Understanding Payroll Taxes

Payroll taxes are the state and federal taxes that an employer is required to withhold and/or to pay on behalf of its employees. An Employer is also required to withhold social security and Medicare taxes from its employees' wages. The Social Security tax and Medicare tax are often referred to collectively as FICA taxes. This tax had its origins back in 1935 when the tax was part of the Social Security program.

What are FICA Taxes?
When the tax provisioning portion of the Social Security Act - Title VIII - was taken out of the program in 1939, it was placed into the Internal Revenue Tax code. At that time a more descriptive name than Title VIII was needed so the tax was renamed as the Federal Insurance Contributions Act or simply FICA. To this day, FICA remains the tax collection mechanism for Social Security.

FICA Tax Rates
Generally, FICA taxes are collected at a rate of 7.65% on gross earnings - earnings before any deductions. The breakdown of FICA is 6.2% for Social Security (Old-Age, Survivors, and Disability Insurance or OASDI) and 1.45% for Medicare. The following table shows the FICA limits for 2005, 2006, 2007 and 2008:

2005 FICA Tax and Social Security Limits
FICA Tax Rate = 7.65%
Social Security Earnings Limit = $90,000
Maximum Social Security Contribution = $5,580.00

2006 FICA Tax and Social Security Limits
FICA Tax Rate = 7.65%
Social Security Earnings Limit = $94,200
Maximum Social Security Contribution = $5,840.40

2007 FICA Tax and Social Security Limits
FICA Tax Rate = 7.65%
Social Security Limit = $97,500
Maximum Social Security Contribution = $6,045.00

2008 FICA Tax and Social Security Limits
FICA Tax Rate = 7.65%
Social Security Limit = $102,000
Maximum Social Security Contribution = $6,324.00

Employers are also required to pay a matching amount of social security and Medicare taxes for their employees and to pay State and Federal unemployment tax.
Each new employee completes IRS form W-4. Employers then use this form to calculate the amount of federal income tax to withhold from the employee's wages. Most of the states have income tax structures that are based on the federal system, so Employers use the W-4 to calculate the amount of state income tax to withhold as well.

Social security and Medicare taxes, also known as FICA taxes must be withheld from employees' wages. As an employer, you must also pay a matching amount of FICA taxes for your employees. Currently the social security tax rate is 6.2%. Employers are required to withhold 6.2% of an employee's wages for social security taxes and to pay a matching amount in social security taxes until the employee reaches the wage base for the year. The wage base for social security tax is $97,500 for the year 2007. Once that amount is earned, neither the employee or the employer owes any social security tax.

Overpayment of Social Security Taxes
If you work more than one job in any tax year and your earnings are in excess of $94,200 in 2006, or $97,500 in 2007, then you may have paid too much Social Security tax. This is because when you have more than one job in a year, each of your employers is required to withhold Social Security taxes on your wages. In this situation, you may then end up exceeding the maximum Social Security contribution limit. You can claim a refund on form 1040 when you file your personal income tax return with the Internal Revenue Service

The Medicare tax rate is 2.9% for the employee and the employer. Employer will withhold 1.45% of an employee's wages and pay a matching amount for Medicare tax. There is no wage base for the Medicare portion of the FICA tax. Both the employer and the employee continue to pay Medicare tax, no matter how much is earned.

The employer also must pay State and Federal Unemployment Taxes (SUTA and FUTA). The FUTA rate is 6.2 %, but you can take a credit of up to 5.4% for SUTA taxes that you pay. If you are eligible for the maximum credit your FUTA rate will be 0.8%. The wage base for FUTA is $7,000. You will stop paying FUTA for each employee once his or her wages exceed $7,000 for the year. You will need to check with your state about SUTA tax rates and the wage base. Generally, SUTA tax rate is based on the amount of unemployment claims that are filed by employees that employer have terminated. When your business is new, SUTA tax rate starts at the maximum and declines if you build a history of few claims.

For information on Federal payroll tax requirements, check out IRS publication 15, Circular E. For information on State payroll tax requirements, contact your state's taxation and revenue department.

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