Home Payroll Tax Understanding the Purpose of Payroll Taxes

Understanding the Purpose of Payroll Taxes

Understanding the Purpose of Payroll Taxes

Payroll taxes are taxes that are levied upon workers’ earnings and are typically used to fund social security programs, unemployment compensation, and Medicare. These taxes can be a confusing topic for many people, and it is important to understand their purpose and how they are used. In this article, we will provide a detailed overview of payroll taxes, their purpose, how they are calculated, and their impact on businesses and employees.

What are Payroll Taxes?

Payroll taxes are taxes that are collected from employers and employees and are used to fund specific government programs. Employers are responsible for withholding certain taxes from their employees’ paychecks and then remitting them to the government on a regular basis. The most common payroll taxes include social security taxes, Medicare taxes, and federal and state income taxes.

Social Security Taxes

Social security taxes are a type of payroll tax that is used to fund Social Security and Medicare programs for retirees, disabled individuals, and their families. This tax is split evenly between employers and employees, with each contributing 6.2% of the employee’s wages. The tax is only applied to the first $142,800 of an individual’s earnings for the year, as of 2021. Once an individual’s earnings exceed this amount, they are no longer subject to this tax.

Medicare Taxes

Medicare taxes are another type of payroll tax that is used to fund healthcare services for individuals over the age of 65, as well as for people with certain disabilities. These taxes are also split between employers and employees, with each contributing 1.45% of the employee’s wages. As with social security taxes, there is a cap on the amount of earnings subject to Medicare taxes. As of 2021, this cap is set at $142,800.

Federal and State Income Taxes

In addition to social security and Medicare taxes, employers are also responsible for withholding federal and state income taxes from their employees’ paychecks. These taxes are based on the employee’s earnings as well as their filing status, number of dependents, and any deductions or credits they may be eligible for. State income taxes may vary depending on the state in which the employee lives and works.

Why are Payroll Taxes Important?

Payroll taxes play a critical role in funding essential government services and programs. Social security taxes, for example, fund retirement benefits for millions of Americans. Medicare taxes help to ensure that seniors and individuals with disabilities have access to affordable healthcare. Without these taxes, these programs would not be able to function effectively.

Payroll taxes also help to ensure that workers have access to critical safety net programs in case they lose their jobs or become disabled. Unemployment compensation, for example, provides temporary income support to workers who have been laid off or who have lost their jobs due to economic conditions. Without these benefits, many workers would be left without a safety net and could face financial hardship.

How are Payroll Taxes Calculated?

Payroll taxes are calculated based on the amount of an employee’s earnings. Employers are required to withhold a certain percentage of the employee’s wages for social security and Medicare taxes. The amount of federal and state income taxes withheld will depend on the employee’s taxable income, tax bracket, and any deductions or credits they may be eligible for.

To calculate the amount of social security and Medicare taxes to be withheld, employers will need to reference the IRS Employer’s Tax Guide. This guide includes tables that provide the percentage of each tax that should be withheld based on the employee’s earnings. Employers can also use online calculators to help them determine the correct amount of taxes to withhold from each employee’s paycheck.

How do Payroll Taxes Impact Businesses and Employees?

Payroll taxes can have a significant impact on both businesses and employees. For businesses, payroll taxes can add a significant amount of administrative burden and cost. Employers are responsible for accurately withholding and remitting taxes on a regular basis, which can be time-consuming and resource-intensive. Employers must also keep track of changes to tax laws and regulations in order to ensure that they are compliant with all applicable requirements.

For employees, payroll taxes can impact the amount of their take-home pay. Depending on their filing status and other factors, employees may see a significant amount of their earnings withheld for social security, Medicare, and federal and state income taxes. However, these taxes also provide the benefits and safety net programs discussed earlier, which can be critical for workers and their families.

Recent Developments in Payroll Taxes

In recent years, there have been a number of developments in payroll taxes that impact both employers and employees. One of the most significant changes occurred in 2020, with the passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. This legislation provided a number of economic relief measures to individuals and businesses impacted by the COVID-19 pandemic.

One of the key provisions of the CARES Act was the deferral of employer portion of social security taxes for the period from March 27, 2020, through December 31, 2020. This deferral allows businesses to delay paying their share of social security taxes, which can provide temporary relief for employers facing financial difficulties due to the pandemic. However, this deferral is temporary and businesses will be required to pay these taxes at a later date.

In addition to the CARES Act, there have been several other changes to payroll taxes in recent years. For example, the Tax Cuts and Jobs Act of 2017 made a number of changes to the tax code, including lowering the corporate tax rate and increasing the standard deduction for individuals. These changes have impacted payroll taxes for both businesses and employees.


Payroll taxes are a critical component of the tax system and play a vital role in funding social security, Medicare, and other safety net programs. While payroll taxes can be complex and confusing, it is important for both employers and employees to understand their purpose and how they are calculated. With accurate and timely payroll tax withholding and remitting, businesses can ensure compliance, while individuals can access the benefits they need to maintain their financial security.

Payroll taxes 

FICA, the Federal Insurance Contributions Act, is an employment tax enacted on all employees and employers that conduct business in the United States.  These taxes cover funds for Social Security and Medicare.

The deductions determined using a payroll tax calculator allow for coverage of unemployment benefits and disability benefits. Employer payroll taxes are usually broken down so that employees can see where there deductions are going.  Some states do not require employers to give a pay stub to employees, but that information is available at the end of the year through a variety of tax forms provided by employers.

The payroll tax calculator utilized by employers allows employees to see how much they have contributed to Social Security. In fact, all taxpayers receive a form from the government that shows what their lifetime contributions to Social Security have been.  That tax contribution is directly correlated with the amount an employee can expect to receive through Social Security upon retirement or disability. A taxpayer can see exactly where they stand financially for retirement, by analyzing their payroll tax calculator estimates for each year.

Employer payroll taxes are utilized to cover many governmental expenses. Many of those expenses are directly related to employees, such as Social Security. However, the government has discretion with other types of taxes. Congress is allowed to utilize tax revenue to fund a variety of programs. For example, income taxes are used in any way that Congress sees fit. The only requirement is that tax revenue be spent for the good of the public. Whereas

FICA taxes are utilized to directly benefit the employee. An employee may utilize their Social Security payments when they retire or should they become disabled. In addition, FICA helps to fund unemployment insurance and Medicare. Employer payroll taxes allow employees and employers to plan for their financial future.