Payroll Taxes

Payroll taxes are of two types: they are either taxes that must be paid by an employer (employer payroll taxes) or they are taxes employees must pay (employee payroll taxes). The requirement to withhold taxes from the wages or salaries paid to employees forces employers to deduct the taxes that are owed by each employee before wages or salaries are paid. This practice makes the employer the government's tax collector. Both employer and employee payroll taxes are usually simply lumped together and called payroll taxes because they are all handled as a part of the calculations needed by an employer to meet payday obligations.

United States

Employer payroll tax obligations are usually generated with a formula directly related to the amount of money an employee has earned. For example, employer payroll taxes in the United States require paying a matching portion of the employee's Social Security taxes (6.2 percent up to the annual maximum), Medicare taxes (1.45 percent of wages or salary), federal unemployment taxes (FUTA), and state unemployment taxes (SUTA).

The FUTA tax rate for employers is 6.2 percent of gross compensation for all employees on the first $7,000 of income. However, because a business must also pay SUTA taxes, it is allowed to take a 5.4-percent SUTA credit on its FUTA obligation. This reduces the net tax owed for FUTA to 0.8 percent; however, because SUTA rates vary between states, the amount owed as an employer payroll tax varies. In addition, employers usually have to pay an unemployment compensation tax.

Employers may also be liable for local taxes calculated on the basis of their employment activities. Sometimes, employers may have taxes levied upon them based on the number of workers they employ on a fixed or variable formula. Additional tax burdens such as business income taxes, inventory taxes, or property taxes may be owed, but these are not payroll taxes.

Taxes that are withheld from wages (hourly earnings) or salaries (payments on a nonhourly basis) are paid on either a pay-as-you-earn (PAYE) or pay-as-you-go (PAYG) basis. Employers in the United States are usually responsible for withholding the following taxes: federal income taxes, Social Security taxes (6.2 percent up to the annual maximum), Medicare taxes (1.45 percent), state income taxes (if applicable), and local taxes (such as city, county, school district, state disability, or unemployment insurance), if applicable.

Payroll taxes on the wages or salaries of individual workers or employees are calculated on their gross earnings unless there are tax provisions that allow for pretax exclusions. Contributions to 401(k) and 403(b) plans may be paid with pretax dollars. These exclusions are part of a policy goal that seeks to promote personal savings for retirement. Employers may allow employees to deduct a wide variety of deductions for union dues, stock plans, life insurance premiums, health plans, uniforms, meals, and other items. These last deductions are voluntary payroll deductions and are not payroll taxes.

Generally, an employer reports total payroll taxes by calculating the gross earnings and then deducting the various payroll deductions to arrive at the employee's net pay. The biggest portion of payroll taxes are the Federal Insurance Contributions Act (FICA) taxes. The FICA tax is a combination of Social Security taxes and Medicare taxes. Both the employer and the employee pay these taxes with each paying half of the amount due. The total for both combined is 15.3 percent.

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