Payroll taxes are withheld from employees' paychecks in the U.S., and are matched by their employers, to fund the Social Security and Medicare programs. Also known as FICA taxes in the United States, the employer withholds a percentage of wages, which is calculated differently for the Social Security and Medicare portions of the tax.
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What is the payroll tax?
As a broad definition, a payroll tax is a tax withheld by an employer and paid on behalf of its employees, based on the wages or salary of the employee. They differ from income taxes in that everyone pays a flat payroll tax rate, as opposed to income taxes, which are progressive, or increasing rates, based on earnings.
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The payroll tax in the United States is also known as FICA, which stands for the Federal Insurance Contribution Act. Essentially, this is a tax paid by employers and their employees, to fund the Social Security (also known as Old-Age, Survivors, and Disability Insurance, or OASDI) and Medicare programs.
As of 2017, about 171 million U.S. workers contribute payroll taxes. The basic idea is that the payroll tax requires the current generation of workers to fund the Social Security and Medicare programs for current retirees, and someday the next generation will fund these programs for them. In theory, the payroll taxes collected by both programs combined with the income earned on their reserves should be enough to cover all of the benefits promised to workers in any given year.
For both taxes, Social Security and Medicare, employers match their employees' contributions. In other words, U.S. workers only pay half of the payroll taxes contributed to Social Security and Medicare on their behalf.
The Social Security and Medicare tax rates
The Social Security part of the payroll tax is assessed at a rate of 6.2% each for the employer and employee, for a combined rate of 12.4%.
Social Security tax is only assessed on earned income up to a certain maximum each year. For 2017, the Social Security taxable maximum is $127,200, and no tax is assessed on income above this amount.
In comparison with the Social Security tax, Medicare is taxed at a much lower rate of 1.45%. Unlike Social Security, however, there is no wage cap -- every dollar of earned income is subject to Medicare taxes. In addition to this, high-income workers pay the Additional Medicare Tax on top of this rate, as part of the Affordable Care Act. For all filing statuses, employers are required to withhold an additional 0.9% of all wages paid in excess of $200,000 to an employee, but the employer doesn't have to match this tax. The thresholds for the Additional Medicare Tax, however, do depend on filing status:
Data source: IRS.
So, the combined payroll tax rate is 7.65% each for employers and employees, for a total rate of 15.3%. However, this amount is only assessed on the first $127,200 of wage income. Beyond this amount, the payroll tax rate is just 2.9% -- the employer and employee portions of the Medicare tax.
Examples of payroll tax calculations
To illustrate how payroll taxes work, let's look at a few examples.
First, let's say that you earn a salary of $75,000. This is less than the maximum Social Security taxable wage cap, so the 7.65% total payroll tax rate would apply to your entire salary. You and your employer would both pay $5,737.50 each in payroll taxes on your behalf.
Next, consider the case where you earn $150,000 from your job. Since this is more than the Social Security taxable wage cap, the 7.65% rate would apply to your first $127,200 of earned income, for a payroll tax of $11,475. For your other $22,800 of income, only the 1.45% Medicare tax rate would apply, which translates to another $330.60. Combined, this results in a payroll tax of $11,805.60 each for you and your employer.
Payroll taxes for self-employed people
Finally, self-employed people must pay both sides of the self-employment tax, since they are considered to be the employer and the employee. So, they pay the combined rates, which for 2017 are:
- 15.3% on the first $127,200 of earnings
- 2.9% on all earnings above this threshold
- Plus, the Additional Medicare Tax of 0.9% if earnings exceed the applicable threshold, as discussed earlier
It's also worth mentioning that if a self-employed individual also has income from an employer with payroll taxes withheld, those will count toward the taxable Social Security wage limit. For example, if you earn $50,000 from a W-2 employer and have payroll taxes withheld, and also earn $100,000 in self-employment income, you'll only need to pay Social Security tax on the first $77,200 of that amount, since when combined with the $50,000 of employment earnings, it reaches the $127,200 maximum.
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