When a business hires an employee, it takes on an obligation to withhold taxes from that employee’s paycheck and forward them periodically to the Internal Revenue Service, and in some cases, to state revenue collection agencies. Generally, though, when you hear the term “payroll taxes,” the term refers to income taxes withheld from employees, and to Social Security, Medicare and FUTA taxes.
As of 2011, employers withhold 4.2 percent of an employee’s income in order to fund a program called Old-Age, Survivors and Disability Income, or OASDI. The more common term for this program is “Social Security,” The 4.2 percent withholding is temporary. Unless Congress intervenes, that 4.2 percent figure will increase to 6.2 percent as of January 1, 2012. The withholding only applies to the first $106,800 in income the employee earns.
In addition to OASDI, employers also withhold 1.45 percent of the employee’s pay for Hospital Insurance. This tax goes to fund current Medicare benefits to today’s retirees. There is no income cap the Medicare tax. The employer must withhold 1.45 percent of the employee’s pay no matter how much he earns.
Each quarter, and for larger employers, each month, the employer must file an IRS Form 941 called the Employers’ Quarterly Income Tax Return, and forward these payments, together with income taxes withheld, to the Internal Revenue Service. In addition, the employer must contribute an additional 6.2 percent for OASDI for the first $106,700 an employee earns, as well as an additional 1.45 percent on all earnings to the IRS for the employee’s contribution.
Since self-employed individuals act as both their own employer and employee, they must contribute both the employer and employee portions of the Social Security Tax. To account for this tax, they must file a Form 1040SE with their individual income tax each year. This requirement applies to anyone who made over $400 in self-employed income for the year, or anyone who earned more than $108.28 from a church or other entity exempt from tax withholding.
In addition to income taxes, OASDI and Medicare, employers must also keep track of the Federal Unemployment Tax, or FUTA. This tax goes to assist states with funding unemployment insurance pools. The employer doesn’t withhold anything from the employee’s pay. Instead, the employer simply fills out a Form 940, and forwards unemployment tax to the IRS when the amount due exceeds $500. You only pay this tax on the first $7,000 you pay to a new employee. The tax rate is 0.008 of the employee’s pay.