Payroll taxes, including FICA tax, are what your employer deducts from your pay and sends to the IRS, state or other tax authority on your behalf. Here are the key factors, and why it’s important to monitor your withholdings.
What is FICA tax?
FICA tax is a combination of a 6.2% Social Security tax and a 1.45% Medicare tax the IRS imposes on employee earnings. For 2019, only the first $132,900 of earnings is subject to the Social Security part of the tax. A 0.9% additional Medicare tax may also apply if earnings exceed $200,000 if you’re a single filer or $250,000 if you’re filing jointly. Typically, employers deduct FICA tax from employee paychecks and remit the money to the IRS on behalf of the employee. FICA stands for Federal Insurance Contributions Act.
What is withholding tax?
When people talk about “withholding,” they’re often referring to Social Security and Medicare (which together make up FICA tax), plus a few other types of taxes that also might come out of your pay. Here’s a breakdown.
- Social Security: 6.2%. Frequently labeled as OASDI (it stands for old-age, survivors and disability insurance), this tax typically is withheld on the first $132,900 of your wages in 2019. Paying this tax is how you earn credits for Social Security benefits later.
- Medicare: 1.45%. Sometimes referred to as the “hospital insurance tax,” this pays for health insurance for people who are 65 or older, younger people with disabilities and people with certain conditions. Employers typically have to withhold an extra 0.9% on money you earn over $200,000.
- State tax: This is income tax withheld from your pay and sent to the state by your employer on your behalf. The amount depends on where you work, where you live and other factors (and some states don’t have an income tax).
- Local income or wage tax: Your city or county may also have an income tax. This money might go toward such expenses as the bus system or emergency services.
What are these other payroll taxes I’m hearing about?
- FUTA tax: This stands for Federal Unemployment Tax Act. The tax funds a federal program that provides unemployment benefits to people who lose their jobs. Employees do not pay this tax or have it withheld from their pay. Employers pay it.
- SUTA tax: The same general idea as FUTA, but the money funds a state program. Employers pay the tax.
- Self-employment tax: If you work for yourself, you may also have to pay self-employment taxes, which are essentially extra Social Security and Medicare taxes. That’s because the IRS imposes a 12.4% Social Security tax and a 2.9% Medicare tax on your net earnings. Typically, employees and their employers split that bill. But self-employed people pay the whole thing. (For 2019, only the first $132,900 of earnings is subject to the Social Security portion.) A 0.9% additional Medicare tax may also apply if your net earnings from self-employment exceed $200,000 if you’re a single filer or $250,000 if you’re filing jointly. Because you may not be receiving a traditional paycheck, you may need to file estimated quarterly taxes in lieu of withholdings.
How does my employer know how much payroll tax to take?
The amount your employer withholds from your check for FICA tax and other payroll taxes largely depends on what you put on your Form W-4, which you probably filled out when you started your job. Here are some things to know:
- Form W-4 asks about your marital status, dependents and other factors to help you calculate the number of withholding allowances to claim. The more allowances you claim, the less tax will be taken out of your paycheck.
- What you put on your W-4 then gets funneled through something called withholding tables, which your company’s payroll department uses to calculate exactly how much federal and state income tax to withhold.
- You can change your W-4 any time. Just download a blank one from the IRS website, fill it out and give it to your human resources or payroll team.
Why do I have to pay FICA tax?
Employers have to withhold taxes from employee paychecks because taxes are a pay-as-you-go arrangement in the United States. When you earn money, the IRS wants its cut as soon as possible.
Some people are “exempt workers,” which means they elect not to have federal income tax withheld from their paychecks. Social Security and Medicare taxes will still come out of their checks, though.
Typically, you become exempt from withholding only if two things are true:
- You got a refund of all your federal income tax withheld last year because you had no tax liability.
- You expect the same thing to happen this year.
Why you really need to manage your withholdings
Remember, one of the big reasons you file a tax return in April is to:
- Calculate the tax on all of your taxable income for the year.
- See how much of that tax you’ve already paid via withholdings.
If it turns out you’ve overpaid your FICA tax or other withholdings, you’ll probably get a tax refund. If it turns out you’ve underpaid, you’ll have a tax bill to pay.
If you ended up with a huge tax bill in April and don’t want another, you can use Form W-4 to increase your withholding. That’ll help you owe less (or nothing) next April.
If you got a huge refund, consider using Form W-4 to reduce your withholding. You’re giving the government a free loan and — even worse — you might be needlessly living on less of your paycheck all year. It may feel great to get a tax refund from the IRS, but think of how life might’ve been last year if you’d had that extra money when you needed it for groceries, overdue bills, getting the car fixed, paying off a credit card or investing.