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What Payroll Taxes Are Actually Used For

Posted December 4, 2019 by Marc Rosenberg in Keeping Compliant
We're here to help breakdown and explain what all of those payroll taxes actually mean.

In the immortal words of Rachel Green, “Who is FICA and why is he getting all my money?” Payroll taxes can be very confusing for employers and employees. Employees see them on paystubs and often have no idea where all that money is going (not in their wallets, that’s for sure). Let us help breakdown and explain what all of those details actually mean.

State Unemployment Insurance

SUI is a tax-funded program, required by both state and federal law, that pays unemployed workers while they are looking for work. States where you have employees generally will require you to establish a SUI account to remit state unemployment insurance taxes.

Related Article: How Does Unemployment Insurance Work?

Federal Unemployment Tax Act (FUTA)

On the federal level, employers also must pay an unemployment tax, called the Federal Unemployment Tax Act (FUTA). FUTA was created to help provide funds for those that have lost their job. FUTA is paid by the employer (i.e., not taken out of an employee’s paycheck) at a tax rate of 6.0% on the first $7,000 of earned income in a given work year. Once the limit is hit, the employer is no longer taxed on that given individual.

Federal Insurance Contributions Act (FICA)

FICA (or Federal Insurance Contributions Act) is a federal tax in the U.S. that must be paid by both employees and employers in order to fund both Social Security and Medicare (programs that benefit those who are retired, disabled, or children of deceased workers). This also helps to fund the nation’s healthcare system so that healthcare can be provided for workers that are unable to attain health insurance on their own.

Through FICA, 12.4% of employees’ income will be remitted to Social Security and 2.9% will go towards Medicare. In 2020, for Social Security, there is an annual taxable limit of $137,700. There is, however, no annual limit for Medicare, although the rate does change based on the amount of wages employees receive.

Employees are only required to contribute towards half (6.2%) of FICA and employers will contribute the other 6.2% for a total of 12.4%. As part of the Affordable Care Act, if employees earn over $200,000, they will be required to contribute a tax in the amount of .9% of compensation towards the additional Medicare tax.

Therefore, depending on an employee’s annual compensation, the Social Security and Medicare taxes can range from 7.65% (6.2 % for SS + 1.45% for Medicare) to 8.55% (6.2% for SS + 1.45% for Medicare + .9% for additional Medicare).

State Income Tax

Most states have their own income tax in addition to the federal income taxes. The rates will vary by state. When calculating yearly federal income taxes, typically state income tax is allowed as a deduction.

Local Income Tax

Local income tax will vary by employees and employers location and can be dependent on where employees work or live. For example, employees that earn income in New York City may be required to pay an additional New York City tax in addition to federal and state taxes. This may be the case for individuals that work in New York City, but live elsewhere.

Tax Withholdings

Any employer provided compensation (salary, bonuses, commission, gambling winnings) may have taxes withheld. These taxes are remitted to the IRS. Employers will withhold from paychecks based on employees’ Form W-4 (and applicable state tax forms).

Estimated Tax

Generally, estimated tax is used to pay tax on income that is not subject to withholding. It is commonly used for self-employment taxes,dividends, interest, capital gains, rent, and royalties.

Use Form W-4 to Verify Amount of Tax Withheld

As a note, the IRS plans to change the information on the Form W-4 effective January 1, 2020. The amount of income tax employers will withhold from a paycheck is dependent on two things: 1) employees’ compensation, and 2) the information employees complete on the employees’ Form W-4 (and applicable state tax forms).

Form W–4 includes information that employers will use to calculate withholdings, such as:

  • Employees’ marital status
  • Number of dependents
  • Whether employees want additional amounts withheld

How Do You File Payroll Taxes?

Now that employees may have a better idea of exactly where their money is going, we can make sure that it’s all going to the right place. If you’re a Justworks customer, we actually take care of all your payroll tax filings. Seriously. We know this is stressful stuff and it’s a lot to keep track of for all of your employees. Let us worry about it for you. We’ll handle all of your quarterly payroll tax filings and remittances.

To learn more, check out how Justworks can support you with your employment-related compliance needs.

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This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, legal or tax advice. If you have any legal or tax questions regarding this content or related issues, then you should consult with your professional legal or tax advisor.