What Is the Payroll Tax and How Much Does It Cost You?
When you get your paycheck, you've probably already noticed that you don't actually get a check equal to the full amount of your annual salary. If you make $52,000 per year, for example, you don't get a $1,000 check every week or a $2,000 check every two weeks. That's because you owe taxes on your paycheck and the U.S. tax system is a pay-as-you-go system -- so your employer actually withholds some of your money to cover what you owe.
When your employer withholds taxes from your income and sends the money off to various government agencies, these taxes have a special name. They're called payroll taxes and there are actually a bunch of different kinds withheld from your check.
This guide will explain exactly what some of these payroll taxes are, along with who is paying them and how much they end up costing you.
What Are Payroll Taxes and How Much Do They Cost?
Payroll taxes include:
- Federal income taxes: Employees have different amounts of federal income tax withheld from their paycheck depending on their tax rate and their number of dependents. When you start a new job, you fill out a W-4 form so your employer can calculate how much money to withhold. If you overpay, you can get a refund and if you underpay, you'll owe money on Tax Day.
- Social Security taxes: These taxes support the Social Security retirement system as well as the Social Security Disability Insurance system. Social Security taxes, along with Medicare taxes, are authorized under the Federal Insurance Contributions Act and are sometimes referred to as FICA taxes. Your Social Security tax equals 12.4% of your income but you pay half and your employer pays the other half. This means you and your employer each pay 6.2% of your wages. Social Security taxes are paid only on wages up to the annual wage base limit, which is $132,900 in 2019. So, you and your employer only pay this tax on your first $132,900 in wages.
- Medicare taxes: These taxes support Medicare, which provides health insurance to Americans who are 65 and older, as well as to some qualifying disabled Americans. Medicare taxes equal 2.9% of your total wages, 1.45% of which you pay and 1.45% of which your employer pays. Medicare taxes are due on all your earnings; there's no wage base limit. In fact, there's an Additional Medicare Tax of .9% imposed on married couples filing jointly with incomes of $250,000 or higher or on other tax filers with incomes of $200,000 or higher. Employers must start withholding this additional tax on all wages paid over $200,000 in a calendar year, regardless of your tax filing status.
- Federal unemployment tax: Only your employer pays this; you don't have to pay any portion. This tax support the unemployment benefits system that, in connection with state unemployment programs, ensures you continue to receive some income if you lose your job through no fault of your own.
Employers are responsible for withholding the appropriate amount of money from your check for all of these different taxes, as well as for reporting payroll to relevant taxing authorities and sending in periodic payments to comply with tax requirements.
Does Your Employer Really Pay a Portion of Your Payroll Taxes?
Employers pick up part of the cost of your FICA taxes. But, of course, employers are aware of these costs when they hire workers and they account for their tax obligations when setting your salary.
So, while employers do technically pay payroll taxes, each employee indirectly pays these taxes because employers adjust wages to account for their obligations to the government when hiring.
Do Self-Employed Workers Owe Payroll Taxes?
If you are self-employed, you don't have an employer to withhold your taxes for you -- and you don't have an employer to pay part of your FICA taxes. This doesn't mean these taxes don't have to be paid, but you're responsible for paying them yourself.
Depending how much you earn, you likely need to send in quarterly estimated tax payments to comply with your tax obligations. These are due in June, September, January, and April. You can learn more about your obligations in our guide to estimated taxes.
One important thing to know is that you're allowed to deduct half the FICA taxes you pay from your income as a business deduction. This helps offset the additional direct costs you incur by not having an employer pick up part of your Social Security and Medicare taxes.
Do Your Payroll Taxes Ever Change?
When tax laws change, your payroll taxes could change.
If you get an income tax cut or an income tax increase, or if your personal tax situation changes, you may need your employer to withhold a different amount of money for income tax
Occasionally, you will also see a cut to your FICA taxes. In 2011 and 2012, the Obama administration temporarily reduced Social Security taxes from 6.2% to 4.2% during a period of economic downturn to prompt an increase in consumer spending.
Traditionally, Democrats have favored payroll tax cuts because these cuts provide a direct tax cut that benefits workers over investors since payroll taxes are only paid on income from work and not on investment income. Because payroll taxes are paid only on income up to the wage base limit, a payroll tax cut also disproportionally benefits low and middle income workers who are taxed on their entire salaries instead of only on part of their income. These workers typically spend -- rather than save -- the extra money, bolstering the economy by helping businesses.
Although Republicans have, in the past, expressed concern that payroll tax cuts can increase the deficit, White House officials in the Trump Administration have reportedly been considering a temporary cut to payroll taxes amid concerns of an economic slowdown early this August. However, these discussions are preliminary and no tax cut has been formally announced.
Understanding Payroll Taxes Is Important
Understanding payroll taxes is important because knowing how these taxes work helps you to figure out what's being deducted from your paycheck. Paying FICA taxes also entitles you to earn work credits that will help you qualify for Social Security benefits as a senior.
The good news is, now you know what payroll taxes are, how they work, and how much they're likely to cost you.