Payroll Tax: What Is Payroll Tax & How It Works

Gabrielle Sinacola | Dec 5, 2023

Payroll Tax: What Is Payroll Tax & How It Works

Navigating the complexities of payroll tax can be a daunting task for any business leader, HR expert, or financial professional.

We’re here to simplify the subject, breaking it down into its essential elements so you can focus on what truly matters: running a compliant and efficient business. From startup founders to HR veterans, here are the insights you need to understand payroll tax and its implications for your business.

What Is Payroll Tax?

Payroll tax is a type of employment tax that affects both employers and employees, and it’s more nuanced than you might think.

Deductions from employees’ wages go toward federal income tax, Medicare taxes, and Social Security tax. These deductions are then remitted to the federal government by the employer.

Employers also contribute their share to Social Security and Medicare under the Federal Insurance Contributions Act (FICA). These taxes fund Social Security and Medicare — programs designed to support healthcare for older Americans and those with disabilities. Employers may also pay federal and state unemployment taxes.

The state and local governments also collect taxes to manage infrastructure and public services. In fact, payroll taxes serve as the financial backbone for specific programs and services that benefit society at large.

The key takeaway here is that payroll taxes are not just about compliance — they also contribute to a broader social and economic ecosystem.

What Do Payroll Taxes Pay For?

Whether you’re operating a small business or a large corporation, a thorough understanding of federal payroll taxes is a must. These aren’t just obligatory payments, but are critical to financing significant societal programs.

Payroll Tax Regulations

Payroll tax regulations can be complex, requiring both employers and employees to make contributions. We can better make sense of these regulations by examining some common aspects across multiple jurisdictions.

These include:

  • Tax Rates: The US government sets specific rates for both employers and employees. Depending on the type of tax, these rates can be fixed or vary based on wage levels.

  • Earnings Cap: Certain payroll taxes, such as Social Security, have a cap on the earnings subject to the tax.

  • Filing Requirements: Employers are mandated to file periodic reports that detail their payroll tax withholdings. They must also forward these withheld amounts to the government.

  • Penalties: Non-compliance with US payroll tax regulations can lead to penalties. This could be due to reasons like not withholding the correct amount or not submitting required reports on time.

  • Exemptions: Specific employment types or income brackets might be either partially or fully exempt from certain payroll taxes.

It’s important for employers to stay updated on local regulations, as changes can occur frequently, and non-compliance can have significant financial and legal consequences. Unfortunately, these regulations can change often, which is why you can also choose to trust Mosey for the most up-to-date information on state and local regulations.

Payroll Tax vs. Income Tax

At first glance, payroll tax and income tax might seem similar since they both come out of an individual’s paycheck. However, they serve different purposes and have distinct characteristics.

Payroll taxes are primarily used to fund social programs like Social Security and Medicare. Income taxes, on the other hand, are used to fund nationwide needs like highways, defense, and police and justice systems.

While payroll taxes typically have a fixed rate up to a certain income ceiling, income tax rates are often progressive. This means that the rate increases as the taxable income of the individual rises.

Both the employer and employee typically contribute to payroll taxes — but with income taxes, only the individual is responsible for the payment, though employers withhold and remit it on behalf of the employee.

In addition, income taxes often come with a host of potential deductions and credits, allowing individuals to reduce their taxable income. Payroll taxes, in contrast, typically have fewer opportunities for deductions.

By tracking these tax payments and understanding their implications, business leaders can make more informed decisions and maintain compliance with IRS regulations.

What Are the Different Types of Payroll Taxes?

Payroll taxes encompass a variety of taxes that are deducted from an employee’s paycheck by their employer. Here’s a breakdown of some of the main types of payroll taxes, specifically in the context of the U.S.

Federal Income Tax

This tax funds general government operations, including Medicaid and Medicare, as well as security measures. Its rate varies based on the individual’s taxable income and filing status.

The amount withheld from an employee’s paycheck is determined by the information provided by the employee on their Form W-4. Factors such as income, number of dependents, and other deductions play a role in determining the withholding amount.

Social Security Tax

The Social Security tax is dedicated to funding the Social Security program, which offers retirement benefits, survivors’ benefits, and disability income. In 2023, both employees and employers contributed 6.2% of an employee’s wages, amounting to a combined contribution of 12.4%.

However, not all income is subject to the Social Security tax. There’s a wage base limit in place — as of 2023, this limit is set at $160,200. This means that only earnings up to this amount are taxed for Social Security purposes.

