Payroll Taxes: What are These and Why Do We Pay Them?
Payroll Taxes: What are These and Why Do We Pay Them?
Payroll taxes are taxes assessed on both the employee and the employer on each employee. They may be a federal payroll tax or a state and/or local payroll tax.
Why do we pay payroll taxes? Payroll taxes are a way for the various governments: federal, state, and even some localities or municipalities, to assess and collect tax dollars from their residents.
Remember: government is not in the money making business, they are in the money taking business.
As an employee, what do I pay in payroll taxes? Let’s start with the basics. If you are not a teacher or do not belong to other unions that have their own retirement plans (including some governmental workers), then you pay the following: federal withholding tax, state withholding tax if your state assesses a state income tax, local or municipal tax if your city or village assesses a tax (think NYC), social security tax and medicare tax.
All of these taxes, in addition to any optional withholdings you may elect to have taken from your paycheck (retirement plan, additional tax withholdings), are taken from your gross salary and leave you with your take home pay.
Your federal, state and local withholdings are your responsibility to pay. Your employer only withholds them on your behalf and remits the payments on your behalf. You are the person truly responsible to make sure that you have paid in your taxes to the government. If the government finds out you never remitted any tax payments and you claim your employer did it for you but they never got it, you are still responsible for paying those tax burdens.
Employers withhold and remit tax payments as a courtesy to their employees, not because they are mandated to do it. They file the forms on your behalf, they remit the payments on your behalf, but they do not bear the responsibility for paying the taxes in your name at the end of the day. Your employer is not obligated to do this for you, although almost all do.
Social security and medicare taxes are a different thing altogether. Social security was enacted as a retirement plan for the elderly. When social security was enacted by FDR in 1935, life expectancy was approximately age 65, assuming you survived childhood. It was therefore projected that most people would not live long enough to draw social security past their own contributions.
By 1939 (still FDR), social security had become a retirement plan, survivor benefits and benefits to the retiree’s spouse and children. Disability benefits were added in 1956.
To figure out how much you pay in social security tax, you first must find the current annual salary limit that is taxed. For 2010, the first $106,800 of income you earn is taxable at 6.2% to pay into social security. That translates to $6,621.60 that one pays in on $106,800 of gross salary.
Now let’s take medicare taxes. Medicare was signed into law in 1965 by LBJ. Medicare’s purpose was to be a health insurance program (an entitlement program) for the elderly population, ages 65 and older, and for people with disabilities.
Medicare taxes are assessed on your entire gross earnings. Unlike social security, there are no income limitations for medicare taxes. If you earn $20,000 or $2,000,000, you pay 1.45% of your gross salary in medicare taxes. For someone earning the same $106,800 from above, you would pay $1,548.60 in medicare taxes.
Employers withhold both social security and medicare taxes on your behalf and remit them on your behalf. This works the same way as your federal, state and local income tax withholdings do.
The difference with social security and medicare taxes are that employers are obligated to match your withholdings with their money. They owe payroll taxes just for employing someone.
The social security and medicare payments you would make on $106,800 would be $6,621,60 and $1,548.60, respectively. Your employer would then owe $6,621.60 and $1,548.60 for employing you, whether the business is profitable or not. As long as they employ you and pay your salary, they owe those taxes.
However, in addition to the employer’s portion of social security and medicare taxes they pay, they also have to pay federal and state unemployment taxes. Those rates have too many variables to get into in this article, but what is important to understand that these are additional payroll taxes the employer must pay which have no immediate effect on their employees.
These unemployment taxes are what is paid out in unemployment benefits when someone is laid off from a job. In the current economic and job climate, you can imagine that these taxes must be quite high and costly to the employer.
Federal unemployment taxes (FUTA) has a current tax rate of 6.2% with an offsetting credit of up to 5.4% for paying into a state unemployment plan (SUTA). The end result for FUTA is .8% of up to the first $7,000 of wages earned on each employee. For our $106,800 employee, that amounts to $56 at .8%, assuming the credit. That is another $56 for each employee, just for the federal unemployment tax.
The state unemployment rates vary so much and have so many factors. Rest assured, however, that employers are also paying into a state unemployment plan at various tax rates on various levels for each employee they have.
To review, we did not cover federal, state, or local income tax withholdings in this article because we covered income tax withholdings in previous articles. We have covered both employee and employer payroll taxes in this article, the impact those tax dollars have on your take home pay, as well as on the employer’s bottom line just for employing people.
Why is all of this important?
What is important to understand is that we are happy to take home a paycheck and pay our bills in this environment. But most of us just go through the motions. We don’t truly understand how and why we are paying these taxes, how those taxes impact our paychecks or our employer’s bottom line and ability to hire and retain employees.
This year we are projected to pass a big milestone. This will be the first time the government will be paying out more in social security benefits than what they take in.
The social security system was set up to fail. It was never going to be able to maintain population growth, or politicians that “borrow” from the social security fund to pay for their other projects or entitlements.
Why would someone want to hire more people in this economic climate? It only means higher taxes for them. Social security, in addition to whatever else may be coming down from Congress and the President, will continue to remain insolvent, broke, bankrupt. Call it what you may.
The bottom line is that rather than addressing the looming financial crisis of social security all of these years, the politicians have been scared away because the solutions to fix it, truly fix it, are not good and comforting to their constituents. It could mean they wouldn’t be reelected. It could mean unpopularity. To a politician, most of whom care primarily about being reelected, it’s a no-win situation so they just don’t talk about it.
What they have done is to gamble that they can borrow from somewhere else to “fix” social security before the American people noticed. The problem with that gambling is that ALL of the federal government is broke, bankrupt, insolvent. There is nowhere left to “borrow” the money from without the American people noticing.
The American people are starting to notice everything. Becoming educated about the basics is the first step. Only then can we formulate real, practical solutions to the problems rather than putting a band aid on it and hoping to just move forward.
Only then can we hold our Congressmen and the President accountable for fixing what needs fixing, not putting a band aid on it or deepening the wound.