Generally speaking, employers report payroll by calculating gross pay and various payroll deductions to arrive at net pay. While this seems simple enough to understand, calculating various payroll deductions requires that the payroll accountant be detail-oriented and work with extreme accuracy.
Basic Formula for Net Pay:
Employee's gross pay (pay rate times number of hours worked)
minus Statutory payroll tax deductions
minus Voluntary payroll deductions
equals Net Pay.
Statutory Payroll Tax Deductions
Payroll taxes must be withheld from an employee's paycheck. This is required by law. Employers must hand these withholdings over to various tax agencies. Payroll tax deductions include the following:
- Federal income tax withholding (based on withholding tables in Publication 15)
- Social Security tax withholding (6.2% up to the annual maximum)
- Medicare tax withholding (1.45%)
- State income tax withholding
- Various local tax withholdings (such as city, county, or school district taxes, state disability or unemployment insurance).
Voluntary Payroll Deductions
Voluntary payroll deductions are withheld from an employee's paycheck only if the employee has agreed to the deduction. Voluntary deductions pay for various benefits which the employee has chosen to participate in. Voluntary payroll deductions include the following:
- Health insurance premiums (medical, dental, and eyecare)
- Life insurance premiums
- Retirement plan contributions (such as a 401k plan)
- Employee stock purchase plans (ESPP and ESOP plans)
- Meals, uniforms, union dues and other job-related expenses
Voluntary deductions can be paid with pre-tax dollars or after-tax dollars, depending on the type of benefit being paid for. Professional grade payroll software will help you keep track of all the tax-related payroll calculations.
Employer Payroll Tax Responsibilities
The responsibility for payroll taxes continues even after paychecks have been issued to employees. The company is responsible for paying the employer's share of payroll taxes, for depositing tax dollars withheld from the employees' paychecks, preparing various reconciliation reports, accounting for the payroll expense through their financial reporting, and filing payroll tax returns.
Employer Payroll Taxes
Companies are responsible for paying their portion of payroll taxes. These payroll taxes are an added expense over and above the expense of an employee's gross pay. The employer-portion of payroll taxes include the following:
- Social Security taxes (6.2% up to the annual maximum)
- Medicare taxes (1.45% of wages)
- Federal unemployment taxes (FUTA)
- State unemployment taxes (SUTA)
FICA Taxes
FICA stands for the Federal Insurance Contributions Act. The FICA tax consists of both Social Security and Medicare taxes. Social Security and Medicare taxes are paid both by the employees and the employer. Both parties pay half of these taxes. Employees pay half, and employers pay the other half. Together both halves of the FICA taxes add up to 15.3%. The 15.3% FICA tax is broken down as follows:
- Social Security (Employee pays 6.2%)
- Social Security (Employer pays 6.2%)
- Medicare (Employee pays 1.45%)
- Medicare (Employer pays 1.45%)
For 2011 only, the employee portion of Social Security is reduced to 4.2% instead of 6.2%. This payroll tax holiday was legislated as part of the Tax Relief Act of 2010. Starting 2012, the employee-portion of Social Security will revert back to the full 6.2%. Reporting Payroll Taxes
Employers are required to report their payroll tax obligations and to deposit payroll taxes in a timely manner. Reporting requirements include:
- Making federal tax deposits
- Annual federal unemployment tax return (Form 940 or 940EZ)
- Employer's quarterly payroll tax return (Form 941)
- Annual Return of Withheld Federal Income Tax (Form 945)
- Wage and Tax Statements (Form W-2)
Employers also have requirements to file reports with various state and local agencies. Employers can find links to state tax agencies through the American Payroll Association website.
Social Security Taxes
The Social Security tax is a tax applied to income related to labor. All employees and self-employed entrepreneurs pay into Social Security through the Social Security tax, which is also known as Old-Age, Survivors, and Disability Insurance (
OASDI).
The Social Security tax functions very much like a flat tax. A single rate of 12.4% is applied to wage and self-employment income earned by a worker up to a maximum dollar limit. Half of this tax is paid for by the employee in the form of payroll withholding. The other half of this tax is paid for by the employer. Self-employed persons pay both halves of the Social Security tax since they are both the employee and the employer.
