What is a Payroll Tax? Purpose, Key Components, Calculations, Example, and Payroll Vs Income Taxes

A payroll tax plays a crucial role in funding essential government programs like Social Security, Medicare, and unemployment insurance. That’s why understanding what is payroll tax is important for both employers and employees. 

Here, you can uncover the detailed information on its purpose, key components, calculations, examples, and the difference between payroll taxes and income taxes.

So, stay adherent to this article!

What is a Payroll Tax?

A payroll tax is an employment tax imposed on employees’ wages and salaries to fund government insurance like Medicare and Social Security. It consists of the Federal Insurance Contributions Act (FICA) tax, which the government uses to fund essential programs. 

These taxes are split between employers and employees, with some portions withheld from workers’ paychecks while others are paid directly by the employers based on salaries.

This indicates that it plays a crucial role in funding Social Security, Medicare, and unemployment insurance.

What is the Purpose of Payroll Taxes?

Payroll taxes fund government programs such as Social Security and Medicare. The purpose of these taxes is to provide financial support to retirees, individuals with disabilities, or other survivors.

On the other hand, the Federal Unemployment Tax Act (FUTA) contributes to the unemployment programs, helping workers who have lost their jobs. Employees should submit Form W-4 when they are hired to have the withholding amount based on their salaries. 

Note: The IRS (Internal Revenue Service) suggests that workers should submit Form W-4 every year to update their latest financial status because it affects their tax situation and business valuation.

Who Actually Pays Payroll Taxes?

Both employers and employees pay payroll taxes in the US. The fund is split between employers (7.65%) and employees (7.65%), meaning the total FICA rate is 15.3%.

It is important to note that employees fund their income tax obligations and contribute their share of FICA (Federal Insurance Contributions Act) taxes. At the same time, employers match employees’ FICA taxes and pay FUTA and state unemployment taxes, which are only funded by employers.

Furthermore, employers manage the administrative side by calculating employees’ withholdings, making deposits based on the payroll schedule, and evaluating tax liability and international tax. They also file monthly or yearly reports with the IRS. 

Let’s look at this breakdown table to figure out the responsibilities of employers and employees.

Employers’ Responsibilities	Employees’ Responsibilities
The FUTA (Federal Unemployment Tax Act) tax rate is 6.0% on the first $7,000 of taxable wages paid to each employee.	Fund federal income tax withholding based on Form W-4.
Matching employee contributions to FICA, such as 6.2% Social Security and 1.45% Medicare.	Contribute the employee portion to FICA, such as 6.2% Social Security and 1.45% Medicare.
Contributing to the State Unemployment Tax Act (SUTA) at rates determined by different states.	State income tax withholding from their paychecks (if applicable).
	Additional Medicare tax (0.9% on income over $200,000).

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Key Components of US Payroll Taxes

There are five types of US payroll taxes, including FICA taxes (Social Security & Medicare), Federal Unemployment Tax (FUTA), State Unemployment Tax (SUI), Income Tax Withholding, and Self-Employed Contributions Act (SECA).

Here are the following payroll tax and rate estimators in great detail. 

1. FICA Taxes (Social Security & Medicare)

The total taxable payroll is 15.3%, in which employees and employers contribute the same amount, i.e., 7.65%. 

• Social Security (OASDI): Both fund 6.2% to Social Security, applied to wages up to an annual limit of $184,500 in 2026.
• Medicare (Hospital Insurance): Contributes up to 1.45% with no wage cap. However, an employee should pay 0.9% Medicare tax on additional earnings over $200,000.

2. Federal Unemployment Tax (FUTA)

It is paid only by employers, generally 6% on the first $7,000 of an employee’s wages. Interestingly, it is often reduced to 0.6% if employers pay unemployment tax on time.

3. State Unemployment Tax (SUI)

It is also paid by employers to state funds, helping workers who lose their jobs through no fault of their own. But rates may vary by state and are based on the employer’s experience rating.

4. Income Tax Withholding

In this payroll tax, employers are required to withhold federal and state/income taxes from employees’ paychecks and submit them to the IRS.

5. Self-Employment Tax (SECA)

It acts as the self-employment equivalent of FICA taxes, covering both employers’ and employees’ funds. The total rate is 15.3%, comprised of 12.4% for Social Security and 2.9% for Medicare if the person earns $400 or more.

