What Is Payroll Tax & How Does It Work?

If you’re an employee, you’re probably used to getting a paycheck on a regular basis. If you’ve ever taken a deeper look into that paycheck, it’s likely you’ve been stumped. You may have asked yourself questions like, “Why is money being deducted from my income?” “Why do I pay that much in Social Security?” “What is payroll tax anyway?” 

Good news: We’re answering some of your most pressing questions to help you better understand what’s being taken out of your pay and how payroll taxes work.

What is payroll tax?

The payroll tax definition is fairly straightforward; it’s a tax imposed on employees and employers that helps fund:

• Social Security: A social insurance program that funds a range of different benefits types, like retirement, disability, and more. 
• Medicare: A healthcare program that provides health insurance for senior citizens and people with disabilities. 

For employees, payroll tax is split into two portions. Half of each employee’s payroll tax is paid by their employer, while the other half, known as FICA (Federal Insurance Contribution Act ) tax, is automatically withheld from each employee’s paycheck.

All qualifying income earners pay taxes, whether employed by an employer or self-employed, but it works a little differently for self-employed individuals. Instead of “payroll taxes,” self-employed individuals pay “self-employment tax,” which also contributes to Social Security and Medicare. If you’re self-employed, you calculate and pay all quarterly self-employment tax yourself.

How much is deducted from your paycheck for payroll tax?

Payroll taxes are a total of 15.3% of your income every year. As we mentioned, this burden is split between you and your employer. As an employee, you’ll pay 7.65% in payroll taxes each year, and your employer pays the other 7.65% 

Social Security tax is imposed on a wage-base limit. You and your employer each pay 6.2% in Social Security tax on the first $160,200 of your income for tax year 2023 and $168,600 for the 2024 tax year.

On the other hand, Medicare tax doesn’t have a wage-base limit. You each pay 1.45% in Medicare tax on your total income. Together, these percentages make up the 15.3% in payroll taxes.

If you make over $160,200 (2023 tax year) or $168,600 (2024 tax year) in the year, you may have noticed that your paychecks get larger toward the end of the year. That’s because you’ve hit your Social Security tax threshold and no longer need to pay Social Security taxes for the year. 

If you’re self-employed, you pay the entire 15.3%. That number may sound steep, but the good news is that the IRS allows you to deduct half the self-employment tax against your income for federal income tax purposes. Additionally, the 15.3% is calculated only on your net taxable income, rather than on your gross income.

State and local payroll taxes

In addition to federal taxes, each state has its own payroll taxes, too. These taxes are made up of unemployment tax, income tax, and sometimes even local taxes.

• Unemployment tax: These taxes fund temporary pay for people who are unemployed due to circumstances out of their control while they look for employment. 
• Local taxes: These are taxes imposed by cities or local jurisdictions like transit taxes, State Disability Insurance, and Employment Training Tax. 

Each state determines its own laws surrounding specific taxes, their percentages, and tax brackets: 

• Some states don’t require employees to pay income taxes.
• Some states have a single, flat rate for state income taxes, regardless of income.

Some states apply the flat rate to taxable income, whereas others apply it to gross income.

How to calculate payroll taxes

If you’re an employee, it’s unlikely that you’ll ever need to calculate your own payroll taxes. But if you’d like to double-check your employer’s work, or you’re simply curious about payroll taxation, here’s how to calculate your payroll tax: 

• Find your gross yearly pay: This is the total amount of money you make in a year before taxes.

• Multiply the applicable portion of your income by the percentage of each type of tax: Multiply your pay by 6.2% to find your Social Security tax amount and 1.45% for your Medicare tax amount. 
• Add these values together: This will give you your FICA, or the amount of your paycheck that goes to your taxes each year.

Let’s try an example. Say you make $80,000 each year: 

• $80,000 x 6.2% Social Security tax = $4,960
• $80,000 x 1.45% Medicare tax = $1,160
• $4,960 + $1,160 = $6,120 

Your employer will pay this same amount.

Note that there are a number of other factors that go into how much comes out of your paycheck each period. For instance, if any of your income comes in the form of a bonus, you’ll need to pay specific bonus taxes on that. 

Self-employed earners are responsible for the total 15.3% tax rate. Want to calculate your self-employment taxes? Use our self-employment tax calculator. 

Does the payroll tax rate ever change?

Generally, the Social Security and Medicare tax rate portions of payroll taxes have remained the same. However, there have been some occasions when rules around payroll taxes have changed temporarily, like when the Economic Recovery Act was voted into law as a part of an economic stimulus.

Employer vs. employee responsibilities 

As mentioned, employers and employees are each responsible for their respective halves of payroll tax. However, the responsibility falls on the shoulders of the employer to both pay their percentage and withhold each employee’s payroll taxation income. 

In the event that an employer fails to do so, they will be responsible for the consequences.

Filing and reporting payroll taxes

Unlike employees, employers are required to pay and file with the IRS multiple times a year. All employers must make federal tax deposits on a specific schedule. These deposits consist of all of the money they’ve withheld from each employee’s paycheck, also known as each employee’s FICA. The IRS designates the schedule for employers.

In addition, employers must file their taxes on a quarterly basis. Again, these requirements are specifically for employers. Employees are responsible for filing taxes once a year by April 15th. 

Don’t worry about knowing these tax laws. TurboTax will ask simple questions about you and give you the deductions and credits you’re eligible for based on your answers.

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