What are Payroll Taxes?

Payroll taxes are federal and state taxes that are withheld from employees’ wages by their employers. This ensures that employees do not have to report, deposit, or calculate payroll taxes independently.

In this guide, we examine how payroll taxes work, the differences between them, and how they are paid.


How Payroll Taxes Work

Payroll taxes are federal taxes that are used to fund social programs within the US. These are funneled directly to the general fund of the US treasury.

Additional taxes can be imposed at a local or state level as well (in the form of local income taxes.). This can help fund local government services, including:

  • Health services
  • Infrastructure maintenance
  • Police departments
  • Education services and facilities

Employers are also required to pay unemployment taxes for every person that they employ, typically on both a federal and state level. This is because employers fund unemployment insurance funds should their employees require unemployment benefits.

Most payroll taxes are not progressive and are instead subject to an annual limit. This means that the rate that employers are required to pay will not be increased based on the profit that they generate annually. The exception to this rule is income tax. 

For example, any income that exceeded $142,800 was not subject to Social Security tax in 2021. This amount will be increased to $147,000 for 2022. Contrarily, progressive taxes increase the percentage of a person’s total income that is subjected to tax based on how much they earn. 

Another difference between income and all other payroll taxes is how they are used by local, state, and federal government agencies. Where the revenue generated from income taxes can be used by governments discretionarily, payroll taxes serve a specific purpose (i.e., to cover social costs).

Types of Payroll Taxes

Federal Income Tax

Employers are generally required to withhold federal income tax from their employees’ wages. Federal income tax is a progressive tax, meaning that it can vary significantly depending on the annual salary in question.

As exemptions can apply, make sure that you consider the Internal Revenue Service’s (IRS) withholding table, which is provided in Publication 15-T.

Social Security and Medicare Taxes

When it comes to Social Security and Medicare taxes, employers are generally required to:

  • Withhold part of their employees’ salaries
  • Contribute an equal amount of money towards their employees’ salaries 

According to the IRS, the current tax rate that employers are required to withhold from their employees’ wages is 6.2% for Social Security taxes. An additional 6.2% needs to be contributed individually by employers. 

The Medicare tax rate that needs to be withheld is 1.45%. Employers need to contribute an additional 1.45%. 

This means that the total amount withheld is:

    • 12.4% for Social Security
    • 2.9% for Medicare

For more information, check out Publication 15-A from the IRS.

Additional Medicare Tax

Additional Medicare Tax was introduced on January 1, 2013, and applies to employees' Medicare wages as soon as they exceed the threshold annual amount of $200,000. This is regardless of their filing status. 

When an employee’s wages exceed $200,000 in a calendar year, employers are required to withhold an additional 0.9% on the excess amount. Each employee’s threshold qualifying amount is based on their filing status:

  • Married filing jointly: $250,000
  • Married filing separately: $125,000
  • Single: $200,000
  • Head of household: $200,000
  • Qualifying widow(er) with dependent child: $200,000

Further instructions can be found on the IRS’ Form 8959 guidelines.

FUTA Tax

Most employers are required to pay both FUTA and state unemployment taxes. These cover the costs necessary to provide compensation to workers who become unemployed as a result of losing their jobs.

Unlike other payroll taxes, FUTA tax is not deducted from an employee’s annual wage; it is paid solely by employers. 

For more information, see the IRS’ Form 940 “About” section.

Self-Employment Tax

In essence, self-employment tax is the Social Security and Medicare tax that is paid by the individuals who work for themselves.

This includes:

  • Sole proprietorships
  • Independent contractors
  • Freelancers
  • Single-member LLCs
  • Partnerships

Rather than having an employer calculate them, self-employment taxes need to be calculated independently. This means that the employer portion (50%) is tax-deductible when determining each person’s taxable income. 

The self-employment tax rate is 15.3%. This consists of these two parts:

  • Social Security: 12.4% (6.2% of which is deductible)
  • Medicare: 2.9% (1.45% of which is deductible)

Just like with employees, the Social Security component of the self-employment tax rate is only applicable for the first $142,800 for 2021 and $147,000 for 2022.

You may also be eligible for the Earned Income Tax Credit (EITC). This assists low-income workers by offering them tax breaks. 

Keep in mind that you will not be required to pay any self-employment tax if:

  • Your net earnings from self-employment do not equate to or exceed $400.
  • You had a church employee annual income of less than $108.28.
  • You provide in-house services to the elderly and/or vulnerable (this can be situational) 

Readers should note that limitations on the amount of money that is subjected to payroll taxes are only present when it comes to Social Security tax. All other forms of employment taxes need to be paid regardless of a person’s annual income.