How to Calculate Payroll Taxes? 

To calculate payroll taxes, you should evaluate an employee’s gross pay > taxable wages > withhold taxable income tax > FICA taxes > state and local tax > employer-only tax > net pay.

Let’s dig deeper into the following steps for in-depth guidance.

Step 1: Calculate Employee’s Gross Pay

Firstly, you should calculate the total earnings of an employee before taxes, including overtime, hourly wages, and bonuses.

Step 2: Determine Taxable Wages

Deduct contributions to plans such as 401(k), 403(b), 457(b) retirement plans, HSA, or Section 125 to determine taxable wages.

Step 3: Withhold Federal Income Tax (FIT)

Now, use the employee Form W-4 and IRS Publication 15-T to withhold federal income tax from an employee’s paychecks. 

Step 4: Calculate FICA Taxes

Calculate 6.2% for employees and employers for Social Security from employee wages on the first $184,500. Also, evaluate 1.45% for employees and employers for Medicare insurance from employee earnings over $200,000 in a year. 

Step 5: Evaluate State and Local Taxes

Apply the specific tax rates according to the state and locality laws to evaluate the state and local taxes.

Step 6: Compute Employer-Only Tax

Now, calculate FUTA (0.6% on the first $7,000 of each employee’s wages) and SUTA based on your assigned state law. 

Step 7: Calculate Net Pay

At last, subtract all employee withholdings like FICA and income taxes from the gross pay.

Note: If you think that calculating payroll taxes can be challenging, you can hire professionals and opt for payroll services for your organization.

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A Detailed Example of Calculating Payroll Taxes

Let’s take a look at a detailed example of how to calculate payroll taxes.

For example, an employee’s annual salary is $60,000 ($2,307.69 gross per biweekly pay period) in a state with no income tax.

Single gross pay = $2,307.69

Employee Tax Withholdings

1. Federal Income Tax (FIT) = $185.00 (estimated based on the Form W-4) 
2. Social Security (6.2%) = $2,307.69 x 6.2% = $143.08 
3. Medicare (1.45%): $2,307.69 × 0.0145 = $33.46 

Total Employee Deductions = $185.00 + $143.08 + $33.46

                                                      $361.54

Net Pay = $2,307.69 – $361.54

                  $1,946.15

Employer-Paid Taxes

1. Social Security Match (6.2%) = $143.08
2. Medicare Match (1.45%) = $33.46
3. FUTA (Federal Unemployment) = $2,307.69 × 0.006 = $13.85 (0.6% on the first $7,000 of annual wages)

Summary of the payroll taxes:

Category	Employee	Employer	Paid to the US Government
Federal Income Tax	$185.00	–	$185.00
Social Security	$143.08	$143.08	$286.16
Medicare	$33.46	$33.46	$66.92
FUTA	–	$13.85	$13.85
Total	$361.54	$190.39	$551.93

Payroll Taxes Vs Income Taxes: What’s the Difference?

Payroll taxes are imposed on both employees and employers to fund Social Security and Medicare. On the other hand, income taxes are paid by individuals based on net earnings.

If you are still confused about the difference between both of them, let’s take a look at the breakdown table of payroll taxes vs income taxes.

Feature	Payroll Taxes	Income Taxes
Purpose	Funds for vital government programs: Social Security and Medicare.	Funds for general government programs: defense, education, and infrastructure.
Who Pays	Split between employer and employee (7.65% each).	Paid by the employee and self-employed people (withheld by the employer).
Rate Type	Flat rate (15.3% total) up to wage base limits.	Progressive brackets (10% to 37%).
Calculation Base	Only wages, salaries, and bonuses.	Total income includes income, interest, and dividends.
Deductions	None	Reduced by deductions or credits (e.g., dependents).
Self-Employed	Pay the total tax rate (15.3%) as “self-employment tax.”	Pay based on net earnings.

Wrapping Up!

A payroll tax is only imposed to fund Social Security, Medicare, and unemployment insurance. It is different from income tax and is split between employers and employees, i.e., 7.65% each.

As a US citizen, you should be aware of what is payroll tax; otherwise, you can hire professional experts to calculate your payroll taxes and manage your financial decisions on your behalf.

Frequently Asked Questions

Sources:  

Understanding employment taxes – IRS