Payroll tax vs income tax : A payroll tax is a percentage deducted from an employee’s pay that is paid to the government on the employee’s behalf by the employer.
Employees’ wages, salaries, and tips are subject to the tax. The Internal Revenue Service deducts federal payroll taxes from an employee’s pay and pays them to the IRS (IRS).
What Is a Payroll Tax and How Does It Work?
Important Points:
• Every employee’s pay is withheld and remitted to the federal government in the form of payroll taxes.
• Payroll taxes are used to fund Social Security and Medicare in the United States.
• Payroll taxes are used for a variety of purposes. Income taxes go to the general fund of the government.
Payroll Taxes: What You Need to Know
The term “federal payroll taxes” refers to the taxes deducted to fund the Medicare and Social Security programmes in the United States.
On pay stubs, these are labelled as MedFICA and FICA. The federal income tax, which is also withheld from employee paychecks, goes into the Treasury’s general fund.
Most states, as well as some cities and counties, levy income taxes, which are paid directly into their coffers.
Employers, but not employees, are also responsible for paying federal unemployment taxes on each of their employees. 1
Unlike the progressive income tax in the United States, some payroll taxes are only levied up to a certain yearly limit.
For example, any income above the Social Security wage base, which is set at $142,800 in 2021, is exempt from the Social Security tax, making the payroll tax in the United States a regressive tax. 2
In many countries, including the United States, federal and state governments collect payroll taxes in addition to income taxes.
On an employee’s pay stub, these payroll tax deductions are itemised.
The itemised list shows how much is withheld for federal, state, and municipal income taxes, as well as the Medicare and Social Security payments collected.
Payroll taxes are used by governments to fund specific programmes such as Social Security, health care, and workers’ compensation.
Local governments may levy a small payroll tax to fund the maintenance and improvement of local infrastructure and services, such as first responders, road maintenance, and parks.
Taxes on Unemployment
The primary source of funding for unemployment insurance is from employers.
Employees are entitled to unemployment benefits if they are laid off.
The amount of unemployment insurance that an employer must pay varies depending on the industry, state, and federal fees
Employee contributions to unemployment and disability insurance are required in some states.
The Federal Insurance Contributions Act (FICA) tax covers Social Security and Medicare contributions, which are covered by federal payroll taxes.
An employee is responsible for 7.65% of the total cost. 3 The idea behind Social Security and Medicare is that you pay into them during your working years in order to be eligible to withdraw funds after retirement or in certain medical situations.
On a maximum salary of $142,800, this rate is split between a 6.2 percent Social Security deduction and a 1.45 percent Medicare contribution.
Medicare has no salary cap, but anyone earning more than $200,000—or $250,000 for married couples filing jointly—pays an additional 0.9 percent in Medicare premiums.
Particular Points to Consider
Contractors, freelance writers, musicians, and small business owners who are self-employed are all required to pay payroll taxes. Self-employment taxes are what they’re called.
Self-employed people, unlike most salaried workers, do not have employers who remit payroll taxes on their behalf.
This means they are responsible for both the employer and employee portions of the tax.
The tax rate on self-employment is 15.3 percent. This rate is made up of two parts: a 12.4 percent contribution to Social Security (old-age, survivors, and disability insurance) and a 2.9 percent Medicare payment.
Self-employment earnings over $200,000 are subject to an additional 0.9 percent Medicare surtax. 6
Payroll Tax on Social Security
The Old-Age and Survivors Insurance (OASI) Trust Fund, which pays retirement and survivor benefits, and the Disability Insurance Trust Fund, which pays disability benefits, receive funds from Social Security taxes.
These trust funds are managed by the Secretary of the Treasury, the Secretary of Labor, the Secretary of Health and Human Services, the Commissioner of Social Security, and two public trustees.
On August 14, 1935, President Franklin D. Roosevelt signed the Social Security Act into law, creating a safety net for the disabled and retirees.
High-wage earners were exempt from paying into the fund and receiving Social Security benefits when the programme was created.
However, Congress repealed the exemption and replaced it with a cap, which has risen at roughly the same rate as wages.
Medicare’s Employer Contribution
Payroll taxes, as previously stated, also contribute to Medicare.
The Hospital Insurance Trust Fund and the Supplementary Medical Insurance Trust Fund are the two trust funds that receive these payroll deductions.
Medicare Part A and the associated administration fees are paid for by the Hospital Insurance Trust Fund.
Part A provides assistance with hospitalisation, skilled nursing inpatient care, and, in some cases, home care.
The Supplementary Medical Insurance Trust Fund helps pay for Medicare Parts B and D, as well as other Medicare administrative costs.
Part B pays for lab tests and screenings, outpatient care, x-rays, ambulance service, and a variety of other expenses.
Prescription drugs are covered under Part D.
Individuals who are enrolled in Medicare pay a monthly income-based fee and are responsible for a portion of their medical costs.
Income Taxes vs. Payroll Taxes
Although both are deducted from paychecks, there is a distinction between a payroll tax and an income tax.
Payroll taxes go towards funding specific programmes. Income taxes are deposited in the Treasury’s general fund.
Up to a yearly cap, everyone pays a flat payroll tax rate. However, income taxes are progressive. Rates are determined by a person’s earnings.
If there is a state income tax, it is paid into the state’s coffers.
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