Any income earned beyond this cap is exempt from Social Security tax, making the FICA taxes effectively regressive. The withholding for Social Security tax is automatically taken out of an employee’s wages, but only up to the aforementioned wage base limit.

Medicare Tax

This tax supports the Medicare program, a health insurance offering for seniors and certain disabled individuals. Employees contribute 1.45% of their wages, while the employer pays the same for a total of 2.9%.

For those earning above a certain threshold, an additional 0.9% tax applies, which is solely the responsibility of the employee. Medicare tax is automatically deducted from employee wages, with no wage base limit for the standard rate. The additional tax kicks in after surpassing the specified income threshold.

Unemployment Taxes

Lastly, we have Unemployment taxes. Fittingly, these taxes fund unemployment insurance programs, providing temporary income to eligible workers who become unemployed through no fault of their own.

There are two primary components to unemployment taxes:

  • Federal Unemployment Tax Act (FUTA): Paid by employers, not employees. The tax rate is 6%, but employers can receive a credit of up to 5.4% for state unemployment taxes, making the effective rate as low as 0.6%. There is a wage base limit applied to FUTA tax, which varies by state.
  • State Unemployment Tax Act (SUTA): The rates and wage base limits for SUTA vary by state, with some states requiring employee contributions.

Collectively, these taxes play a crucial role in funding essential government programs and services. It’s important for both employers and employees to be familiar with these tax types, their purposes, and their rates to ensure compliance and proper financial planning.

Do Payroll Taxes Differ by State?

The landscape of payroll taxes isn’t uniform across the United States. In fact, variability in tax structures and additional assessments is the norm rather than the exception.

Special Considerations for Local Taxes

State and local taxes introduce an added layer of complexity for businesses. Some states don’t have an income tax, while others add additional taxes that can impact employees’ wages. Employers must stay updated on these rates to ensure accurate income tax withholding.

Failure to do so can lead to serious repercussions, not just from federal agencies like the IRS but also from local governments and taxpayers. So, keeping tabs on local taxes isn’t just good practice — it’s essential for legal compliance.

Tracking Payroll Tax Regulations With Mosey

No one wants to spend their weekend combing through legislation on tax credits or health insurance stipulations. That’s where payroll tracking software like Mosey comes in handy.

Designed to be your go-to guru for all things payroll tax setup-related, Mosey helps employers navigate the ever-changing landscape of payroll tax rates, tax credits, and regulations.

We make it easy to open the right payroll tax accounts in each state, city, or local jurisdiction for your business.

Mosey can even account for those working in nonprofit sectors, helping to clarify what tax liabilities or exemptions may apply. For business owners, Mosey can be your second pair of eyes, making sure remitting is done timely and accurately.

Our software streamlines the complexities of business compliance allowing you to focus on growing your business and increasing tax revenue rather than getting bogged down in paperwork.

How Do You Calculate Payroll Taxes?

Navigating the landscape of payroll taxes requires precision and a good grasp of regulatory guidelines. Two critical initial steps set the groundwork: obtaining W-4s from employees and establishing your tax deposit schedule.

Collect Form W-4s From Employees

The cornerstone of federal income tax withholding is the Form W-4, provided by employees. This form indicates essential variables like marital status and potential tax credits, which are important for calculating the correct withholding from employees’ wages.

Determine Payroll Tax Deposit Schedule

Adherence to an appropriate tax deposit schedule is key to compliance and avoiding penalties. The IRS dictates this schedule on the federal level, which may be monthly or semi-weekly, based on your overall tax liability.

You have two primary techniques for calculating these taxes:

  • Wage Bracket Method: Suitable for salaries not exceeding $100,000, this method relies on tables that factor in an employee’s marital status and pay period. It also incorporates any applicable tax credits the employee may be eligible for.
  • Percentage Method: This method is generally reserved for higher earners and requires a more nuanced calculation process. It’s most effective when using an automated payroll system or third-party service.

Both federal and state mandates, along with any applicable local income tax ordinances, should be carefully observed when calculating these withholdings.

Stay Compliant With Mosey

Mosey is your streamlined solution for navigating payroll taxes, employee tax withholdings, and ever-shifting local and state income tax rates.

With Mosey, you can confidently meet due dates, manage your employee-specific requirements efficiently in each state, and steer clear of penalties. Choose Mosey to simplify your payroll and business tax management today.

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