Before you even get your hands on your paycheck, a lot of the money you earned has already been spent—on taxes. This is because employers have a legal obligation to collect payroll taxes for the government.
Understanding what a payroll tax is can help you understand the system and identify better ways to manage your tax planning.
What is payroll tax?
Employers collect payroll taxes to pay for the Medicare and Social Security programs. The payroll taxes for Social Security and Medicare are known as Federal Insurance Contribution Act (FICA) taxes. They fund your contributions to qualify for the 2 major benefit programs.
Don’t get these confused with federal, state, and local income tax withholding. Income tax is withheld from an employee’s paycheck to cover their income taxes. The amount of income tax that is withheld is specific to the amount of income you earn and the deductions you plan to claim. When you start a job, your employer’s payroll/HR department will have you fill out Form W-4, known as the Employee’s Withholding Certificate.
How much is payroll tax?
Social Security: The Social Security tax rate is 12.4% but is split between employees and employers. You, as the employee, owe 6.2% of your pay for Social Security taxes. Social Security taxes only apply to income up to a certain level. In 2024, the limit is $168,600, which tops out at $10,453.20 for your portion of payroll taxes. If you earn over $168,600, payroll will not collect Social Security taxes beyond this limit.
Medicare: Your payroll taxes also cover Medicare. Once again, this tax is split between you and your employer. It’s 1.45% each, for a total of 2.90%. Medicare payroll taxes apply to all your earnings. What’s more, if you earn more than $200,000, an additional 0.9% surcharge is added to any amount over this limit, which your employer does not match.
How to calculate payroll taxes
If you’re wondering how payroll taxes might affect your paycheck, there’s a straightforward way to find out. The combined Social Security and Medicare tax rate for employees is 7.65% (6.2% for Social Security and 1.45% for Medicare.) To calculate your payroll taxes, multiply your gross income by 7.65%.
Tip: If it supports your financial goals and situation, you can save on payroll taxes by reducing income subject to Social Security and Medicare taxes with contributions to a health savings account (HSA) or flexible spending account (FSA). But there’s a catch, the contributions must be made through payroll deductions, like 401(k) contributions.
An HSA is a tax-advantaged account you can use with an HSA-eligible health plan to pay for qualified medical expenses. They come with a triple-tax advantage:1
- Tax-free (or tax-deductible) contributions
- Tax-free earnings growth
- Tax-free withdrawals for qualified medical expenses
An FSA is an account offered as a benefit by employers that you can use to pay qualified expenses. Though you can’t contribute to an HSA and a health care FSA in the same year, there are other types of FSAs that may be offered including the limited purpose FSA which can be used for qualified dental and vision expenses.
Read Smart Money(SM): HSA vs. FSA: Which is right for you?
Contributions to HSAs and FSAs are made pre-tax, including FICA payroll taxes, when made through your employer. If the contributions to an HSA are made on your own, they are deductible—you can get a refund at tax time but will still pay FICA taxes. (Contributions to FSAs can only be made through employers.)
Saving on taxes can help boost cash flow and help you save for other goals now. But do keep in mind that paying less to Social Security could lower your benefit in retirement.
How do payroll taxes work?
FICA taxes, the payroll taxes that nearly everyone in the US pays, fund the Social Security and Medicare programs. The Social Security Administration estimates that 183 million people paid payroll taxes on earnings covered by Social Security in 2023.2
Social Security includes Old-Age, Survivors, and Disability Insurance programs so not only does it provide benefits to retirees, it also helps children and people who have been disabled. At the end of 2023, about 67 million people were receiving benefits from the Old-Age, Survivors, and Disability Insurance (OASDI) program of Social Security.3
The Medicare program provides health insurance for people over age 65, for some people who are disabled, and people with end stage renal disease. About 67 million people were enrolled in Medicare as of January 2024.4
How payroll taxes may affect you
Employees
Payroll taxes fund your future Social Security and Medicare retirement benefits, along with your income taxes. Generally, the more you pay into Social Security, the more you will receive in retirement.
Self-employed workers and contractors
People who are self-employed or working as independent contractors are responsible for paying payroll taxes along with income taxes. You must figure out how much you owe the government during the year and submit FICA taxes with these estimated taxes quarterly: April 15, June 15, September 15, and January 15.
As a self-employed worker, you are both the employer and employee—so you must cover the full share of Social Security and Medicare taxes, 12.4% and 2.9%, respectively. Some high earners are subject to an additional 0.9% Medicare tax. The income thresholds are $200,000 for single filers and $250,000 for those who are married and filing jointly.
Visit IRS.gov for more information.
Paying 15.3% tax on top of income taxes sounds like a lot but there is a silver lining. You can deduct half (the employer’s portion) of the tax as a business expense. These tax tips for the self-employed can help you get prepared.