What are Payroll Taxes?

5paisa Research Team Date: 29 Aug, 2023 03:59 PM IST


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Payroll taxes are an essential aspect of our financial lives. It's impacting both employees and employers. They referred to the deductions made from employees' wages and paid by employers to fund various government programs. Think of them as a small portion of your paycheck supporting important initiatives. These can be:

● Social Security, 
● Medicare, and 
● Unemployment insurance. 

Payroll taxes play a vital role in funding essential services that benefit society. If you're curious about payroll tax and how much should be paid? This article will provide insights into the IRS payroll tax. Including who pays it, how payments are made, and the appropriate amounts.
So, let's delve in.

What are Payroll taxes?

Payroll taxes are taxes employees, and employers pay on wages, salaries, and tips. When employees receive their paychecks, the employer withholds certain taxes. Later, send it to the government. These taxes encompass federal, state, and local income taxes. It also encompasses employees' share of Social Security and Medicare taxes (known as FICA). 

Meanwhile, employers are also responsible for paying their share of FICA and federal/state unemployment taxes. In essence, the payroll tax is imposed on an employer's payroll. It encompasses gross salaries, wages, perks, and other forms of employee compensation. It is worth noting that payroll taxes are charged uniformly. It is irrespective of an employer's residence, family situation, or personal circumstances.

Understanding how payroll taxes work can help you track your finances. Also, grasp their significance in maintaining social welfare systems.

Understanding Payroll Taxes

Payroll taxes are an important part of your paychecks that go unnoticed. But they have a big impact on your finances. When you get paid, a portion of your earnings is taken out to cover different taxes. These taxes help support vital programs like Social Security and Medicare. These taxes are deducted from your earnings to fund these programs, providing support to retired and disabled people. There are main types of payroll taxes:

● Federal Insurance Contributions Act (FICA) tax 
● Federal Unemployment Tax Act (FUTA) tax.

FICA taxes include Social Security and Medicare taxes. Social Security taxes help with retirement benefits. In contrast, Medicare taxes support healthcare for the elderly and disabled. Both employees and employers share this responsibility. A percentage is withheld from employees' paychecks, and employers also contribute. The amount of taxes depends on your income level.

Therefore, understanding payroll taxes is essential because they affect your take-home pay. By grasping this concept, you can better manage your finances and plan for the future. Consult a tax professional for personalised guidance if you have concerns about payroll taxes.

Categories of Payroll Tax

Deduction from an employee's salary
● Employers are required to withhold taxes from their employee's wages.
● These taxes are also known as withholding taxes. It covers income tax, unemployment, and disability insurance.

Taxes Paid By The Employer In Lieu of Employee's Wages
● Employees pay taxes directly from their funds.
● These taxes are linked to employing a worker. It can be fixed charges or proportional to the worker's salary.
● They cover the employer's contribution to Social Security, insurance programs, and more.

Objectives of Payroll Tax

The objectives of payroll taxes are as follows:

● One of its primary goals is to generate revenue for the government. It supports public programs and services benefiting society as a whole.
● Payroll taxes contribute to crucial social security programs. It includes retirement benefits, disability benefits, and health programs. It ensures financial support for those in need.
● By levying taxes based on income, payroll promotes fairness in tax contributions. It ensures that higher-income individuals contribute proportionally more to the tax system.
● Payroll taxes aim to support and enhance the business sector. It provides incentives for businesses to thrive and expand.
● It facilitates employer rebates, where employers contribute towards their employees' payroll taxes. It lightens the financial burden for both parties.
● It helps businesses during their early stages. It aids them to establish themselves and navigate the challenges of starting up.
● The payroll tax encourages businesses to increase their workforce and take responsibility for paying payroll taxes. It promotes job creation and economic growth.

How much is payroll tax?

The federal income tax withheld depends on your W-4 withholdings. Social Security and Medicare taxes are 7.56% each, split between you and your employer. The social security tax rate is 2.4%, but you pay only 6.2% as an employee. If you're self-employed, you're responsible for the full amount.

