Payroll Taxes: What Is It, calculation, Imbursement and more

When considering payroll taxes, you might initially assume they encompass all taxes deducted from employees' salaries. However, payroll taxes specifically pertain to Social Security and Medicare contributions, collectively known as FICA (Federal Insurance Contributions Act) taxes.

Note: Most employers are required to compute and deduct these payroll taxes from their employees' gross taxable earnings.

‍

What are payroll taxes?

Payroll taxes include Social Security plus Medicare, with both employers and employees contributing equal amounts. The combined contribution rate is 7.65%, divided between Social Security and Medicare taxes. 

Here's how it breaks down: 

Social Security Tax Rate

Social Security tax is 6.2% for both the employee and the employer. For example, if an employee earns $2,000 during a pay period, both the employee and the employer would contribute $124 each to Social Security.

The Social Security wage base for 2024 is set at $175,000, an increase from $168,600 in 2023. This cap means that once an employee's earnings exceed $175,000 a year, no further Social Security taxes are required from the employee or employer for the remainder of that year.

Medicare Tax Rate

The Medicare tax is consistently 1.45% on all of an employee's wages, matched by the employer, with no wage limit. Additionally, an extra Medicare tax of 0.9% kicks in for higher earners above certain thresholds, which are based on their tax filing status:

• Single: $220,000
• Married filing jointly: $280,000
• Married filing separately: $140,000

This additional 0.9% tax is the responsibility of the employee alone; the employer does not match it. When an employee's earnings surpass these amounts, the employer should withhold both the standard 1.45% and the additional 0.9% Medicare tax.

Read further: Startup tax tips - file and pay with Inkle.

‍

Example

Let's walk through an example involving a well-compensated employee, Employee D. This individual earns $12,000 biweekly, resulting in an annual salary of $312,000 ($12,000 x 26 pay periods).

Here's how you would manage and send FICA taxes for Employee D to the IRS:

‍Employee Contribution to FICA

From each of Employee D's $12,000 biweekly pay-checks, you'll need to withhold 7.65% for FICA taxes, which totals $918.

As Employee D is your only employee in this example, your employer's contribution to FICA mirrors Employee D's:

‍Employer FICA Tax Liability

Your contribution | $12,000 x 7.65% = $918

This withholding should continue until Employee D's wages surpass the Social Security wage base or change in any other way.

When Employee D's total earnings exceed $200,000 for the year, you'll need to adjust the FICA withholding calculations. Beyond this point, Social Security taxes cease, and only Medicare taxes are considered, including an additional tax. You'll now combine the regular Medicare tax rate of 1.45% with an additional Medicare tax of 0.9%, for a total of 2.35%.

Here's how to handle the withholding once Employee D's income is over $200,000:

‍Employee Medicare Withholding

From Employee D’s paycheck | $12,000 x 2.35% = $282

You'll withhold $282 from Employee D's wages for combined Medicare and additional Medicare taxes. 

Meanwhile, your employer contribution remains at the standard Medicare rate:

‍Employer FICA Tax Liability for Medicare

Your contribution | $12,000 x 1.45% = $174

Therefore, while your contribution is $174 per pay period, Employee D's deduction for Medicare taxes increases to $282 each pay period.

Check out Form 1120 today. 

‍

How to calculate self-employment tax?

Self-employment taxes are similar to FICA taxes in that they fund Social Security and Medicare. Whether you need to calculate these taxes for yourself depends on how your business is set up. Typically, if you don't draw a regular salary like your employees, then self-employment taxes are something you'll need to handle.

Unlike FICA taxes, where the burden is shared between employers and employees, self-employment tax is something you take on entirely yourself. As a self-employed individual, you're responsible for the full 15.3% tax rate that contributes to Social Security and Medicare. This is referred to as the Self-Employment Contributions Act (SECA) tax.

Here's how it breaks down: 12.4% of this tax goes to Social Security, and the remaining 2.9% is allocated to Medicare. You only pay the Social Security portion on earnings up to the Social Security wage base limit. After your earnings exceed this threshold, you no longer need to pay into Social Security, though Medicare contributions continue without a cap.

Moreover, if your income crosses the additional Medicare tax threshold, you'll also owe an extra 0.9% in Medicare tax. The thresholds for this additional tax under SECA are the same as those under FICA.

To calculate your self-employment tax liability, complete Schedule SE and attach it to your IRS Form 1040 when you file your U.S. Individual Income Tax Return. This form will help you calculate the exact amount of tax you owe for the year.

‍

What are gross taxable wages?

Gross taxable wages are the earnings of an employee that are subject to income tax withholding and/or FICA taxes. These wages exclude non-taxable income and pre-tax deductions, such as expense reimbursements or Section 125 health insurance deductions.

For instance, suppose an employee earns $2,000 in gross wages but receives an expense reimbursement of $300 and a health insurance deduction of $200. To calculate the gross taxable wages, subtract the health insurance deduction from the gross wages ($2,000 - $200 = $1,800). 

The expense reimbursement is not included in this calculation. 

Thus, the gross taxable wages would be $1,800, which is the amount used to calculate the FICA taxes.

After determining the taxes on the $1,800 of taxable income, add the $300 expense reimbursement. This increases the net wages paid to the employee.

Learn more about Inkle Tax. 

‍

Income and Unemployment: Understanding Other Employment Taxes

Now that you understand Social Security and Medicare are categorised under payroll taxes, let's explore additional taxes involved in processing payroll. Employers are required to withhold income taxes from employee wages unless the employee qualifies for exemption. Income taxes generally include:

• Federal income taxes
• State income taxes
• Local income taxes

Most states require state income tax withholding. If your business operates in one of these states, you will need to obtain state W-4 forms from your employees to calculate the withholding amount accurately for each paycheck. Additionally, consult your local government to determine if there are any local taxes that must be withheld from your employee's wages.

Unemployment taxes constitute another key component of employment taxes. Contrary to income taxes, unemployment taxes are typically the responsibility of the employer and include:

• Federal unemployment tax (FUTA)
• State unemployment tax (SUTA)

These unemployment taxes should be calculated based on your employees' gross wages.

Although income and unemployment taxes are not classified as "payroll taxes," they are essential components of the employment taxes that must be managed during payroll processing.

Follow us on LinkedIn.