Payroll Tax Rate: Everything You Need to Know

The payroll tax rate is the percentage of all employees' income that is withheld from their paychecks in order to fund the Social Security and Medicare programs. The current payroll tax rate is 15.3 percent, and employees pay half while employers pay the other half.

In simple terms, a payroll tax is for the benefit of a company's employees. It is based on their hourly wages or salary. Medicare and Social Security 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 and Income Tax?

The words "payroll tax" are often used when referring to all employment taxes, but this can be misleading as there are a few other types of employment taxes that don't count as payroll taxes, such as state and federal income taxes. Medicare and Social Security taxes, also called FICA taxes, are the two components of actual payroll taxes.

Two other taxes must be paid by employers each pay period. These are for State Unemployment Tax (SUTA) and Federal Unemployment Tax (FUTA). These taxes are 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, the Social Security tax rate for 2018 is 6.2 percent for employees; the Medicare tax rate is 1.45 percent. Employers must match this and contribute 6.2 percent and 1.45 percent, respectively. The percentage rate applies to an employee's first $128,400 earned in a year.

The total Medicare tax is 2.9 percent, with the employer paying 1.45 percent and the employee 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 $128,400 in annual wages, Social Security deductions will not apply to any wages above this amount for the employer or the employee. The wage cap is decided on a year-to-year basis. Medicare contributions apply 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 $128,400 earned. Of the first $128,400, 2.9 percent is allocated to Medicare tax and 12.4 percent to Social Security tax. However, self-employed taxpayers can deduct half of this 15.3 percent from their federal tax return.

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 as a W-2 employee and earns $100,000 as a self-employed individual. In this case, the individual will pay the Social Security tax only on the first $78,400 of their self-employment income. When the two are combined, the figure equals the $128,400.

What Are the FICA Rates Set by Law?

The Federal Insurance Contributions Act (FICA) is responsible for the collection of Medicare and Social Security payroll taxes. New legislation is required for the rates to change. 

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 2018?

The following are a few of the tax limitations in effect for 2018.

  • The elective contribution limit for an employee participating in the Thrift Savings Plan, 457 plans, 403(b), and 401(k) is $18,500.
  • For employees ages 50 and older participating in employer plans other than 401(k) and 401(p) SIMPLE, the catch-up contribution is $6,000. The catch-up contribution for 50 and older individuals who do participate in the 401(k) or 401(p) SIMPLE plans is $3,000.
  • The annual contribution limit to individual retirement arrangements is $5,500.
  • For defined contribution plans, the limit is $55,000.
  • $275,000 is the limit for annual compensation for qualified plans.

What Is the Purpose of the W-4 Form?

The W-4 form is filled out and signed by each employee to determine the amount of withholdings from their paychecks. Employees can choose to pay more in withholding tax to avoid a large tax bill for the year. 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 Taxes?

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 for both Medicare and Social Security plus earned income on the monies in reserve, the funds should be sufficient to cover worker's benefits in a given year.

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