Payroll Tax Law

In contrast to gift taxes and estate taxes, payroll taxes are a part of most individuals’ day-to-day life. They cannot be avoided and are included in almost every paycheck that an employee receives. While many individuals see payroll taxes as abstract numbers that merely detract from take-home pay, they serve an important purpose and are worth understanding.

Required Payroll Taxes

There are a wide variety of payroll taxes that federal law requires individuals to pay in their monthly or bi-weekly paycheck. These include obvious taxes such as federal and state income tax withholding and Medicare taxation, as well as more complicated taxes. For instance, all individuals receive a deduction for Social Security tax from their paycheck. This tax is levied at a 6.2 percent rate, but only on a certain amount of income that an individual receives. After the individual reaches this annual maximum, the rest of income is not subject to a Social Security tax. Likewise, individuals who reside in certain communities may be subject to city, county, and local taxes of varying rates. Depending on state laws, they may also be required to pay state disability taxes.

Voluntary Payroll Payments

In addition to the above required payroll taxes, many individuals also make voluntary payroll payments, for several reasons. Sometimes this is done to offset expected taxes on other income. For instance, if you have a small-business on the side for which you also receive income, this income may not be taxed as it does not come from an employer or in the form of a paycheck. Yet, you will likely still owe income taxes on these amounts. For this reason, some individuals take taxes out of their normal “job” in order to offset taxes due from other income they have received. Individuals may also take deductions for other purposes such as health insurance, retirement, or other individual benefits. These are not as tax-related.

Taxes Paid by Employers

While it may seem like only employees must deal with the tough reality of payroll taxes, these taxes are also imposed on employers as well. Employer payroll taxes include paying an equivalent amount of Social Security and Medicare taxes, as well as unemployment taxes. This means that while an employee pays 6.2 percent in Social Security taxes and 1.45 percent in Medicare taxes, an employer pays the same amount to the federal government for each employee it employs. This is known more broadly as the “FICA” tax, which stands for Federal Insurance Contributions Act. Additionally, employers must pay federal and state unemployment taxes to the applicable governments. Finally, employers bear the burden of properly ensuring that payroll taxes are collected. This means that they must account for their own tax payments, as well as taking the time to ensure that all taxes are correctly taken out of all employees' paychecks and that the correct tax forms, such as W-2s and 1099s are filed for all employees.

Keeping Track of Your Taxes

Payroll tax rates can change frequently, whether due to changes in legislation or changes in your personal income. As your income goes up, your federal and state withholdings are likely to increase. However, you may also experience a corresponding cessation in Social Security taxes after your income meets the annual maximum for the year. It is important to keep track of these types of tax issues both to ensure that you are not paying more taxes than are required, but also to make certain that you will not be subject to a large tax bill at the end of the year.  

Last reviewed October 2024