employers must usually match these amounts.

Definition and Examples of Payroll Taxes

Payroll taxes are taxes employers withhold from employees' pay and remit on both behalf of their works and themselves to the appropriate taxing agencies. Employers collect and pay these taxes through the company's payroll process.

  • Alternate name: FICA taxes

Some payroll taxes are also known as “FICA taxes.” FICA stands for the “Federal Insurance Contributions Act” and includes Social Security and Medicare taxes. Other examples of payroll taxes include additional Medicare tax, self-employment tax, federal income tax withholding, and federal unemployment tax (FUTA), the latter of which is not considered a part of FICA taxes.

How Payroll Taxes Work

Payroll taxes are levied as a certain percentage of your earnings. Your employer typically pays half this percentage, and you pay the other half through paycheck withholdings. Employers are legally obligated to contribute to these taxes and report the amounts withheld from employees’ pay on Form W-2. Your employer sends the contribution information to the IRS after year’s end.

Employers must keep this money in a dedicated account and deposit these amounts with the federal government on a monthly or semiweekly schedule. Unemployment taxes must be paid quarterly whenever you owe more than $500. Employers are responsible for paying all the unemployment tax you owe.

Payroll taxes raise significant revenue. They generated $1.24 trillion in 2019, according to the Center on Budget and Policy Priorities. This works out to 5.9% of the country’s gross domestic product (GDP) and 35.9% of the nation’s overall revenues. Social Security alone received $914 billion from payroll taxes, making them the second-highest source of income for the federal government behind income taxes.

The self-employed must pay all payroll taxes because existing tax law considers them to be both employer and employee. Their Social Security and Medicare taxes are collectively referred to as the self-employment tax, provided for under the Self-Employed Contributions Act (SECA).

Types of Payroll Taxes

There are four payroll taxes: Social Security, Medicare, Additional Medicare Tax, and Federal Unemployment Tax.

Social Security Tax  

This payroll tax is levied at 12.4% (split evenly between employer and employee). Of this 12.4%, 10.6% goes to an OASI fund for retirement benefits and survivors, and the other 1.8% goes to disability insurance.

The Social Security tax is payable only on annual earnings up to $142,800 in 2021 ($147,000 in 2022). Income over $142,800 (in 2021) isn’t subject to the Social Security tax—but only for the remainder of the year. You pay this tax on earnings up to this amount, with the earnings counter resetting on January 1 of the next year.

The wage base is indexed for inflation, so it tends to increase every year. To give you context, the Social Security tax was levied at just 1% in 1937, when it was first imposed.

Medicare Tax

Medicare taxes fund the nation’s hospital insurance (HI) program. This payroll tax pays for hospital stays, some home health care, and hospice care for qualifying individuals. Also known as “MEDFICA,” Medicare payroll tax contributes to Part A Medicare benefits for senior taxpayers and those with certain illnesses or impairments. Other parts of Medicare aren’t covered. The tax is 2.9%: The employee and employer pay 1.45% each. This tax was capped at a certain amount of annual earnings, but it was eliminated from the federal code in 1994.

Medicare tax has expanded to Medicare Advantage plans and prescription drug costs since its inception. It contributed 36% to these programs in 2019, the last year before effects from the pandemic distorted the data.

There’s no salary or earnings cap on the Medicare tax. In fact, high earners are hit with an extra tax, known as the Additional Medicare tax.

Social Security and Medicare tax rates are the same for self-employed taxpayers. The only difference is that they have to pay the total percentage, not just half.

Additional Medicare Tax  

The Additional Medicare Tax is 0.9%, and employers are obligated to withhold this from a worker’s paycheck as well, but they don’t have to match it.

It’s only payable on earnings of more than $200,000 (single taxpayers) or $250,000 (married filing jointly). The income threshold drops to just $125,000 if you’re married filing separately.

Those who earn more than the threshold will pay regular Medicare tax and the Additional Medicare tax.  

Unemployment Tax

States pay unemployment compensation to workers who’ve lost their jobs. States partner with the federal government to provide for this program. Unemployment taxes collected from employers are placed in a federal trust fund. Employees don’t have to contribute to this payroll tax. 

The unemployment tax rate is 6% of earnings paid up to $7,000, but the federal government provides tax credits that can bring this down to just 0.6%. Unemployment tax is payable at the state level as well.

Drawbacks of Payroll Taxes

All these taxes add up to a large amount of money, which has led to much debate over the years.

It’s been argued that employers effectively pass on their share of Social Security and Medicare taxes by paying workers 7.65% less than they would have otherwise—half of that 15.3% total—to compensate for having to pay their own half of these taxes. Their payroll tax obligation results in lower wages, and employees still have to pay their 7.65% share. 

Lower-income workers also pay that Social Security tax on all their earnings, while high earners don’t have to once they reach the wage-based threshold.  

But high earners are at a bit of a disadvantage because of the additional Medicare tax. They’re paying more into the Medicare system, but the services they’re eligible for are the same as those for taxpayers who contribute less. Then again, high earners don't pay Social Security taxes on income above the threshold, but they’re eligible to collect Social Security when the time comes.

Key Takeaways

  • Payroll taxes consist of four separate taxes: Social Security, Medicare, Additional Medicare, and unemployment insurance tax. However, not everyone pays all of these.
  • Employers and employees share the Social Security and Medicare tax, each paying half; self-employed individuals must pay both halves.
  • The additional Medicare tax is reserved for high earners. Employers don’t have to share in this tax.
  • Employees don’t have to contribute to the unemployment insurance tax.

Article Sources

  1. Internal Revenue Service. “Depositing and Reporting Employment Taxes.” Accessed Jan. 27, 2022.

  2. Center on Budget and Policy Priorities. “Policy Basics: Federal Payroll Taxes.” Accessed Jan. 27, 2022.

  3. Peter G. Peterson Foundation. "Payroll Taxes: What Are They and What do They Fund?" Accessed Jan. 27, 2022.

  4. Social Security Administration. "What Are FICA and SECA Taxes?" Accessed Jan. 27, 2022.

  5. Congressional Research Service. "Social Security: The Trust Funds," Pages 2-3. Accessed Jan. 27, 2022.

  6. Internal Revenue Service. “Social Security Announces 5.9 Percent Benefit Increase for 2022.” Accessed Jan. 27, 2022.

  7. Social Security Administration. "Social Security & Medicare Tax Rates." Accessed Jan. 27, 2022.

  8. Internal Revenue Service. "Topic No. 751: Social Security and Medicare Withholding Rates." Accessed Jan. 27, 2022.

  9. Congressional Budget Office. "CBO's Options for Raising Revenues and Chances in Tax Law, 1980 to 1993." Page 16. Accessed Jan. 27, 2022.

  10. Internal Revenue Service. "Topic No. 560 Additional Medicare Tax." Accessed Jan. 27, 2022.

  11. Internal Revenue Service. "FUTA Credit Reduction." Accessed Jan. 27, 2022.

  12. Internal Revenue Service. "Topic No. 756 Employment Taxes for Household Employees." Accessed Jan. 27, 2022.