How to calculate payroll tax liabilities
/What is a Payroll Tax Liability?
The payroll tax liability is comprised of the social security tax, Medicare tax, and various income tax withholdings. The liability contains taxes that are paid by employees and taxes that are paid by the employer. The employer withholds those taxes that are paid by employees, and remits them to the applicable government authorities, along with the taxes that are paid by the company. Thus, the employer acts as an agent for the government, in that it collects payroll taxes from employees and remits them to the government. The payroll tax liability is comprised of both groups of taxes, since the employer is responsible for remitting all of them to the government. The employee is not responsible for remitting any taxes directly associated with a paycheck.
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Optimal Accounting for Payroll
Payroll Taxes Paid by Employees
The payroll tax liabilities that are paid by employees are noted below.
Social Security Tax
The social security tax is set at 6.2% of an employee’s wages, and is capped at an inflation-adjusted amount of a person’s wages (which increases each year). The employer matches this amount.
Medicare Tax
The Medicare tax is set at 1.45% of an employee’s wages. It is applied to all compensation levels, since there is no cap on it. The employer matches this amount. The tax is increased by another 0.9% if an employee earns a relatively high compensation level.
State and Local Income Tax Withholdings
An income tax withholding is not technically a tax, but rather an advance payment to the government on the income tax that employees will compute following the end of the tax year.
Payroll Taxes Paid by Employers
The payroll tax liabilities that are paid by the employer are noted below.
Social Security Tax
The social security tax amount matches what the employees paid.
Medicare Tax
The Medicare tax amount matches what the employees paid.
Unemployment Tax
The unemployment tax can be substantial, depending on the company's layoff history. A history of laying off large numbers of employees in the recent past can trigger a sizeable state tax. A portion of the unemployment tax is paid to the state government, and a smaller amount to the federal government.
Other Taxes
In addition, the city or county in which a company is located or an employee resides may charge other taxes. For example, a city may charge a head tax for every person employed within the city limits.
Payroll Tax Payments When Payroll is Outsourced
When payroll is outsourced, the payroll provider calculates all of these taxes and remits them on behalf of the employer, thereby effectively eliminating the workload of the employer in regard to calculating payroll tax liabilities.
Changes in Payroll Taxes Over Time
The aggregated tax rate that an employer pays tends to decline somewhat over the course of a calendar year, since some taxes are capped at a certain amount of employee pay, and do not apply to any compensation earned above the cap limit. Thus, employees with higher compensation tend to pay a slightly lower tax rate on their earnings later in the year, which is reflected in the matching taxes that the employer pays.