Payroll Tax

Payroll taxes are a type of tax taken out of workers' wages. Employers are required to withhold these taxes from their employees' paychecks and then turn the money over to state and federal tax agencies. The employer pays half of these taxes. Many companies hire outside payroll companies to calculate and withhold payroll taxes.

It's important to know whether the people who work for you count as employees or if they are independent contractors. Payroll taxes must be withheld for employees, while independent contractors are responsible for paying their own payroll taxes.

Federal payroll taxes

Federal payroll taxes include Social Security (or FICA, for Federal Insurance Contribution Act), Medicare, and Federal Unemployment (FUTA) tax. Social Security is the U.S. government program that provides income and benefits to retirees and disabled workers and their dependents. Medicare provides health-care coverage for workers and retired workers over age 65 and their spouses. Currently, the social security tax rate per paycheck is 6.2 percent, while the Medicare tax rate is 1.45 percent.

Social security is deducted only up to a certain limit of earned gross annual income: In 2008, it was $97,500, and the maximum tax withheld was $6,045. This figure changes from year to year. But after the cutoff amount has been earned, no more social security tax should be deducted from a worker's paycheck for the remainder of the year.

Payroll taxes for the self-employed

Self-employed people who make more than $400 per year pay self-employment tax on their own income, rather than having payroll taxes deducted from their paycheck. Self-employed people usually pay this tax in quarterly installments along with their estimated income tax. An accountant or tax-preparation software program can help self-employed people estimate how much combined payroll and income tax they owe for the coming year.

Note that the self-employed pay Medicare and social security payroll tax at a different rate from workers: 2.9 percent for Medicare and12.4 percent for social security.

State payroll taxes

States also deduct payroll taxes, usually to pay for state unemployment insurance and workers' compensation for injured workers. There may be limits to the amount of employee income on which these payroll taxes are assessed. Rates and rules vary from state to state.

Failure to pay payroll taxes

As an employer, if you fail to remit payroll taxes to the proper tax authority in a timely fashion, fines and penalties may be assessed, compounding the amount owed. Eventually, the IRS or state tax agency may place liens on your property or business as they seek to recover the money they are owed. The situation is similar if you are self-employed and fail to pay your self-employment tax.

Additional resources:

IRS: Payroll tax tutorial

PayrollTaxes.com: Links to state payroll tax information