Taxes under Payroll Taxes are:

Tax Amounts
The amount refers to the compulsory deductions from an employee's income or earnings. These deductions are determined based on income level and tax slabs. It also depends upon the applicable tax rates set by the government. They include payroll taxes, which employees and employers contribute towards programs like Social Security and Medicare.

Unemployment Taxes
Unemployment Taxes are collected to fund the unemployment insurance programs. That provides financial assistance to individuals who lose their jobs. Both employers and employees contribute to these taxes. Later, these taxes are used to support people during periods of unemployment. The unemployment insurance rate employers pay varies by industry, state, and federal fees. In some cases, employees may also contribute to unemployment and disability insurance.

Self-Employment Taxes
If you are self-employed, you are responsible for paying taxes that cover the employer and employee portions of certain taxes. These taxes include contributions towards Social Security and Medicare. Since self-employed individuals don't have employers to withhold these taxes. Self-employed individuals must calculate and directly pay the government. 

Social Security Payroll Tax
The Social Security payroll tax is a tax that is imposed on employees and employers. It supports the Social Security program. It is designed to provide financial assistance to retired individuals and the disabled. It also assists the survivors of deceased workers. The tax amount is calculated based on a percentage of an employee's wages. It is up to a certain income limit.

The funds collected through the Social Security Payroll Tax are allotted to two trust funds:
● Old-Age and Survivors Insurance (OASI) Trust Fund
● Disability Insurance (DI) Trust Fund

OASI funds provide retirement and survivor benefits, and DI funds support individuals with disabilities. Various government authorities manage these trust funds.

Medicare Payroll Tax
Medicare payroll taxes also impose on employees and employers. The purpose of this tax is to finance the Medicare program. It offers healthcare insurance to individuals 65 and older and those with disabilities. The Medicare payroll tax is calculated as a percentage of the employee's wages without any income threshold.

The funds collected from the Medicare payroll tax are allocated to two separate trust funds:
● Hospital Insurance Trust Fund: It covers hospital care, skilled nursing inpatient care, and in some cases, home care.
● Supplementary Medical Insurance Trust Fund: It assists in paying for additional medical services. It includes laboratory tests, outpatient care, ambulance services, and prescription drugs.

Payroll Taxes vs. Income Taxes

Payroll Taxes

Income Taxes

Payroll taxes are withheld from employees’ wages to fund social programs like Social Security and Medicare.

Income taxes are imposed on an individual’s earnings and other sources of income to support various government expenditures.

Both employees and employers contribute to payroll taxes, with each party sharing a portion of the tax burden.

Income tax rates vary based on an individual’s earnings. They follow a progressive structure, meaning higher income levels are taxed at higher rates, while lower income levels are taxed at lower rates.

The revenue from payroll taxes is specifically earmarked for funding social programs such as Social Security and Medicare.

Income taxes contribute to the general funds which are used for a wide range of government activities and programs.

Payroll taxes are calculated based on a flat rate up to a yearly cap. It means everyone pays the same percentage of their income until a certain income threshold is reached.

The calculation of income taxes takes into account an individual's total income, deductions, and applicable tax brackets to determine the amount owed.


In essence, payroll taxes play a crucial role in financial lives, benefiting both employees and employers. They support vital initiatives such as Social Security, Medicare, and Unemployment insurance. It provides essential services to society. Understanding and managing payroll taxes helps individuals track their finances and plan for the future. By contributing to payroll taxes, you can contribute to the welfare of society. It promotes fairness in the tax system. Consultation with a tax professional can provide personalised guidance on payroll taxes.

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Frequently Asked Questions

If you earn $147,000 or more, your payroll taxes won't exceed that amount. If you have multiple employers and earn above the limit. You can claim a refund for any excess Social Security taxes paid. There's no income limit for Medicare tax. All your wages are subject to Medicare tax.

To deal with IRS payroll tax issues effectively. It's beneficial to seek assistance from tax professionals like certified public accountants (CPAs), enrolled agents (EAs), or tax attorneys. They provide guidance and represent you when dealing with the IRS.