Payroll tax is the tax withheld from employees’ wages and the taxes paid directly by employers based on employee earnings. Understanding payroll taxes is crucial for both business owners and employees to ensure compliance and accurate financial planning.

Payroll Tax Definition

Payroll tax is a type of employment tax calculated as a percentage of an employee’s wages and paid to the government to fund social programs. In the United States, this includes Social Security and Medicare taxes. These funds support retirement benefits, disability insurance, and healthcare coverage.

Payroll Tax Rate

The payroll tax rate depends on the type of tax and the employee’s income. In the U.S.:

• Social Security payroll tax: 12.4% of wages, split evenly between employer and employee (6.2% each).
• Medicare payroll tax: 2.9% of wages, split evenly (1.45% each), with an additional 0.9% surtax on high earners.
• Federal payroll tax: Generally includes Social Security and Medicare contributions collected at the federal level.
• State payroll tax: Varies by location and typically includes state income tax withholding, state unemployment insurance, and in some states, additional requirements like disability or paid family leave contributions.

These rates are updated periodically, so it’s important for employers and employees to stay informed.

Social Security Payroll Tax

The Social Security payroll tax funds retirement, disability, and survivor benefits. Both employers and employees contribute equally, ensuring that workers accumulate benefits based on their earnings.

Medicare Payroll Tax

The Medicare payroll tax supports the federal healthcare program for adults aged 65 and older. Like Social Security, this tax is split between employers and employees. High earners are subject to an additional Medicare surtax of 0.9%.

Federal Payroll Tax

Federal payroll taxes are the mandatory taxes that fund national programs like Social Security and Medicare. These taxes are collected by the IRS and are shared by both the employer and the employee. Employers withhold the employee portion directly from each paycheck and then contribute their own matching share.

Federal Payroll Tax vs Federal Income Tax

Federal payroll taxes are often confused with federal income tax, but they serve entirely different purposes. Federal payroll taxes fund social insurance programs, while federal income tax helps fund general government operations such as defense, infrastructure, education, and public services. Income tax withholding also varies based on the employee’s earnings, filing status, and personal tax elections—whereas payroll tax rates are fixed for most workers.

It’s important to note that federal payroll taxes are separate from both federal income tax and state payroll tax obligations. Even if an employee owes little or no federal income tax, payroll taxes still apply. Understanding this distinction ensures accurate withholding, cleaner payroll records, and fewer surprises during tax season.

The payroll tax includes two types of taxes: those that employers withhold from employees' wages and those paid by employers based on the employee's wage. In the United States, for instance, payroll taxes fund Social Security and Medicare.

The current (as of 2021) Social Security tax rate is 12.4%, split evenly between the employer and employee, and the Medicare tax is 2.9%, also split evenly. An additional Medicare surtax of 0.9% applies to high earners.

State Payroll Tax

State payroll taxes are a key part of year-end compliance, and because rules vary widely across states, it’s important to understand what applies to your team. Here’s a clear, scannable breakdown of what small businesses need to review before closing out the year.

State Income Tax Withholding (Most States)

If a state has income tax, employers must withhold the correct amount from each paycheck based on the employee’s work location and state forms.

• States with no income tax: Texas, Florida, Nevada, Washington, Wyoming, South Dakota, Alaska, Tennessee.

Everywhere else, correct withholding ensures accurate filings and prevents double taxation headaches for employees.

State Unemployment Insurance (SUTA/SUI) – Required in All States

All employers pay into their state’s unemployment program — even in no-income-tax states.

• Rates differ by industry, payroll size, and employer history.
• States assign new SUTA rates each year.
• Typically paid by the employer (with a few exceptions).

Additional State-Level Payroll Taxes (Varies by State)

Some states require extra payroll contributions, such as:

• State Disability Insurance: CA, NY, NJ, HI, RI
• Paid Family & Medical Leave (PFML): CA, NY, NJ, MA, CT, OR, WA, CO, RI, D.C.
• Local Wage or City Taxes: NYC local tax, Philadelphia wage tax, Ohio municipal taxes, and select cities in KY, PA, and MI
• Transit or Employment Taxes: Oregon statewide transit tax, SF/Oakland payroll tax, Seattle payroll expense tax

Why Payroll Taxes Matter

Payroll taxes are essential for funding government programs that provide financial security and healthcare benefits. They are also critical for businesses to maintain compliance and avoid penalties. Employers need to calculate payroll taxes accurately to ensure they are contributing the correct amounts on behalf of their employees.

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