How to Pay Your Payroll Taxes

Employers are legally required to deposit and report their payroll taxes. The due dates and process for this can vary depending on the type of payroll tax.

Depositing Employment Taxes

Employers are required to deposit:

  • Federal income taxes
  • Social Security taxes
  • Medicare taxes
  • Additional Medicare taxes
  • FUTA taxes

There are two different deposit schedules, operating either biweekly or monthly. You will be required to determine which deposit schedule you will need to use at the beginning of your business’s calendar year. 

For more information on deposit schedules, see Publication 15 (Forms 941, 944, and 945) and Publication 51 (Form 943).

Keep in mind that all deposit payments must be made by electronic fund transfers through the Electronic Federal Tax Payment System (EFTPS).

Reporting Payroll Taxes

Generally speaking, Form 941 must be filed by employers at the end of each quarter to report:

  • Federal income taxes
  • Social Security taxes
  • Medicare and Additional Medicare taxes

This includes any withholding as a result of sick pay or unemployment benefits.

However, there are a few exceptions:

  • Agricultural workers: Form 943
  • Backup withholding: Form 945
  • Employers who have received written notification relating to the Form 944 program: Form 944

In addition to Form 641, FUTA taxes must be reported by filing Form 940

All of these tax forms can be filed electronically by using E-File on the IRS website.

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Frequently Asked Questions

Do I need to withhold Additional Medicare Tax from wages as soon as they exceed $200,000 if an employee’s threshold is higher?

Yes, even if your employee’s filing status means that their threshold is $250,000, you are still legally required to withhold Additional Medicare tax on any income that is over $200,000, according to the IRS. 

However, your employee will be able to claim this back on their individual tax returns.

What are regressive taxes?

Regressive taxes are any taxes whose rate does not rise as an individual’s or as a business’s income increases and are instead applied equally to everyone.

These include:

  • Social Security taxes
  • FUTA taxes
  • Medicare and Additional Medicare taxes
  • Corporation taxes (21%)

In comparison, progressive taxes rise as a person’s income increases. The most common example of a progressive tax is the federal income tax.

Are sole proprietorships tax-friendly?

Sole proprietorships benefit from what is known as “pass-through” taxation. This means that the owners of a sole proprietorship business are taxed on an individual level (personal tax returns), with no corporation tax.

This can make sole proprietorships beneficial as they are not taxed twice (unlike corporations).

Other “pass-through” taxation business structures include general partnerships, LLCs, and S corporations.

Having said that, it’s important to note that sole proprietorships do not receive the same number of tax write-offs that incorporated structures do (e.g., corporations, nonprofits, LLCs, etc.).

Can I register as an employee of my business?

You can, but only where that business is incorporated. This is because an incorporated status guarantees that your business is viewed as a separate legal entity to yourself.

This means that it can independently:

  • Accrue debt
  • Generate legal liability
  • Live perpetually
  • Hire employees

There are additional benefits to incorporating your business that you will want to consider. These include:

  • Increased funding opportunities
  • Limited personal liability
  • Easier business ownership transfers
  • Improved brand image

How can I incorporate my business?

Incorporating your business can be very simple, especially when relying on third-party incorporation services.

You will generally want to:

Keep in mind that corporations are subject to annual filing requirements. These will need to be satisfied in order to maintain your incorporation status. 

For more information, see our Corporation Filing Information guide.

What is the corporate income tax rate in the US?

As of January 2018, the corporate income tax rate in the US is 21%. This was reduced from 35% following the introduction of the Tax Cuts and Jobs Act.

Corporations may also have to pay additional corporate tax at a local or state level, but these are deductible and can vary significantly depending on the state. 

Corporations are also required to pay:

  • Estimated taxes
  • Employment taxes
  • Excises taxes

What is the best business structure for small businesses?

It is hard to name a “best” business structure because this will ultimately depend on:

  • Your managerial style
  • Your industry
  • The number of persons that you employee
  • Your future plans

Having said that, sole proprietorships and LLCs are the two most popular business entity structures for small businesses because they are:

  • Easy and affordable to create
  • Subject to almost no government scrutiny
  • Tax-friendly

Owners of LLCs additionally benefit from limited liability under the law, meaning that their personal assets are protected if their business happens to accrue significant debt or become insolvent in the future.