Updated: Sep 7, 2019
The government taxes your wages to fund federal social insurance programs. Since your employer is responsible for paying and tracking this tax on your wages, these taxes are commonly referred to as "payroll taxes." According to the Tax Foundation, payroll tax revenue is the second largest source of government revenue in the United States.
On your paycheck, these taxes might show up under the acronym FICA. FICA stands for Federal Insurance Contribution Act. The FICA tax is different from the income tax - it is an additional 15.3% of tax levied on wages to fund the government's Social Security and Medicare programs. A portion of the FICA is a Social Security tax, the remainder is a Medicare tax.
SOCIAL SECURITY TAX
Social Security benefits provide income to the retired and disabled. Almost all of us contribute to this fund via the Social Security Tax. The Social Security Tax is a 12.4% tax on wages up to a maximum wage of $132,900. On an employee's paycheck, this tax withholding might show up as Old Age, Survivors and Disability Insurance (OASDI). For employees, 6.2% is withheld from wages. Employers pay the other 6.2%. Self-employed individuals pay the full 12.4% tax on yearly wages.
Note, the maximum wage is adjusted on a yearly basis. The $132,900 maximum wage is applicable for 2019.
Medicare is hospital insurance - and almost EVERYONE with a (legal) job pays into this fund. The Medicare Tax is 2.9%. For employees, 1.45% of this tax is pulled out of your paycheck every year. Your employer pays the other half. Self-employed taxpayers must pay in the full 2.9% every year (if net earnings were greater than $400). Individuals who make over the maximum wage threshold of $132,900 are taxed an additional 0.9%
Together, the Social Security tax and Medicare tax make up Self-Employment Taxes. Self-Employment Taxes are paid on any income from a trade or business. As mentioned earlier, self-employed individuals pay the the full 15.3% FICA tax on self-employed income in addition to income tax. If self-employment taxes and/or income tax is expected to be greater than $1,000, the self-employed individual is required to make quarterly estimated tax payments.
Self-employed individuals can deduct the employer-equivalent portion of their self-employment tax in figuring adjusted gross income. This deduction only affects income tax. It does not affect net earnings from self-employment or self-employment tax.
It is important to consider federal and state payroll taxes when projecting wage or business income. Late or unpaid payroll, self-employment, or income taxes will incur an IRS penalty. If you have additional questions on payroll taxes, please contact me for information.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.