Having employees is an amazing feeling. Learning the responsibilities of being an employer can be daunting, though. One responsibility you have once you hire employees is withholding taxes from their paychecks. For accurate withholding, learn how to calculate payroll taxes.
What are payroll taxes?
When you think of payroll taxes, you might think of all taxes you withhold from your employees’ paychecks. However, payroll taxes are just one type of employment tax. Payroll taxes include FICA (Federal Insurance Contribution Act) and self-employment taxes. Both self-employment and FICA taxes cover Social Security and Medicare taxes.
Most employers must calculate and withhold payroll taxes from their employees’ gross taxable wages.
Do you need to calculate self-employment taxes for yourself? Well, that depends on your type of business entity. Typically, if you do not receive a salary like your employees, you must pay self-employment taxes.
What are gross taxable wages?
Gross taxable wages describes the money your employee earns that is subject to income tax withholding and/or FICA tax. Taxable wages do not include non-taxable income or pre-tax deductions, such as expense reimbursements or Section 125 health insurance deductions.
For example, an employee earns $1,000 in gross wages but has an expense reimbursement of $200 and a health insurance deduction of $100. To calculate the gross taxable wages, subtract the health insurance deduction from the gross wages ($1,000 – $100 = $900). Do not add the expense reimbursement. The gross taxable wages are $900 (this is the amount you use to calculate the FICA tax on).
After you calculate all taxes on the gross taxable $900, add the $200 expense reimbursement. The $200 expense reimbursement increases the net wages you pay to the employee.
Income and unemployment: The other employment taxes
Now that you know FICA and self-employment taxes are payroll taxes, let’s take a brief look at income and unemployment taxes. Withhold income taxes from employee wages unless your employee is exempt from income taxes. The types of income taxes include:
- Federal income taxes
- State income taxes
- Local income taxes
Most states have state income taxes. If you’re in a state with state income tax withholding, collect state W-4 forms from your employees to determine the amount per paycheck. Remember to check with your local government to determine if you need to withhold local taxes from your employees.
Unemployment taxes are the other type of employment taxes you must pay. Unlike income taxes, employers typically pay unemployment taxes. The two types of unemployment taxes are:
Like payroll taxes, calculate your unemployment tax contributions based on your employees’ gross wages.
Keep in mind that income and unemployment taxes are not technically payroll taxes.
Calculating payroll taxes
Again, payroll taxes include FICA and self-employment taxes. Read on to learn tax rates for both types of payroll taxes.
FICA tax is an employee and employer-paid tax for Social Security and Medicare. Both you and your employee pay matching contributions.
The total employee contribution is 7.65%, and you pay a matching 7.65%. This FICA tax rate goes toward Social Security and Medicare taxes.
Social Security tax rate
Each employee pays a Social Security tax rate of 6.2%. You also pay a matching 6.2% for each employee. So if an employee’s gross taxable wages are $1,000 for the pay period, the employee pays $62, and you would pay $62.
The Social Security wage base is $160,200 for 2023. The wage base means that employees pay into Social Security taxes until their gross taxable earnings for the year reach the threshold.
After an employee earns $160,200 in 2023, stop withholding Social Security taxes from their paychecks. And, stop contributing the tax for that employee, too.
Medicare tax rate
The Medicare tax rate is 1.45% of each employee’s wages. You must also contribute a matching 1.45%.
There is no wage base limit for Medicare taxable wages. Instead, there is an additional Medicare tax of 0.9% after an employee earns a certain wage. This additional tax is based on their filing status:
- Single: $200,000
- Married filing jointly: $250,000
- Married filing separately: $125,000
If an employee earns above the threshold, calculate 1.45% plus the 0.9% additional Medicare tax. Employers do not contribute the additional Medicare tax.
Unlike FICA tax, employers and employees do not share the responsibility of self-employment tax. Instead, the employer is responsible for paying the total 15.3% toward Social Security and Medicare taxes. Self-employment tax is also known as the Self-Employment Contributions Act (SECA) tax.
Of the 15.3% total SECA tax, 12.4% goes to Social Security and 2.9% goes to Medicare tax. After you earn above the Social Security wage base, you do not need to pay the Social Security tax portion.
If your gross taxable wages exceed the additional Medicare tax threshold, you also need to pay the additional 0.9% for Medicare tax. The wages for the additional Medicare tax are the same for SECA as they are for FICA.
File Schedule SE to determine the amount of self-employment tax you should pay during the tax year. Attach IRS Schedule SE to Form 1040, U.S. Individual Income Tax Return.
Example of how to determine payroll taxes
Take a look at the following examples to understand how to calculate FICA and SECA payroll taxes.
FICA tax example 1
You are a sole proprietor with three employees: Employee A, B, and C. Employees get paid on a biweekly basis. Below is the amount of each employee’s gross wages.
To determine each employee’s FICA tax liability, multiply their gross wages by 7.65%, as seen below. These are the amounts you withhold from employee wages and send to the IRS.
|Employee||FICA Tax Liability|
|Employee A||$1,500 X 0.0765 = $114.75|
|Employee B||$1,200.00 X 0.0765 = $91.80|
|Employee C||$2,000.00 X 0.0765 = $153.00|
Now, onto calculating payroll taxes for employers. You need to match each employee’s FICA tax liability.
- Employer FICA Tax Liability Total | $114.75 + $91.80 + $153.00 = $359.55
You owe $359.55 per pay period to cover the employer portions of FICA tax. Continue paying this amount until employee wages change. These employees do not earn above the Social Security wage base limit.
FICA tax example 2
This example is for a highly compensated employee, Employee D, who is your only employee. Employee D earns $10,000 biweekly, and their filing status is single.
Here is how much to withhold and send to the IRS for Employee D’s FICA tax.
- Employee D | $10,000 X 0.0765 = $765.00
Now, take a look at your FICA tax liability. Because Employee D is your only employee in this example, your FICA contribution matches Employee D’s FICA tax.
- Employer FICA Tax Liability Total | $10,000 X 0.0765 = $765.00
Continue paying this amount until Employee D’s wages change or they earn above the Social Security wage base.
Take a look at how FICA works once the employee earns above $200,000. You no longer withhold or contribute Social Security tax. Add the regular Medicare tax rate (1.45%) to the additional Medicare tax rate (0.9%). Withhold a total of 2.35% for Medicare.
This is how much to withhold from Employee D’s wages for FICA.
- Employee D | $10,000 X 0.0235 = $235.00
Withhold $235.00 from Employee D’s wages for the Medicare and additional Medicare taxes. Continue to contribute only 1.45% of Employee D’s wages.
- Employer FICA Tax Liability Total | $10,000 X 0.0145 = $145.00
The employer contribution is $145.00, but Employee D’s withholding for Medicare is $235.00.
SECA tax example
For self-employment tax, we’ll use a simple example. You earn $198,000 in 2023. Only apply the Social Security tax (12.4%) up to $160,200.
Let’s determine your Social Security tax liability on your first $160,200. Social Security is 12.4% of your wages up to the wage base.
- Employer SECA Tax Liability (Social Security) | $160,200 X 0.124 = $19,864.80
Now, determine your Medicare tax liability on your wages. Medicare tax for SECA is 2.9%.
- Employer SECA Tax Liability (Medicare) | $198,000 X 0.029 = $5,742.00
Since you do not earn above $200,000, you do not need to worry about the additional Medicare tax.
Your total SECA tax liability for 2023 would be $25,606.80 ($19,864.80 + $5,742.00).
This article has been updated from its original publication date of July 3, 2017.This is not intended as legal advice; for more information, please click here.