Payroll tax is the set of taxes triggered by paying wages for employment and measured as a percentage of those wages, rather than assessed on taxable income. At the federal level that means the Social Security and Medicare taxes under the Federal Insurance Contributions Act (FICA), which the employee and the employer each pay on the same wages, with one further Medicare charge the employee alone pays above a threshold, plus the federal unemployment tax the employer pays alone. State unemployment tax sits beside them under state law, and some states levy further wage-based charges of their own. Income tax withheld from the same paycheck is the employee’s own income tax collected at source, and it is not a payroll tax in the sense defined above.
What Sits Inside the Term, Tax by Tax
Each part of the term is a separate tax under its own imposing law, and the payers do not line up.
The Employee Tax Under Section 3101
In addition to other taxes, the Code imposes on the income of every individual a tax equal to 6.2 percent of the wages received with respect to employment, for old-age, survivors and disability insurance, and a further tax of 1.45 percent of the same wages for hospital insurance (26 U.S.C. 3101(a) and 3101(b)(1)). The employee owes both, but does not remit them: the tax imposed by section 3101 is collected by the employer of the taxpayer, by deducting the amount of the tax from the wages as and when paid (26 U.S.C. 3102(a)).
The old-age, survivors and disability insurance side stops at an annual cap on wages while the hospital insurance side does not, because the exclusion that creates that cap reaches only the taxes imposed by sections 3101(a) and 3111(a) (26 U.S.C. 3121(a)(1)). The cap itself, and the wage bases behind it, are worked through in gross wages.
The Employer’s Own Tax Under Section 3111
The employer’s charge is a separate tax on a separate taxpayer, not a share of the employee’s. The Code imposes on every employer an excise tax, with respect to having individuals in his employ, equal to 6.2 percent of the wages paid with respect to employment, and a second excise tax of 1.45 percent on those same wages (26 U.S.C. 3111(a) and 3111(b)). Nothing about it is deducted from anyone, which is why it stays outside the figure the employee is paid.
The Additional Medicare Tax Has No Employer Half
One FICA charge lands on the employee alone. The Code imposes on every taxpayer other than a corporation, estate or trust a tax equal to 0.9 percent of wages received with respect to employment above a threshold, being $250,000 on a joint return, half that amount for a married taxpayer filing a separate return, and $200,000 in any other case (26 U.S.C. 3101(b)(2)). There is no employer match for the Additional Medicare tax, and an employer must begin withholding it in the pay period in which it pays an employee wages in excess of $200,000 in a calendar year (IRS, Understanding Employment Taxes).
Federal Unemployment Tax Under Section 3301
Federal unemployment tax falls on the employer alone. The Code imposes on every employer, for each calendar year, an excise tax with respect to having individuals in his employ, equal to 6 percent of the total wages paid by that employer during the calendar year with respect to employment (26 U.S.C. 3301). Employees do not pay this tax or have it withheld from their pay (IRS, Understanding Employment Taxes).
Its base runs out early in the year. For the federal unemployment tax, wages exclude the part of the remuneration paid to an individual by an employer during a calendar year after $7,000 has already been paid to that individual by that employer (26 U.S.C. 3306(b)(1)).
State Unemployment Tax Is a Charge Under State Law
The state tax is imposed by a state’s own unemployment compensation law, not by the Code, which meets it chiefly as a credit: an employer may, to the extent the section allows, credit against the federal tax the contributions it paid into an unemployment fund maintained under the unemployment compensation law of a State that is certified as provided in section 3304 (26 U.S.C. 3302(a)(1)). What that credit leaves as a net federal rate, and the state rate stacked beside it, are priced in the offshore staffing cost calculator.
Income Tax Withholding Is Not a Payroll Tax
The tax an employer withholds for income tax comes from a different chapter of the Code and settles a different liability. Withholding is required of every employer making payment of wages, except as the section itself otherwise provides (26 U.S.C. 3402(a)(1)), and the amount withheld as tax under chapter 24 is then allowed to the recipient of the income as a credit against the tax imposed by the subtitle (26 U.S.C. 31(a)(1)). It is the employee’s own income tax, paid early, and the employer collects it rather than owing it.
The IRS bundles the two anyway. Its guidance for employers names federal income tax, Social Security tax, Medicare tax and federal unemployment tax together as examples of the federal employment taxes an employer must deposit and report, on returns including Form 941 and Form 940 (IRS, Understanding Employment Taxes).
The two terms are not interchangeable. Employment taxes is that administrative bundle, while payroll tax in the sense defined above is the subset that is a tax in its own right, measured on the wages, rather than the employee’s income tax collected in advance.
Payroll Tax and Self-Employment Tax Are Different Charges
Self-employment tax is the parallel charge outside employment. It is imposed for each taxable year on the self-employment income of every individual, not on wages paid by an employer (26 U.S.C. 1401(a)), so no employer matches it and nothing is withheld at source. Its rates sit beside the FICA pair in federal income tax liability.
A Worked Example: FICA on One Pay Period
Say an employee’s year-to-date wages sit well below both the old-age, survivors and disability insurance cap and the Additional Medicare Tax threshold, and the pay period’s only input is the wages paid.
INPUTS
Gross wages for the pay period 6,000.00
EMPLOYEE, 26 U.S.C. 3101
Old-age, survivors, disability 6.2% x 6,000.00 372.00
Hospital insurance 1.45% x 6,000.00 87.00
Employee total 459.00
EMPLOYER, 26 U.S.C. 3111
Old-age, survivors, disability 6.2% x 6,000.00 372.00
Hospital insurance 1.45% x 6,000.00 87.00
Employer total 459.00
COMBINED FICA ON THE PERIOD 918.00One wage figure produces two FICA totals, owed by two different taxpayers, and only the first is deducted from the employee. Any unemployment tax the employer owes on the same wages sits outside this figure.
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