What Is the Payroll Tax Rate?

The payroll tax rate is the dollar amount withheld by an employer when computing an employee's paycheck. The money deducted is for federal, state, and local taxes. The taxes are a combination of income taxes, Medicare taxes, and Social Security.

In simple terms, a payroll tax is for the benefit of a company's employees. It is based on their hourly wages or salary. Payroll taxes are paid by everyone using a flat payroll tax rate. Income tax is based on an individual's earnings and can fluctuate from year to year.

What Is the Difference Between Payroll Tax versus Income Tax?

The words "payroll tax" are often used when referring to all employment taxes. This can be misleading as there are a few other types of employment taxes. Medicare taxes and Social Security are often referred to as "payroll tax."

There are two other payroll taxes paid by the employer that must be accounted for. These are for state unemployment tax (SUTA) and Federal Unemployment Tax (FUTA). The tax is based on the wages of each employee along with other factors.

How Is Payroll Tax Calculated?

The payroll tax is calculated using the current tax rate. For example, last year's Social Security tax rate was 6.2 percent for employees. The Medicare tax rate was 1.45 percent. Employers had to match this and contribute 6.2 percent and 1.45 percent. The percentage rate applies to an employee's first $127,000 earned in a year.

The Medicare tax is 2.9 percent, with the employer paying 1.45 percent and the employer paying 1.45 percent. Medicare does not have a cap on wages that are subject to taxes.

Married employees earning more than $250,000 annually and filing jointly will pay an additional 0.9 in Medicare tax. If married and filing separately, the tax is based on earnings over $125,000. For everyone else, the tax is based on wages of more than $200,000.

Once an individual reaches $118,500 in annual wages, there will no longer be Social Security deductions for the employer or the employee. The wage figure is decided on a year-to-year basis. Contributions to Medicare continue no matter what the amount of the wages may be. 

What Is the Self-employment Tax Rate?

For those who are self-employed, federal payroll taxes must also be paid. These are paid in the way of a self-employment tax versus the FICA tax paid by employees. 

The Self-employment Contributions Act (SECA) tax rate is 15.3 percent, which applies to the first $127,000 earned. Of the $127,000, 2.9 percent is allocated to Medicare tax and 12.4 percent to Social Security tax. If an individual's wages exceed $127,000, only payment of the Medicare tax applies. 

Self-employed individuals who also draw a paycheck from an employer will see that the withheld payroll taxes are counted towards the wage limit for Social Security. An example would be an individual who earns $50,000 and fills out a W-2 form and earns $100,000 as a self-employed individual. In this case, the individual will only pay the Social Security tax on the first $77,000. When the two are combined, the figure equals the $127,000.

What Are the FICA Rates Set by Law?

The Federal Insurance Contributions Act (FICA) is responsible for the collection of Medicare payroll taxes and Social Security. In order for the rates to change requires new tax legislation. 

Self-employed individuals are required to pay both the employee and employer portions of Medicare and Social Security FICA taxes.

The 2017 share of the FICA rate for an employee was 7.65 percent and 7.65 percent for the employer. Self-employed individuals paid the rate of 15.30 percent for total wages.

What Are the Payroll Tax Limitations for 2017?

The following are a few of the tax limitations in effect for 2017.

  • The elective contribution limit for an employee participating in the Thrift Savings Plan, 457 plans, 403(b), and 401(k) is $18,000.
  • For employees ages 50 and older participating in the above-mentioned plans, the catch-up contribution is $6,000. Additional catch-up contributions for 50 and older individuals for an individual retirement arrangement is $1,000. 
  • The annual contribution limit to individual retirement arrangements is $5,500.
  • For defined contribution plans, the limit is $54,000.
  • $270,000 is the limit for annual compensation.

What Is the Purpose of the W-4 Form?

The W-4 form is filled out and signed by each employee. On it, the employee declares what their withholding will be. Employees can choose to pay more in withholding tax. For its part, the Internal Revenue Service provides the calculation used to tax those declarations. State tax calculations are similar and based on the tax board calculation for each individual state.

What Are the Benefits of Social Security and Medicare Tax?

Employers match the payroll tax paid by their employees for Medicare and Social Security taxes. Social Security serves as a benefit for those who retire, disabled individuals and their dependents, and dependents of retired workers.

Medicare tax funds are the medical benefits individuals receive once they turn 65 years old. The two taxes combined are known as the FICA tax (Federal Insurance Contributions Act.)

In the United States, approximately 171 million workers contributed to payroll taxes as of 2017. Payroll taxes were created so that current generations of workers would fund the Medicare and Social Security programs for current retirees. The next generation of workers would be in the position of funding the programs for those same workers who are funding the current group when they retire, and so on.

The programs are designed to work so that they will be beneficial to current and upcoming retirees. By using the combined payroll taxes collected by both Medicare and Social Security plus earned income on the monies in reserve, the funds should be sufficient to cover worker's benefits in any year. 

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