What is payroll tax?

Editor’s Note: The following post outlines general definitions and concepts for payroll taxes. Review information about the 2020 payroll tax deferral, which pertains only to the Social Security portion of these taxes.

If you earn a wage, you’re probably wondering: “What is payroll tax?” This article will discuss IRS payroll tax, including who pays, how payments are made, and how much to pay.

What is payroll tax?

Payroll tax is withheld from employees’ wages by their employer. Payroll tax includes three main components:

• Federal income tax withholding
• The employee’s portion of Medicare tax
• The employee’s portion of Social Security tax

How does payroll tax work?

Payroll tax is taken out of an employee’s earnings. Employers then send the withheld taxes along with their portion of Social Security and Medicare taxes when they deposit taxes.

As an individual tax filer, you don’t have to manually pay in payroll tax from each paycheck. Your employer will do this for you.

How much is payroll tax?

Federal income tax withholding can be 0% or higher depending on your W-4 withholdings. (You can use our W-4 calculator to determine withholding amounts.)

Social Security and Medicare is 7.65% for the employee portion withheld from their gross pay and the employer also pays 7.65% for their portion when they deposit the employee’s portion (6.2% is Social Security and 1.45% is Medicare.)

The total Social Security tax rate in 2020 is 12.4%. If you are an employee, you are only responsible for paying 6.2% of your paycheck and your employer pays the other half. If you are self-employed, you are responsible for the full amount.

What are wage limits for payroll tax?

For earnings in 2020, this wage base limit is $137,700. So, if you earn that amount with one employer, your payroll taxes cap at that amount. If you have more than one employer and you earn more than that amount, you’ll claim an adjustment of any overpaid Social Security taxes on your return.

There is no wage-based limit for Medicare tax. All covered wages are subject to Medicare tax. But, if you receive wages over $200,000 a year, your employer must withhold a .9% additional Medicare tax. This will apply to the wages over $200,000. This is on top of the 1.45% employer tax rate.

If you’re married, you might not have enough Medicare taxes withheld. If you’re married filing jointly with earned income over $250,000, you’re subject to an additional tax. This also applies to married filing separately if your income is over $125,000. You can cover additional Medicare taxes by adjusting your withholdings or making estimated tax payments.

Payroll taxes for small businesses, including CARES Act payroll tax breaks and the payroll tax credit

If you are self-employed or an employer, your tax considerations are different from an individual taxpayer’s. As such, you should read up on small business taxes.

According to the IRS, a qualified small business may elect to claim up to $250,000 of its credit for increasing research activities as a payroll tax credit against the employer’s share of social security tax.

This payroll tax credit must be elected on an original income tax return that is timely filed (including extensions). When can you apply for this? The portion of the credit used against the employer’s share of Social Security tax is permitted in the first quarter beginning after the date the business filed its income tax return.

The election and determination of the credit is calculated and assessed on IRS Form 6765, Credit for Increasing Research Activities. The amount from Form 6765, line 44, must then be reported on Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. Form 8974 is used to determine the amount of the credit that can be used in the current quarter. For more information on the Payroll Tax Credit, visit IRS.gov/ResearchPayrollTC.

Another recently passed tax law that impacts businesses is the CARES Act, an act that has provisioned and created new tax laws that benefit U.S. small businesses during Coronavirus. There are multiple tax credits that benefit small businesses, including the Payroll Tax Postponement (otherwise known as a deferral of employment taxes) and the Employee Retention Credit. Self-employed taxpayers are eligible for deferrals as well.

Need more tax help with IRS payroll tax?

Whether you need help figuring out your withholding for IRS payroll tax, or you are looking for tax guidance as a small business, we can help! With multiple ways to file your taxes, we make sure your tax outcome is optimized, earning you every tax credit and deduction you are entitled to.