Payroll taxes are a crucial part of social insurance programs that provide income to retirees, people with disabilities and their families.

They’re also a big part of how much money the government raises each year.

Employers’ responsibilities include withholding federal payroll taxes, depositing them and reporting payroll activities. It’s important to understand these responsibilities so that you can keep your business running smoothly.
Social Security

The employer portion of payroll taxes is the Social Security tax that employers withhold and remit on behalf of employees. This tax is part of the Federal Insurance Contributions Act (FICA), a federal law that requires businesses to withhold a certain percentage of employees’ wages to pay for Social Security and Medicare.

The Social Security system provides benefits to workers who retire or become disabled, their spouses, and surviving children. It is administered by the Social Security Administration (SSA).

Employees and employers both contribute to the Social Security program, which is called the Old-Age, Survivors and Disability Insurance (OASDI) system. Unlike company pensions, which are "pre-funded," Social Security is a “pay-as-you-go” system that uses payroll taxes collected today to fund future benefits paid out to beneficiaries.

Employers and employees each withhold and remit 6.2% of an employee’s gross wages for Social Security taxes. Those funds are then deposited into a government trust fund. The amount of taxable wages is determined by an annual maximum wage base that changes each year.

For example, for 2023, the maximum wage base is $147,000, which means that each party pays 6.2% of an employee’s earnings up to this limit and 1.45% on earnings beyond this limit. The combined employer and employee tax rate is 15.3% of an employee’s total wages, which includes both the 6.2 percent Social Security tax and the 1.45% Medicare tax.

Individuals who work as self-employed individuals also must pay a portion of these Social Security and Medicare taxes through the Self-Employment Contributions Act (SECA). This individual tax is a combination of both the employer and employee portions of the FICA tax.

The SSA pays out retirement and survivors' benefits to people who have reached full retirement age, usually 65 years or older. The benefits are based on the average indexed monthly earnings during your 35 highest-earning years.
Medicare

Medicare is a program that provides health care to older adults. It is funded by a combination of a payroll tax, premiums for Part B, and surtaxes from beneficiaries, as well as a general government revenue source.

When you are an employee, you pay 6.2 percent of your applicable earnings in Social Security taxes and 1.45 percent on your Medicare-taxable wages. Your employer also contributes an equal amount to the two taxes. This tax is grouped together under the Federal Insurance Contributions Act (FICA).

In addition, the Affordable Care Act (ACA) created a 0.9% additional Medicare surtax that you must withhold on an employee’s wages once their wages exceed $200,000 per year, regardless of their filing status. There is no employer matching required with this additional Medicare tax, so it is entirely the responsibility of the employee to pay it.

The ACA also created a 3.8% Unearned Income Medicare Contribution Surtax that applies to income earned in the form of dividends, interest, capital gains, passive income, annuities and royalties. This is a new tax that was added to help fund the ACA.

Another ACA change is the elimination of the federal alternative minimum tax (AMT). This was a tax designed to protect lower-income workers from being hit with an AMT penalty.

If you earn less than $250,000 in 2022, you don’t have to pay the 0.9 percent Medicare surtax. However, if you earn more than $200,000 in 2022, you do have to withhold the Medicare surtax on any wages over $200,000.

You can’t opt out of paying this tax or ask for a refund if you have made mistakes withheld from your pay. You must contact your employer if you are unsure if you have paid Medicare taxes or if you have any questions about the tax.

Once you’ve reached age 65, you’ll qualify for Medicare and be able to buy either a Part A or a Part B plan that covers your hospitalization costs. You can also opt for Medicare Advantage, which is a managed care program.

The IRS has a number of resources available to help you learn more about the Medicare and Social Security taxes. You can visit their website or contact the IRS to get a free consultation.
Federal Unemployment Tax

If you have employees, you will probably have to pay Federal Unemployment Tax (FUTA) and State Unemployment Taxes (SUTA). This is a payroll tax that funds unemployment insurance benefits.

The FUTA tax covers a number of programs, including unemployment insurance (UI) and job service program administration costs. It also pays one-half the cost of extended UI benefits during periods of high unemployment and provides federal loans to states that have depleted their unemployment benefit accounts.

You are responsible for FUTA taxes if you are an employer with at least one employee who worked at least 20 weeks out of the year or who paid at least $1,500 in wages during any quarter. You are also required to file Form 940, which is an annual tax return used to figure the FUTA tax based on your business's payroll.

There are several ways to reduce the amount of your FUTA tax. For example, you can take a credit against your FUTA tax for the state unemployment taxes that you pay on time and before the due date of your FUTA return. You can also claim a credit of up to 5.4% of your gross FUTA tax, effectively reducing the FUTA tax rate from 6.0% to 0.6% for most businesses.

However, there is a caveat to this credit reduction. In addition, some states have not repaid the money they borrowed from the federal government to pay for their unemployment insurance benefits, so a portion of this 5.4% credit is lost in these states.

Therefore, if your business has employees in some of these states, it's best to make sure you pay your state unemployment taxes on time and in full. This can be done by filing a form called Form 940, which is required of all employers with at least one employee.

In most cases, you can claim a credit for the state unemployment tax you pay as an employer against your gross FUTA tax. This can effectively lower your FUTA tax rate from 6.0% to a more reasonable 0.6% of your employee's earnings.

To find out whether your company is subject to a credit reduction for the state unemployment tax you pay, check with your local or regional IRS office. They can provide you with the necessary information to complete your Form 940, or you can contact the SUTA office in your state for more details.
State Unemployment Insurance

State Unemployment Insurance is a state-run program that provides benefits to workers who lose their jobs through no fault of their own. UI is financed by federal and state taxes on employers.

Like the Federal Unemployment Tax Act (FUTA), state UI tax rates are based on a number of factors. These include the amount of wages an employer pays to employees, the taxable wage base and the experience rating system used by state unemployment agencies.

The size of the state's UI fund is also an important factor. Collections of UI taxes are deposited into the state's UI trust fund and paid to former employees as a part of their unemployment insurance benefits. In 2021, New York's UI fund balance was $28 billion, a figure that continues to increase each year.

When states have exhausted their UI funds, they can borrow from the federal government to pay for unemployment benefits. However, the interest on the loan must be paid back within two to three years. If the state does not repay the debt, federal tax rates on employers will automatically increase until it is paid.

Benefits are usually capped at a percentage of an individual's prior earnings, up to a maximum. Some states provide additional weeks of UI benefits to cover periods of high unemployment.

In most states, UI replacement rates range from 30 to 50 percent of previous wages, with higher amounts for lower-income workers. Most programs pay benefits for up to 26 weeks. employer

Employers may choose the "reimbursement" method of paying UI taxes, in which they reimburse the state for all UI benefits charged to their account. If an employer chooses this option, they must notify the state division no later than December 1.

Regardless of their method, employers must be aware of their UI tax liabilities and make sure they comply with all laws and regulations. Businesses that commit fraud, misclassify employees as independent contractors or set up fictitious employer accounts to avoid state unemployment taxes can face serious penalties and fines.

In addition to UI, the federal government also provides benefits to workers who lose their jobs due to natural disasters or other catastrophic events. These benefits are called Disaster Unemployment Assistance (DUA) and are administered by the Department of Labor.