Social Security tax rates
Employees pay 6.2% of their wage earnings, up to the maximum wage base.
Employers pay 6.2% of their employee's wage earnings, up to the maximum wage base.
Self-employed persons pay the combined rate of 12.4% of their net earnings from self-employment, up to the maximum wage base.
The Math behind the Social Security Tax
All wages and self-employment income up to the
Social Security wage base in effect for a given year is subject to the Social Security tax. For the year 2011, the Social Security wage base is $106,800. Earnings up to this base amount have the Social Security tax applied. Earnings over this base amount do not have the Social Security tax applied.
The math works like this:
- If wages are less than $106,800, then wages times 6.2% is the amount the employee pays and wages times 6.2% is the amount the employer pays.
- If wages are more than $106,800, then 106,800 times 6.2% is the amount the employee pays and wages times 6.2% is the amount the employer pays.
Special Rate Reduction for 2011 Only
For the year 2011 only, the Social Security tax rate paid by employees is
4.2% instead of the normal 6.2% The maximum wage base remains unchanged. Employers still pay the full 6.2% rate. Thus for 2011, the combined Social Security tax rate is 10.4%. Self-employed persons will pay this 10.4% combined rate on their earnings. This special
payroll tax holiday was enacted as part of the
Tax Relief Act of 2010.
Thus for 2011, we substitute 4.2% for 6.2% in the above math formulas for the amount paid by the employee. At the maximum wage base of $106,800, this translates into a tax savings of $2,136, as follows:
- Social security tax at the normal rate: 106,800 times 6.2% = $6,621.60
- Social security tax at the reduced rate for 2011: 106,800 times 4.2% = $4,485.60
You can plug in your own salary level to determine your own personal savings from the payroll tax holiday. If your labor income is less than the 106,800 wage base, simply multiply your salary by 2% to find your savings. If your labor income is more than the wage base, you receive the maximum savings of $2,136.
Employers have until January 31 to Implement the new withholding rates
The Internal Revenue Service has instructed employers to implement the lower 4.2% Social Security tax rate by January 31, 2011. By that time, you should see a reduction in the amount withheld for Social Security. Some employers label this as "Soc Sec" or "OASDI" on your paystub. Other employers use the label "
FICA" which combines both Social Security and Medicare tax withholding.
Employers are also supposed to refund to you any Social Security tax withheld at the higher rate. If employers withheld at 6.2%, they should be refund to you the 2 percentage point difference no later than March 31, 2011.
What Happens to the "Missing" Social Security Funds?
To prevent Social Security from losing tax revenue, Congress mandated that revenues be transferred from the general fund to the Social Security trust funds to make up for the tax reduction. This is provided for in section 601 of the Tax Relief Act, which reads in part, "There are hereby appropriated to the Federal Old-Age and Survivors Trust Fund and the Federal Disability Insurance Trust Fund established under section 201 of the Social Security Act (42 U.S.C. 401) amounts equal to the reduction in revenues to the Treasury by reason of the application of subsection (a). Amounts appropriated by the preceding sentence shall be transferred from the general fund at such times and in such manner as to replicate to the extent possible the transfers which would have occurred to such Trust Fund had such amendments not been enacted."
What is the Social Security Tax For?
The Social Security tax is that goes directly to the Social Security trust funds and is used to pay for Social Security retirement benefits, benefits for widows and widowers, and disability benefits. Unlike income taxes, which are paid in the general fund of the United States and can be used for any purposes, Social Security taxes are paid into special trust funds that can be used only to fund social insurance benefits.
Medicare Tax
Definition:
The medicare tax is a payroll tax that must be withheld from an employee's paycheck by an employer. The medicare tax is one part of the employer's obligation to withhold Federal Insurance Contributions Act (FICA) taxes which also includes social security taxes.
Employers pay a matching percentage of FICA taxes; employees pay 1.45% and employers pay an additional 1.45%. Self-employed individuals pay the whole amount of medicare and social security taxes.
Also Known As: FICA taxes
